Commercial real estate making a comeback, stands to benefit from lower rates (2024)

With inflation tame and the labor market starting to loosen, the Fed is expected to start lowering short term rates. That has floating rate commercial real estate borrowers singing Gloria Gaynor’s hit (made better by Cake) “I Will Survive.”

The Collateralized Loan Obligation (CLO) market is basically the CMBS market for floating rate loans and was used heavily for so-called bridge loans during the last five years. The amount of outstanding loans grew quickly and there were so many lenders using CLO’s to support their business they were hard to count. That all began to crumble in the last two years as the Fed pumped short term rates up and cracks formed in the asset class.

Currently, there is an 8.64% delinquency rate for that type of loan and by some accounts over 80% of CLO backed loans have been modified. With numbers like that, it is hard to see light. However, with potential Fed cuts looming, optimism has returned, and the market is mounting a comeback. Likewise, borrowers who took out 2–3-year term bridge loans to perform a value-add transition on an apartment complex or office building may get a little relief when rates start to fall.

Indeed, the whole industry has effectively been in a hold pattern for some time. Going back to 2022 many were waiting for rates to stop rising – which occurred in July of 2023 – and into this year awaiting some clear signs that Treasury yields would start turning downward.

For the year ended July 31, 2024, the average yield on the 10-year Treasury was approximately 4.33%. Now, over the past two weeks, the yield has fallen below 4% and investors are feeling a sense of relief that rates might stabilize at a reasonable level.

With Treasury yields down, 5- and 10-year interest rates have fallen and now range from 5.50% to 6.00% for lower leverage institutional quality properties. Banks are still struggling with high short-term rates, which they need to pass on to depositors, and are pricing in the mid to high 6% range. Depending on swaps and other hedging instruments, the rate could be lower.

The market seems very dependent on data at this point and the positive attitude may be short-lived if some report changes its perception. However, inflation seems in check, employment is neither weak nor strong, the consumer is still spending and the “soft” or “no landing” scenario many would like is now expected.

Here in Richmond, activity is clearly picking up. Both sales activity and leasing activity. Just in the past two months, an office complex in Innsbrook sold for $31 million. A Publix anchored center on Hull Street traded for $35.75 million, five industrial properties traded, Shady Creek Apartments off of Hull Street sold for $16.5 million and several large land trades occurred including the $118 million QTS purchase of data center zoned land in Henrico.

As one investor quipped, commercial real estate stands to benefit from lower rates even at the cost of slower growth and the years old mantra of “stay alive to 2025” may be accurate.