by Cypress Ventures Group
As the federal Reserve continues to raise rates, it affects residential real estate but has nothing to do with the commercial real estate market. Commercial Real Estate interest rates are priced by the bond market. Primarily the 10 year treasury rates.
Bonds are a predictive metric and react on a daily basis.
The Jobs Report is Very Important
The number of jobs increased in June 2023 by 209,000 and the unemployment rate changed little at 3.6 percent. What’s happening? We are becoming de-globalized as US companies are bringing jobs back to the US. This includes microchips, manufacturing, steel and construction.
The more jobs, the more the market thinks the economy is going to grow and the Fed is going to raise rates to combat inflation. More jobs, more incomes, more income, more spending and more spending, more demand, more demand = inflation. The market reacts by raising rates.
When rates go up, the yield on bonds goes up. On July 3, 10 year treasury rates were 3.86%. On July 7, it was 4.05 % and on July 13, the rate was 3.76.
WHY? Because the CPI (Consumer Price Index) came in at .2 in June, annualized at 2.4 %. This is the Fed’s target and where the it wants it to be – in the 2-3% range – see CPI below.
The Fed is reactionary. They are late to the game. Remember that bonds are proactive and predict what is going to happen to the market. What we are suggesting is that the more you see inflation hold at about 2-3%, the less likely the Fed is going to raise rates and the more likely the rate for the 10 yr treasury is going to start incrementally going down.
Commercial Fannie and Freddie Mac rates are based on the 10 year treasury plus a margin of 2.25 to 2.5 percent. When it comes to acquisitions, we believe the sweet spot is going to be Q1 2024. Our assumption is the 10 year treasury rates are going to be in the low 3 percent range and commercial rates are going to be in the mid 5 percent range. Last week commercial rates were in the high 6’s.
When you look at the cost of debt with the 10 year treasury around 3.7% plus 2.5% margin the cost of borrowing for commercial multifamily real estate debt is in the low 6 percent range.
As long as the CPI stays at 2-3% the trend will be downward, forcing the Fed to lower rates to protect against the possibility of abrupt deflation.
We think that in Q3 and Q4, the Fed will do nothing and if the CPI holds at 2 to 3.5% We will see that in Q4 October, November and December – the Fed will start to lower interest rates.
Here is the other reason why. The 2 year and 10 year yield curve is still inverted. This is an indicator that the market is still predicting a recession. When the yield curve is inverted, it means rates on short term debt rates are more than long term debt rates. More info on the inverted yield curve
Q1 GDP is now at an annualized basis of 2.0 percent and appears to be trending down.
If GDP is trending down and actually ends up negative by Q3, Q4, even a little bit, everybody will be saying that we have hit a recession and this will trigger the Fed to lower rates to get us out of recession – yet another reason to lower rates. When the Fed lowers the overnight federal funds rate, it will lower the cost of residential mortgages which will lower the yield on 10 year treasury bonds and should lower the cost of interest on commercial mortgages. When you have lower cost interest on commercial mortgages, the value of commercial assets will rise in 2024. All this predicts that cap rates will decline and commercial real estate value prices will go up.
When commercial rates are higher the value of the underlying asset is lower. This is a direct result of the cost of debt. This makes for a soft market hence lower sales prices. Lower sales prices pushes cap rates higher which has the domino effect of increasing cap rates.
While we are in this trough, we are actively going hard to purchase multifamily assets in the next six months for a Q4, 2023 or Q1 2024 close. This will give us an immediate bump in value. We are underwriting at current rates, 6-6.5% and hope to close in the mid 5’s.
If you want to learn more about see GDP, see this Bureau of Economic Analysis article. See the current 10-year treasury rates. Learn more about 10 year treasury bills,
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