The Great Reset of Interest Rates – A Return to Normal

The commercial real estate (CRE) landscape has experienced fluctuating interest rates over the past fifteen years. Following the Great Recession, an extended period of historically low interest rates fueled a surge in CRE investment and asset valuations, culminating in a market peak in the first quarter of 2022. However, as the economy recovered and concerns about inflation due to the Covid effects rose, central banks globally initiated a phase of monetary tightening. This resulted in a significant increase in interest rates, leading to a decline in CRE asset values.

The recent cycle of interest rate hikes has had a profound impact on the CRE market, with multifamily transaction volumes down by up to 70%. Borrowers are now grappling with higher financing costs, affecting their ability to acquire or develop new properties. Simultaneously, investors have been carefully evaluating potential deals to ensure projects can yield adequate returns considering the heightened cost of capital and the dramatic increase in operating costs led by the run up in insurance rates nationwide. As rates and costs went up the goal post on pricing agreement between buyers and sellers continued to move further and further away.

Despite these challenges, we believe that the current interest rate environment signifies a return to stability after years of unsustainable price increases. The market is recalibrating to a more sustainable level and while this recalibration is painful, it ultimately bodes well for the enduring vitality of the CRE sector.

Comparing the current climate with the post-recession and pre-recession eras provides valuable insights:

Pre-Recession Era (2005-2007):

In the years before the financial crisis, interest rates gradually rose, remaining relatively low compared to historical averages. This period saw a surge in speculative activity, particularly in the subprime mortgage market, contributing to the crisis.

Post-Recession Era (2009-2016):

After the Great Recession, interest rates hit unprecedented lows, stimulating CRE investment, boosting property values, and fostering robust growth. However, concerns about potential overvaluation and the risk of a market bubble also emerged.

Post-Covid Era:

To address economic shutdowns, central banks lowered rates further, and governments injected unprecedented fiscal stimulus into global economies. These actions led to soaring inflation and the need for central banks to initiate the fastest rate increase in modern history.

Current Scenario (2022-Present):

The ongoing interest rate environment reflects a more measured and controlled tightening approach. This strategy aims to combat inflation without causing a sudden economic slowdown. While higher rates have temporarily reduced investment activity, they are likely to instill stability and sustainability in the long term.

At Offerd, we see the shift toward a normalized interest rate environment as a positive development for the enduring health of the CRE market. Current sentiment suggests the Federal Reserve may lower rates somewhat next year as inflation risks abate. Still, unless there is another economic shock of the magnitude of the Great Recession, a return to the pre-2022 interest rate environment is doubtful. We believe that when the 10-year yield briefly hit 5% a month ago, that may have been the market bottom. If that’s the case then this makes this the opportune time to deploy dry powder, as asset values are likely to recover as rates subside.

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