Recovery time for commercial real estate?
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RECOVERY TIME FOR COMMERCIAL REAL ESTATE?
Plenty of investors breathed a sigh of relief as the Federal Reserve kicked off its easing cycle with a 50 basis point rate cut last week - and investors in the battered commercial real estate sector have good reason, Wells Fargo economists say.
While not a magic bullet for all that ails the CRE sector faces, lower rates could mark a turn in the tide, Wells Fargo analysts said in a note, detailing some ways it could benefit.
First, lower interest rates will reduce the cost of capital, relieving pressure on real estate capitalization rates (cap rates).
"CRE capital flows, investor risk preferences, local market conditions and property-specific supply and demand dynamics all play a role (in cap rates), (but) the cost of capital is the keystone for many of these drivers," Wells Fargo says.
Many of the banks that drastically tightened lending standards on CRE underwriting are already starting to relax policy, Wells Fargo says, while other financiers like life insurance companies and investor groups may also be starting to move off the sidelines.
Second, property valuations appear to be steadying. MSCI's index tracking U.S. real estate investment trusts (REITS) has gained about 4% this year, picking up off all time lows touched in October 2023, as per LSEG data.
Lower interest rates will also help with the high levels of debt in the sector. Distressed debt sales in the CRE sector have been fairly low, despite close to $1.9 trillion of CRE debt scheduled to mature by the end of 2026, Wells Fargo says.
That's occurred since lenders have been fairly open to amending loans and pushing debt maturities out to later dates - and now, with rates coming down it will be easier for borrowers to refinance.
Finally, if the U.S. consumer remains resilient, aided by a Fed rate cutting cycle, demand for commercial properties such as retail, industrials and hotels should increase.
The market for office real estate, however, remains a challenge. The office commercial mortgage-backed security (CMBS) delinquency rate rose to 8.3% in July, up from the pre-pandemic low of 2.7%, as per Wells Fargo.
(Lisa Mattackal)
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