Will CRE Let Interest Rate History Repeat Itself?
The federal funds rate reached 7% for the first time in 1969. “The first day that I stepped into a real estate office in the early 1970s, interest rates had hit 7% for the first time that anybody could remember,” Curtis Kaufman, a Matthews™ Capital Markets advisor, recalled during a recent webinar. “Rates went much higher from there, then back down—in the sixes for the most part—up to the 2000s.” Kaufman left out that, at one point, rates had jumped over 1,000 basis points since his first day. “I think we have to consider a more conservative interest rate and fewer loan dollars on leverage,” he added.
It’s true that interest rates have strayed from moderation in recent years. But how could they not? The U.S. economy faced a massive recession and a global pandemic in just two decades. At the mercy of fate, the Federal Reserve employed its best intentions to right the ship, slashing rates to near zero twice in roughly 11 years. The rate cuts were unprecedented. At no point before 2008 had the federal funds rate ever been reduced so low. Such extreme and recent measures by the Fed beg the question: What are “normal” interest rates?
Lessons in Patience
With all the chatter about rate cuts this year, it’s easy to forget that the Fed delivered two huge, unscheduled cuts in early 2020 and held rates at around zero as recently as 2022. “Cutting rates is used to stimulate the economy,” offered Clark Finney, VP and Director at Matthews™. “Right now, the economy doesn’t require any more stimulating,” he added during an April 2024 webinar. The Federal Reserve appears to think so, too. So far in 2024, the Fed has held the benchmark policy rate the same—in the 5.25% to 5.50% range—citing concerns about sticky inflation and a relatively strong job market. The Fed’s preferred measure of inflation, the personal consumption expenditures price index (PCE), reached 2.7% at the end of Q1 2024.
Inflation and unemployment are two expected levers the central bank uses, but recent hawkish commentary from the Federal Open Market Committee (FOMC) members adds another dimension to their motives. Federal Reserve Chair Jerome Powell stated in a May 2024 meeting that “inflation is still too high” and it “will take longer than previously expected” for policymakers to feel comfortable that inflation is cooling down. The FOMC generally accepts 2% as its inflation target. Although the central bankers agreed that inflation has eased over the past year, it seems they are willing to wait as long as needed to see the desired conditions for change.
A Federal Funds Rate History
A recent compendium by Forbes Advisor summarizes the last 20 years of Federal Reserve meetings and changes to the federal funds rate. Since the Fed often enacts policy in a series of like changes, each era is characterized by either rate hikes or rate cuts.
Rate Hikes: 2022-2023
In 2022, the Fed bought billions of dollars of bonds a month to stimulate the economy. Meanwhile, U.S. inflation reached 40-year highs. Once the central bank decided it was time to step in, it moved quickly, performing an aggressive series of 11 rate cuts that brought the federal funds rate up by 500 basis points.
Rate Cuts: 2020
Amid news of a global pandemic, the FOMC delivered two rate cuts at unscheduled meetings in March 2020, dropping the federal funds target rate to zero to 0.25%. The U.S. unemployment rate would jump to 14.7% the next month after 20.5 million jobs were cut.
Rate Cuts: 2019
In June 2019, the PCE indicated that inflation was below the Fed’s 2% target at 1.7%. When the central bank decided to cut rates in August, it was a modest, mid-cycle adjustment, according to Federal Reserve Chair Jerome Powell.
Rate Hikes: 2015-2018
The fallout from the GFC in 2008 kept the Federal Reserve away from setting policy rates for seven years. When it finally did so, Federal Reserve Chair Janet Yellen cited improvement in labor market conditions and an expected rise in inflation—then at 1.1% in December 2015—as reasons for the hikes.
Rate Cuts: 2008
After a brief pause in interest rate cuts, the central bank resumed cuts to combat collapsing home values, a crashing stock market, and an unemployment rate that would eventually reach 10% in October 2009. The Fed reduced rates to zero and began a new policy known as quantitative easing (QE).
Rate Cuts: 2007-2008
It’s hard to forget the economic conditions that began in early 2007. As the housing bubble started to burst and unemployment rose, the FOMC began a reduction in rates that would total a cumulative 275 basis points in less than a year. The Fed only briefly paused cuts in what would be seen as a calm before the storm.
Rate Hikes: 2004-2006
By 2004, people were already talking about a U.S. housing bubble. Rate cuts from the year prior made room for easy money that prompted the expansion of GDP from 1.7% in 2001 to 3.9% in 2004. The Federal Reserve moved to cool down the economy with a series of 17 rate hikes in two years that brought the federal funds rate up by 400 basis points.
CRE: The Long Game
Is it reasonable to accept the current interest rate range as normal? Evidence from the 30 years before the Global Financial Crisis, when the federal funds rate averaged 4.78%, suggests that it’s a start. Given the impact of COVID-19 and the GFC, a 6% to 7% rate may make even more sense. But at a certain point, endless discourse about interest rates (Will they go up or down?) leaves little room for reality. “What matters more than ever are fundamentals,” Finney concluded. “Do deals make sense in the current environment? If they don’t, then simply readjust—don’t buy.” Indeed, when investors set aside expectations about interest rates, they’re left with a clearer picture.
Plus, commercial real estate has never been a short game. In recent years, the investor mindset has all but yielded to cheap, easy money. But real estate investment wasn’t built for quick wins or near-zero rates. Sure, interest rates will go down. And they’ll go up again. But when? And by how much? Those questions are likely better left to economists. Mark Twain wrote that history doesn’t repeat itself, but it often rhymes. Perhaps it’s time for commercial real estate to listen to the rhythm.
