Rising Treasury Rates Amid Fed Cuts and Their Impact on Commercial Real Estate Lending
October 17, 2024 (HOUSTON) –
Recent trends have shown a surprising rise in U.S. Treasury yields, even as the Federal Reserve has paused or cut interest rates. The benchmark 10-year Treasury yield recently climbed to its highest levels in over a decade, driven by various factors such as inflation concerns, high government debt issuance, and expectations of sustained economic growth. This shift has important implications for commercial real estate (CRE) lending, which relies heavily on interest rate conditions.
Understanding the Disconnect: Treasury Yields vs. Fed Cuts
The recent increase in Treasury yields, despite the Fed’s rate cuts, highlights the disconnect between short-term monetary policy and longer-term market dynamics. The Fed’s rate decisions primarily influence short-term borrowing costs, while long-term Treasury yields are affected by factors like inflation expectations, fiscal policy, and global demand for U.S. debt. Recently, higher government spending and increased issuance of Treasuries to finance the deficit have led to an oversupply, pushing yields higher.
Impact on Commercial Real Estate Lending
Rising Treasury rates have a significant impact on the CRE sector, particularly because many commercial loans are pegged to the 10-year Treasury yield. As these rates increase, the cost of borrowing rises, making financing more expensive for property developers and investors. This can lead to several consequences for the CRE market:
1. Higher Financing Costs: Higher Treasury rates translate into increased mortgage rates for commercial properties, making it costlier for borrowers to refinance or take out new loans. This may deter investment in new projects or the acquisition of existing properties, potentially slowing market growth.
2. Pressure on Property Valuations: With higher borrowing costs, the required returns on real estate investments also increase. This can result in downward pressure on property values, especially for assets with fixed income streams that may not grow enough to keep pace with rising rates.
3. Tighter Lending Standards: Lenders may tighten their credit criteria in response to the higher cost of capital and perceived risks, making it more challenging for borrowers to secure funding. This is particularly true for sectors within CRE that are already facing headwinds, such as office spaces, which have struggled with high vacancy rates post-pandemic.
Navigating the New Landscape
For commercial real estate stakeholders, the current environment requires strategic adjustments. Investors may need to explore properties with higher income growth potential, while lenders could look at structuring loans with more flexible terms to account for rate volatility. As Treasury yields continue to impact borrowing costs, the sector will likely see adjustments in investment strategies and property valuations.
In summary, the recent increases in Treasury rates, despite Fed rate cuts, are creating a more challenging landscape for commercial real estate lending. Investors have sat on the sidelines for several months waiting on rates to drop. Rates have come down from the highs to late 2023 and early 2024 but seem to be leveling out. Waiting to refinance is hurting more than helping for the foreseeable future.
Source: Lee & Associates – Houston Jason Dannatt, Commercial Resource Capital
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