Ready or Not

Highlights

·????? Inflation is sticky, not stuck.

·????? 25 bps cut likely looms.

·????? Fed’s messaging matters.

·????? More August data to watch.

·????? CRE market won’t wait forever.

If you’re reading this, hopefully you’re ready. We have certainly been writing about it enough over the last 9 months. The Fed is going to cut interest rates this week. While many will feel like this took too long, it agrees with our long-held house view on rate cuts - that the Fed wouldn’t cut until the latter half of this year. We first made that prediction in December of last year, making us a significant outlier. But as time went on, the market moved from too optimistic, to too pessimistic, before finally settling down into something that looks more like our way of thinking. The cut will also kick off an easing cycle designed to support the economy. Will that prove successful? What comes next? And what will that mean for commercial real estate (CRE)?

Final Hurdle

It would have taken something remarkable in the August inflation data last week to halt a rate cut. In short, we didn’t get it. Some of the inflation data, particularly the core consumer price index (CPI), came in a bit hotter than expected. But a few notes here. First, mismeasured housing inflation is still skewing the overall results. Second, core inflation looks unsustainable at those rates. Third, the yearly CPI reached its lowest rate since March 2021. Fourth, the other inflation readings released last week – the producer price index (PPI) and the import price index – also did not show anything that would stop the Fed. Fifth, none of these indexes are the Fed’s preferred measure, the core personal consumption expenditures (PCE) deflator, which is also showing significant slowing. We knew inflation was going to decelerate slowly this year and any individual month can contain noise. But the overall trend is still downward with no credible thesis for inflation to meaningfully reaccelerate anytime soon.

Here It Comes

The only real question remains how large of a rate cut we will get. We continue to believe that two cuts of 25 basis points (bps) each would be the most prudent path for the Fed to take, starting with one of those cuts this week. The inflation data (especially once mis-measured housing inflation is considered) completely supports a rate cut at this juncture, with the labor market loosening. But the remainder of the economic data shows a resilient economy that is slowing, not collapsing, and the Fed wants to carefully manage rates on the way down. And while the Fed certainly wants to signal to the market that things are shifting, they don’t want to send the wrong signal and frighten the market into thinking things are worse than they appear. A relatively large cut of 50 bps would likely do just that. Plus, moving at a measured pace enables the Fed to adjust course if it feels that more potent medicine is necessary.

What To Watch This Week

It almost feels superfluous to discuss anything else, but the calendar is full of noteworthy releases this week. Although auto sales for August already came in weak, we expect relative strength in overall retail sales for the month, especially the control group which feeds directly into GDP calculations. Industrial production for August likely changed little, with the manufacturing sector of the economy still struggling. Housing starts and permits for August look set to increase slightly on an annualized basis, homebuilder sentiment for September could see a slight increase, and existing home sales for August seem poised to post a decline amidst tepid financing activity.

CRE Implications

Let’s be clear about this. One rate cut of 25 bps by itself won’t have much of an impact. But as the Fed shifts its actions and its narratives, that should filter through to the risk premia embedded in discount rates and cap rates. In fact, that’s already occurring as we discussed in our quarterly US CRE outlook just last week. But the market will gain confidence as monetary policy and forward guidance shift and become clearer. Over time, we should see something similar to what occurred in previous monetary easing cycles: higher transaction volumes, greater liquidity, improved credit availability, lower cap rates, higher valuations, and greater appreciation and total returns. Investors that can act would be wise to get ahead of these changes and not wait for cheaper debt to fund a transaction. Ultimately, the change in valuations and returns should more than offset any benefit from a declining cost of debt capital. Investors don’t need to act tomorrow, and they shouldn’t make rash decisions just to act, especially in an environment where a strong selection bias is dictating which properties are brought to market and which are not. But today’s pricing will not last forever. The clock is already ticking.

Thought Of The Week

Last week, the Fed reported that household net worth rose $2.8 trillion during the second quarter to a record $163.8 trillion. This should not only support the wealth effect, but also assuage some concerns about outstanding national debt.

Thanks for reading this week's edition and you can be sure you'll be seeing much more from this newsletter in the weeks ahead. As always, please share your thoughts below or reach out directly if there is something you'd like me to cover in a future report.

Ryan S.

BentallGreenOak (“BGO” or “BentallGreenOak”) includes BentallGreenOak (Canada) Limited Partnership, BentallGreenOak (U.S.) Limited Partnership (“BGO U.S.”), their worldwide subsidiaries, and the real estate and commercial mortgage investment groups of certain of their affiliates, all of which comprise a team of real estate professionals spanning multiple legal entities.

This document is for informational purposes only and does not constitute an offer to sell or solicitation of an offer to buy units in any BentallGreenOak fund (a “BGO Fund”, “Fund”, or, collectively, “BGO Funds” or “Funds”). Prospective investors must not construe the contents of this document as legal, tax, financial, accounting, investment or other advice, and each prospective investor is urged to consult with its own advisers with respect to legal, tax, financial, accounting, investment and other consequences of investing in a BGO Fund, the suitability of a BGO Fund for such investor and other relevant matters concerning an investment in a BGO Fund. A decision as to an investment in any Fund must be made solely by the investor and in consultation with its own advisers.

Statements in this document that are not historical facts are based on current expectations, estimates, projections, opinions and beliefs and are subject to change. Such statements are subject to known and unknown risks, uncertainties and other factors. Moreover, this document contains statements, estimates and projections as well as certain forward-looking statements, which can be identified by the use of forward-looking terminology such as “may”, “will”, “would”, “should”, “expect”, “project”, “intend”, “target” or “believe” or the negatives thereof or other variations thereon or comparable terminology (together, the “Projections”). Economic outcomes may differ materially from those reflected in or contemplated by such forward-looking statements, and undue reliance should not be placed thereon.? The market analysis presented in this document represents the subjective views of BGO.