Continued treasury volatility

“Treasury yields have a life of their own, distinct from actions taken by the Fed,” Kraft said. “For example, when the Fed dropped its target by 0.25% on December 18, 2024, Treasury yields jumped by 0.15% or more based on longer term expectations.”

Since the election, the market has tried to answer the question: Will the new administration’s policy proposals increase inflation? In doing so, the market has swung back and forth, adding to bond volatility.

“By and large, the market has been mollified as of late, but the question remains over the longer term, and volatility is likely to continue,” Kraft said.

How the Fed affects short- and long-term interest rates

As always, it’s important to differentiate between short- and long-term interest rates and how the Fed’s actions impact each.

• Short-term interest rates are directly impacted by the Federal Reserve. As the Fed’s primary tool for influencing interest rates and the economy, the federal funds target range directly drives other short-term market rates such as prime and SOFR.
• Medium- and long-term interest rates—such as yields on Treasury notes and bonds, interest rate swaps and corporate bonds—can be influenced by the Fed but ultimately depend on the market’s long-term expectations of inflation and the direction of the economy. From day to day, supply and demand can also drive these rates. Because the collective view of the market is outside of anyone’s control and can be driven by many factors, long-term rates are more difficult to forecast and—particularly in the current market environment—can exhibit considerable volatility.

What future interest rates could mean for commercial real estate

“The outlook is still for interest rates to drop over the course of 2025, just at a more gradual pace than expected back in September, when it looked like softer labor market conditions might warrant quicker Fed easing,” said Ginger Chambless, Head of Research for Commercial Banking at JPMorganChase. “Since then, economic activity, inflation and labor market data have been a little on the firm side, suggesting the Fed doesn’t need to rush cutting interest rates.”

“Sentiment is improving among business leaders, which would also benefit commercial real estate,” Chambless said. “There is a sense that the worst is behind us in the commercial real estate cycle.” 

Higher-for-longer interest rates could keep the environment for commercial real estate somewhat challenging, but to varying degrees. “Each market will face its own unique dynamics depending on population trends, employment trends and supply and demand,” Chambless said.

• Demand for affordable multifamily properties remains elevated, while there’s some downward cyclical pressure on luxury properties.
• Industrial real estate is experiencing tailwinds related to domestic manufacturing capacity and infrastructure investments to meet customers’ on-demand expectations.
• Retail performance has been mixed depending on location and concept.
• Office is starting to show signs of normalization as more employees return to the office full time.

Opportunities amid uncertainty for multifamily investors

“In the current rate environment, there’s a lot that’s out of investors’ control,” said Al Brooks, Vice Chair of Commercial Banking, JPMorganChase. “What can you focus on that's going to drive better cash flow? Being a better operator.” That means scrutinizing your buildings and operations to best position them for the long term, which could include:

• Streamlining operations: By closely examining operations, owners and operators can identify areas of inefficiency. For example, multifamily owners and operators could reduce costs by purchasing in bulk. Operators can also draw on digital treasury tools to streamline accounts payables and receivables and ultimately reduce costs.
• Upgrading properties: “Our best owners and investors regularly walk their properties,” Brooks said. “They proactively make certain that all health and safety issues are addressed before anything could remotely negatively affect tenants. For example, walkways, catwalks and railings are always kept in good conditions. None of these things are especially costly, but when tenants are looking at a property they demonstrate that the owner cares about tenant health and safety.” There may also be opportunities to make cost-effective upgrades, such as swapping well-worn carpeting for more durable laminate flooring.

The possibility of a recession

Typically, interest rates decrease in a recessionary environment. How quickly rates drop and to what degree depends on how high inflation is running and the severity of an economic slowdown. 

“Unless there is an unanticipated geopolitical event or other form of supply shock, the likelihood of a U.S. recession in the coming months is low,” Chambless said. “If the soft landing scenario plays out as we expect, interest rates will likely be stable to modestly lower.”

While interest rates have a unique influence on commercial real estate, it’s important to look at multiple economic factors, including:

• Labor markets: Labor markets ended 2024 on a high note. The economy added 256,000 jobs in December, marking the largest increase since March 2024. The unemployment rate also dropped slightly from 4.2% to 4.1%.  
• Inflation: Inflation progress has stalled in recent months. As of November, Personal Consumption Expenditures (PCE) exhibited an annual growth rate of 2.4%, while the core PCE price index, excluding food and energy, was up 2.8% year over year. Core PCE—the Fed’s preferred inflation index—has been in the 2.6% to 2.8% range since May 2024.
• Commercial mortgage rates: Treasury yields can impact hybrid- and fixed-rate loan pricing for commercial real estate investments. Rising yields may reflect higher levels of expected inflation in the long term, while falling yields could indicate lower inflation and a possible slowdown or recession.

It’s also important to consider factors specific to commercial real estate, such as location, asset class and cap rates, as well as demographic shifts and supply and demand.