The Long-Awaited Rate Cut

The Fed cut rates by 50 bps on Wednesday, bringing rates down from the highest point in 23 years, following the most aggressive tightening of monetary policy in roughly forty years. This was anticipated, but the size (a half a point rather than 25 bps) comes as welcome news.?

Let’s be a little less dry: this is friggin’ huge. ?

Rates are an enormous factor for real estate investing, as we have discussed at length. In short, rates impact values. Rates go up, values go down; rates go down, values go up. Correlation does not imply causation, but CRE values and the Fed’s benchmark rate are tightly coupled. The most obvious ingredient in this soup is debt cost as a direct factor in the P&L of any real estate investment. When the Fed lowers its key rate, it puts downward pressure on the prevailing rates banks and other lenders offer to real estate operators. This reduces monthly cost for real estate operators (debt service)? makes deals more profitable (all else being equal) and puts upward pressure on demand in real estate capital markets, hence boosting values.?

Another simple dynamic in play: when rates return to something within the normal range, more deals happen. Buyers are more optimistic, and sellers are no longer “holding on” for brighter days.?

Movements in the benchmark Fed rate impacts real estate markets in other ways that may be more unique to the moment. A brief rundown:

Impact on Consumers

A lower rate environment can benefit consumers in various ways. Let’s talk about some current nuances.

Following the supply-side inflation in the car market, plus rapidly rising rates on car loans and outsized inflation in car insurance, cars have become much more expensive. Overall vehicle debt in the United States has increased by 85% over the past 10 years. Overall household debt has been steadily creeping up. While a drop in the Fed’s key rate won’t provide debt relief instantly, it will trickle through all major types of household debt. If not directly, consumers may benefit from more refinance and debt consolidation options as rates drop.?

This could be important for real estate markets. Debt relief reliably improves consumer confidence, which in turn could improve prospects for retail (including mixed use spaces and physical space for “non-essential” goods and services like restaurants, spas, or boutique goods). Less obviously, improving household balance sheets, if only marginally, should help with rent. While inflation overall has come down, shelter inflation continues to outpace overall inflation by a wide margin.?

Increasing housing costs means increased rent, which is good for multifamily investors, right? Sort of… but not forever. The pace of shelter inflation so far this cycle does drive home the point that multifamily, as an asset class, can “capture inflation.” However, there’s clearly an upper limit. When households are stretched thin elsewhere, unchecked shelter inflation ultimately leads to delinquencies, vacancy risk, lower rates of household formation, and trouble for the multifamily sector. A drop in interest rates may help to support renters, in turn mitigating risk for operators. Over time, a drop in rates should inject liquidity into capital markets and help to calibrate supply and demand for multifamily at a time when the supply pipeline is thinning considerably.?

Impact on Businesses

Generally rate cuts are good for business and good for the stock market. Lower borrowing costs factor into discounting of future cash flows, and hence investors view stocks more favorably. That said, this isn’t true across the board, or with every cycle of rate cuts. Corporate performance and stock performance depend on various other macroeconomic and sector-specific factors, and it remains to be seen how much anticipated rate cuts have already been priced in.?

Rate cuts figure to drive strong tailwinds in areas that depend on significant investment. Namely:

• Manufacturing, logistics, and other cap ex-heavy sectors.
• Ecommerce, where inventory management, logistics, and consumer confidence all come into play.?

Hence, industrial may be a CRE sector to watch carefully. Rate cuts could drive significant physical investment and leasing activity for warehouses, logistics facilities, and other industrial assets.?

What Does This Mean for EquityMultiple Investments??

Again, dropping rates are generally good news for real estate, so long as those rate cuts are not a response to a clear and present recession threat (as of now, we can still remain hopeful for a “soft landing.”) In some cases, this may create favorable refinancing scenarios for our sponsors.?

This moment could signal opportunity for forward-looking investors as well, across several different categories of investment:

• Alpine Notes: get ‘em while you can — Higher rates (as noted) are a drag on consumers and the economy in various ways. Higher rates do mean higher rates for CDs and money market accounts, however. Rates of return investors can earn on cash holdings respond fairly quickly and directly to changes in the Fed’s key rate. EquityMultiple Alpine Notes offer a spread above typical CD rates. While the rates we offer on Alpine Notes are not directly influenced by the Fed’s rate moves, Alpine Note rates will eventually mirror the overall rate environment. Hence, now may be the time to lock in current Alpine Note rates, particularly for 9 month notes.?
• Ascent Income Fund and debt products — we remain confident that real estate private credit offers a compelling risk-adjusted return thesis in almost any rate environment. However, the rates that private lenders can command is now likely at the high point of the current cycle, and today’s rate cut may signal that we are at the high water mark. Investments made in the Fund before capital markets recalibrate may benefit from a higher blended rate.?
• “Buy and hold” strategies — rates go up, values go down. Rates go down, values go up. Again, correlation does not imply causation and it’s more complicated than this, but the relationship tends to hold. A period of dropping rates should benefit any current asset operator and investment strategy. However, a climate of gradually dropping rates may particularly advantage core and core-plus investors. This is because relatively little else needs to change to engineer healthy returns. The cap rate expansion during this period of rising rates means that simply by maintaining (or marginally improving) rent rolls at core or core-plus properties, within established markets, operators can benefit from asset appreciation. And, because core and core-plus properties tend to be in more established markets and sub-markets, exiting the asset at a favorable moment may be easier, with more buyers entering the market in a favorable rate environment in established markets.?

We’ll repeat a couple of things that we’ve said (many) times before.?

• While rate cuts are a welcome development for real estate markets, none of us can predict the future. As a wise man once said, diversification is the only free lunch in finance.?
• The specific types of CRE investment listed above are a great place to start. But given that we can’t predict how fast, or how much, rates will come down (or how the rate environment will impact the broader economy) diversifying across various types of real estate, and at different moments, may serve investors best.? ? ?