How the Fed rate cut could increase dealmaking

The Federal Reserve’s decision to lower interest rates may influence commercial real estate investors to continue buying property, even at lofty valuation levels.

July 31, 2019

Win McNamee / Staff / Getty News Images

The Federal Reserve’s decision to lower interest rates may boost real-estate investor confidence, leading to increasing investment volumes and, potentially, riskier dealmaking.

The Fed lowered its benchmark interest rate Wednesday by a quarter point to about 2.25 percent, the first of what could be multiple cuts this year.

Commercial real estate investors will likely take the decision as a signal to continue buying property, even at lofty valuation levels, says Ryan Severino, Chief Economist at JLL. This could extend the trend real estate markets worldwide have seen during the last decade, with  investors piling into the asset class amid a hunt for higher yields and stable returns.

“The rate cuts should keep the market attractive to investors in the short run,” Severino says.

Longer term, “it risks widening the rift between market expectations and the underlying economic reality, which could form the seeds of an asset bubble,” he says. “Since we did not see a strong chance of the economy backsliding into negative growth over the rest of this year if there was no cut, the risks associated with the Fed’s decision may be greater than any boost to the market.”

Global slowdown?

The rate cut is the Fed’s first since 2008, when rates were cut amid the financial crisis. It was also an abrupt reversal from last autumn, when the Fed was signaling multiple rate increases for 2019.

Similar turnarounds — or at least the maintenance of dovish stances —are happening at central banks worldwide. The European Central Bank, which appeared to at least prepare for the prospect of tightening, now sees rates unchanged through at least the middle of 2020 and could cut rates if data further weakens. Other major central banks are watching the data as well, looking for greater clarity before making decisions.

“The Fed’s decision on interest rates will hold far-reaching implications for other central banks and the global economy,” Severino says.

Explaining the cuts, the U.S. Federal Reserve chair, Jerome H. Powell cited risks to the United States economy from the U.S.’s trade war with China and a global economic slowdown.

 “Fear and uncertainty, more than any tangible economic metric, were at the root of this slowdown in the global economy during the second quarter,” Severino says. Actual fallout in the U.S. from trade policy remains limited thus far, and the risk of recession in 2019 is quite low, he says.

Although growth in 2019 seemed set to slow after a growth spurt in late 2017 and 2018, it’s really fear and uncertainty over trade policy that exacerbated the loss of momentum in the first half of this year, Severino says. Underlying momentum, particularly in the labor market, is still stout, and while the unemployment rate has cooled and job growth is slowing, both remain at healthy levels, he says.

“Real estate valuations already sit at or near record-high levels, while cap rates hover at or near record-low levels, so the market is hardly deteriorating,” Severino says.

 “Many feel the economic outlook alone did not justify the bullishness of the rate cut, which is why the Fed cited trade war tensions as a major factor. But the political headwinds, notably on trade, that are causing so much consternation could also evaporate quickly. If anything, they appear stable, if not improving.”

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