What a less hawkish interest rate outlook means for CRE debt

The Federal Reserve announced a 25 basis-point interest rate increase this week and has so far signaled future bumps will be made at a more gradual and reduced pace compared to prior installments. But while the more tempered outlook was welcomed by the market, any impact will be muted because the credit markets have already anticipated and priced in this change.

“The market confidence has already bounced back since inflation turned out to be lower than expected in the last 3 to 4 months as the expectation shifted toward a lower peak level and closer pause,” said Wei Luo, senior economist at CBRE Investment Management.

While the full effect of rate increases has yet to be clarified beyond a current target range of 5 percent to 5.25 percent, with room for more assessment at the central bank’s next meeting in March, the Fed is still hawkish compared to market expectations.

“Investors will continue to be very cautious and selective about taking out new debt because the environment is not ideal for refinancing a large amount of existing debt,” Luo said. She explained investors are more likely to find liquidity and pay higher interest rate caps and that the balance sheet priority will be paying off maturing loans.

‘Frothy’ market

Larry Jacobson, president and CEO at Jacobson Equities, told Real Estate Capital USA that Federal Reserve chair Jerome Powell’s comments included guidance that interest rates are more likely to hold than drop at any point this year. “Obviously, this is because a frothy equity market begets more inflation,” Jacobson said.

“At this point, it is clear inflation has flattened out. If we look at the last one to three months, inflation is no longer at a frightening level,” he said. “But the Fed is not looking at that, they are looking at the output gap, the difference between GDP and available labor and capital, as well as specific measures of wage growth.”

Jacobson said the Fed is not seeing wage growth retrenchment the way they want to yet and the central bank is placing a higher premium on a stop to inflation compared to the risk of recession.

“When rates do start to come back down, they will settle at levels where we can make deals but not at the two to three percent levels we were seeing before inflation took hold,” Jacobson said.

While Jacobson doesn’t believe the Fed will lower rates this year, he believes rate increases will likely plateau in 2023. Such a plateau would create more clarity on the cost of capital alongside evolving price discovery as sponsors try to attain pricing in line with their target returns. “I still think 2023 will find a somewhat muted market in terms of available product,” he said.

Luo said the New York-based investment manager expects debt issuance to continue falling compared to last year.

Since March 2022, the Federal Reserve has raised rates by 450 basis points which curtailed much of the lending market’s momentum. The Fed’s current target rate of 4.5 to 4.75 percent is closer to its expected range of 5 percent to 5.25 percent.

The Fed will reconvene on March 21 and 22 with an additional 25-basis-point rate hike on the table, as well as reassessment opportunities, Powell said during the February conference.