Investors, including those in commercial real estate, have been waiting for more clarity around a potential recession, interest rates and the election. With resilient macroeconomic activity, the easing cycle underway and the election behind us, the outlook for 2025 is improving.

The Fed starts gradual move to neutral

The Fed’s September rate cut was based on signs of a weakening job market and the belief that inflation was nearly under control. The October and November employment reports further clouded the status of the labor market, based on unexpectedly high and extremely low growth, respectively.

After the November report, the bond market focused on the possibility of inflation in 2025 fueled by deficit spending, regardless of the presidential election outcome. That led to elevated bond yields, shifting futures market expectations. As of Nov. 7, futures markets see an additional 75 bps to 100 bps in rate cuts from the Fed.

"At this point, the Fed is seeing risks to both sides of the dual mandate—inflation and employment—as roughly balanced," said Ginger Chambless, Head of Research for Commercial Banking at JPMorganChase. “This likely keeps them on a gradual easing path through 2025.”

The possibility of a recession

The Fed’s goal remains balancing employment with inflation to create a soft landing. But a recession is still a possibility. “The risk of a near-term recession in the U.S. is relatively low, and we are cautiously optimistic the economy will continue to expand at a healthy pace in 2025,” Chambless said. “Most of the risks we see right now have to do with geopolitical tensions, which are difficult to predict.” 

How cuts could impact adjustable and fixed interest rates

The Fed’s interest rate reduction directly impacts adjustable-rate mortgages indexed to short-term rates, such as SOFR or Prime.

“It’s tempting to think that the actions of the Fed in lowering short-term rates would be directly mirrored in Treasury yields and mortgage rates,” said Mike Kraft, Commercial Real Estate Treasurer for Commercial Banking at JPMorgan Chase.

But that’s not the case. Fixed interest rates work to build in all future Fed activity, the long-term economic outlook and inflationary expectations—not just what happens at next FOMC meeting.

“The challenge for our industry is that the 10-year rate has increased about 80 bps over the last 45 days,” Brooks said. “This development is the impact of market expectations for higher longer-term inflation.” 

But fixed interest rates work to build in all future Fed activity, the long-term economic outlook and inflationary expectations—not just what happens at next FOMC meeting.

The Fed’s actions don’t directly affect fixed rates, which are linked to long-term inflationary expectations. Economic data, such as consumer spending and jobs reports, are more likely to shift these medium- to long-term fixed rates than short-term interest rate reductions.

“Because volatility will surely continue, it may pay for borrowers to put themselves in a position where they can lock rates very quickly whenever mortgage rates dip,” Kraft said.

What lower interest rates could mean for multifamily investors

Rate decreases impact multifamily and commercial real estate in other ways, too. Most notably, liquidity increases across the financial system.

“As interest rates decrease, cash flow coverage increases, bringing down loan loss reserves for banks," Brooks said. "Lower reserves can then be put back into the market and facilitate more deal flow.”

Increased liquidity and lower borrowing costs often lead to rising prices, which may alter apartment building values. “It’s not dollar-for-dollar, but as interest rates decrease, cap rates usually fall a little bit with them,” Brooks said.

Lower rates present multifamily investors with many opportunities, including:

• Refinancing properties: Falling rates can be especially beneficial for investors with loans near the end of their term. By refinancing, investors can lower their monthly payments and potentially save thousands of dollars in interest. Property refinancing can also help improve cash flow and free up capital for renovations or new building purchases.
• Growing their rental portfolio: “The recent 25 bps decrease in the Fed funds rate is helpful. Lower short-term rates are helpful for real estate investors primarily helping short-term financial needs like construction loans,” Brooks said. Valuations have continued to stabilize,  especially true in larger markets such as Los Angeles, New York and San Francisco, where the cost of living tends to be higher and there’s a naturally large pool of renters. Aside from expanding to new markets, multifamily investors can add new asset classes to their portfolios, such as mixed-use, retail and industrial properties.

Higher-for-longer interest rates are relative, something particularly evident over the last 20 years. 

“The extremely low rates seen not long ago should be viewed as an anomaly stemming from the 2008 Great Financial Crisis and COVID,” Kraft said. “Near-zero interest rates are unlikely to return.” It may take investors and consumers some time to adjust to the new landscape.