Story Highlights
- Lower interest rates would boost investor confidence in commercial real estate.
- The office sector probably has the most to gain from lower interest rates.
- Some assets still face headwinds that have little to do with interest rates.
For the commercial real estate sector, an interest-rate cut on Wednesday would be nothing but positive, said Mark Rose, CEO of real estate firm Avison Young.
Economists largely expect the Federal Reserve's Federal Open Market Committee will conclude its two-day meeting this week with the announcement of a 25-basis-point reduction in interest rates.
The Fed has kept interest rates steady to date this year, particularly as tariffs were expected to drive inflation, but a weakening job market has increased the likelihood among experts of a rate cut on Wednesday.
A 25-basis-point dip would put the Fed’s target range at 4% to 4.25%. There also is a chance the rate cut might be larger than 25 basis points.
What a rate cut means for CRE investors
“This is a shot in the arm,” Rose said. “This is a confidence boost. Any time you can factor into your developments or your investments a lower cost of capital, it’s a positive.”
Recovery in the commercial real estate sector takes place in three arenas: fundamentals, financials and confidence, Rose said. Beleaguered by the economic effects of the Covid-19 pandemic, commercial real estate's fundamentals have already been improving as return-to-office trends progress, and lower interest rates help on the financial side by increasing debt availability. Those two dynamics combined help to drive more confidence in the sector, Rose said.
“That translates into confidence, and that’s when people get back to work,” he said.
In a broad sense, lower interest rates help drive returns for alternative asset classes, of which commercial real estate is one, said Brent Maier, national real estate advisory leader with Baker Tilly's development advisory practice.
“It allows, in theory, for higher returns," Maier said. "That helps separate real estate as an investment class from other competing investments.”
Which CRE sectors might benefit most?
A 25-basis-point reduction — while broadly positive for CRE — isn’t going to be make-or-break for any particular sector, Rose said. That said, the office market, which has faced stiff headwinds in the aftermath of the pandemic, probably has the most to gain from a lower interest rate, Rose said. Maier agreed with that sentiment.
“There are a lot of opportunities where there is capital pursuing returns, and office probably has the quickest path to a higher rate of return,” Maier said.
Despite that, there are headwinds in the office sector that have little to do with interest rates, and properties that are facing those fundamental challenges — such as buildings perceived to be on the losing end of a flight to quality, often coinciding with poor occupancy — are going to have trouble overcoming those market forces, Maier said.
Likewise, for office owners facing a something like an large upcoming lease rollover, “the clock is ticking," Maier said, "so it almost doesn’t matter what the rate reduction is. At some point you have to transact.”
Data centers don’t have a capital problem
The data-center market, which is enjoying a surge of demand from the burgeoning artificial-intelligence sector, also probably doesn’t change much as a result of lower interest rates. The bottleneck to more data-center development is infrastructural — largely related to data centers’ voracious appetite for electricity — so a lower cost of capital isn’t going to change much in an industry that already has an enormous amount of capital available to it.
“We don’t have the power,” Rose said, “and until you get the power, it doesn’t matter what you want to do. It’s not going to happen.”
At most, interest rates are going to make the companies that already can develop data centers happier, because those projects will cost less, Rose said.
