Fed interest rate cuts may help turn around commercial real estate. However, investors should tread carefully if they are wading into the market. Central bank policymakers' half-point cut last month “marks the beginning of the end for the worst decline in real estate prices since the global financial crisis,” Wells Fargo said in a September 25 note. “Lower interest rates are not a silver bullet, but less restrictive monetary policy lays the foundation for a commercial real estate recovery,” chief economist Charlie Dougherty wrote. “Lower long-term interest rates appear to be easing upward pressure on cap rates and slowing the decline in property valuations. At the same time, rising expectations for a soft economic landing appear to be giving capital the green light to move off the sidelines.” He added. There are some bumps in the road. On Monday, the 10-year Treasury yield rose above 4% for the first time since August, following a better-than-expected jobs report on Friday. Bond yields move inversely with prices. One basis point equals 0.01%. Trading in Fed funds futures indicates a roughly 84% probability of a quarter-percentage-point rate cut at the Fed's next meeting in November, while no one expects another half-percentage-point cut, according to the CME FedWatch tool. Of course, there is no shortage of hurdles facing the market, especially for office space, Dougherty said. He added: “However, lowering interest rates should prevent the spread of distress and shorten the obstacles in the way.” Lower refinancing rates for borrowers Douglas Gimbel, senior portfolio specialist at Diamond Hill, said companies, which had been expanding mortgage deals through a higher interest rate environment, will see some relief and eventually be able to refinance at lower rates. His firm's Short Duration Securitized Bond Fund (DHEIX) had about 25% of its portfolio in non-agency commercial mortgage-backed securities, as of Sept. 30. “It's not going to happen overnight, because we know that when the Fed takes action — whether higher or lower — it takes time for it to work its way through the system,” Gimple said. He believes investors can find value now from “If you can find a diamond in the rough that's been hurt from a pricing standpoint because of its association with commercial real estate, you can find some really good opportunities,” he said, focusing on the bottom-up process Investors need to understand what their managers are buying or, if they're investing themselves, what they're buying Gimple specifically likes single-asset, single-borrower CDOs The first, as the name suggests, involves a single asset – such as a high-end hotel – Or a single borrower, which could be a hotel chain with multiple locations. The latter are short-term, floating-rate deals usually entered into by a company to upgrade a property, such as putting in a swimming pool or energy-efficient air conditioning in an apartment complex, Gimpel said Every investment will always depend on the deal. For example, he doesn't buy office space in Los Angeles or New York, but might consider a deal in the suburbs. He will look at Class A offices, which are typically the most modern, have a 95% occupancy rate and a diverse occupant population. Within hotels or accommodations, “award rich” properties are seen in areas such as Miami or Hawaii. “It's not about the hotel, it's about the location,” Gimple said. It also looks at single-family rentals and industrials, as well as retail to some extent. Any holdings of mortgage-backed securities should be just part of a diversified fixed-income portfolio that includes credit and Treasuries, he said. “It depends on the risk appetite that will determine what type of allocation they should consider,” Gimple noted. “You're remiss as an investor if you're avoiding a whole part of the market because you're reading the headlines. There are still opportunities out there.”
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