By Ryan Severino
It’s been more than two months since the Federal Reserve (Fed) cut interest rates by 25 basis points (bps), but the market optimism around monetary policy has shifted significantly since then. This move was widely anticipated by most; however, the market reaction was complicated and confused by other follow-up statements. Commercial real estate (CRE) investors want to understand how shifting monetary policies will affect the CRE environment. The answer may not be so cut and dry.
The Fed had initially projected four rate cuts in 2024, however, it then scaled back its guidance to just two. That decision prompted uncertainty across financial markets. More uncertainty came when, on Feb. 11, Fed Chair Jerome Powell told a Senate Committee that with 1) a strong job market and 2) inflation still elevated, they “do not need to be in a hurry” to cut interest rates in 2025.
Despite a cumulative 100-bps (or 1%) rate reduction over the past year, the 10-year Treasury yield remains near where it was last spring – hovering in the mid-4% range. This is a deviation from some historical patterns and is largely attributed to the inconsistent messaging from the Fed.
For example, last September, policymakers initiated a more aggressive 50-bps cut, responding to short-term labor data rather than broader economic fundamentals. At the time, the Fed didn’t need to cut that much – it was just overreacting to a noisy July employment situation release. A more measured approach could have been to cut slowly, reserve more in reserve for when needed and preserved flexibility. Now, the market is now adjusting to a revised trajectory that appears reactionary.
In prior easing cycles, Treasury yields typically declined after rate cuts. This time, though, the yield has climbed by approximately 90-100 bps, which introduces complications for commercial real estate stakeholders.
But the yield is not the only variable that affects (or is affected) by interest rate cuts. Let’s take a closer look at the job market and inflation triggers that Powell identified.
A Confusing Labor Market
Since last summer, the labor market has created some confusion for the Fed, which is trying to deftly balance price stability and full employment. And the most recent spate of labor-market data will only further complicate the situation for them. A November Job Openings and Labor Turnover Survey showed that while job openings remain elevated, hiring has slowed. December’s employment report reflected a modest decline in job growth and stable unemployment rate.
To be fair, the labor market’s path is a bit complicated this cycle. Heading out of the pandemic, the market glowed white hot. An intensifying labor shortage ran headlong into resurgent demand. The unemployment rate plummeted, and wage growth surged. But between mid-2022 and mid-2024, the labor market reached some level of normalization. Demand for labor slowed as employment rolls swelled, but layoffs also remained at low levels as companies learned hard lessons during the post-pandemic hiring frenzy.
Then in the summer of 2024, labor market data got disrupted by idiosyncratic events such as inclement weather and labor strikes. The Fed misread the data and took it as a sign of the labor market deteriorating more quickly than it was. The Fed overreacted and cut interest rates quickly while also publishing an aggressive forward rate schedule. The Treasury market got over its skis too, sending the 10-year yield down near 3.6% around the time of the first rate cut of this cycle. Since then, the market has maintained a “don’t hire, don’t fire” stance – weak hiring but low layoffs – which is keeping it tight, but in a potentially precarious position.
Inflation Is Easing
Meanwhile, recent inflation data suggests a gradual easing trend as the U.S. economy remains on firm footing. The personal consumption expenditures price index for November came in below expectations (at 2.4%), reinforcing a broader disinflationary trajectory. While base effects contributed to a temporary uptick in annual inflation toward the end of 2024 (at 2.6%), projections indicated a reversal in early 2025, leading to more favorable inflation readings.
So far in 2025, the consumer price index (CPI) and producer price index (PPI) came in below expectations. Of note, housing inflation continued to decelerate even as it remains mis-measured and overstated. The good news: it should continue to slow through 2025, and more favorable base effects in the first quarter should only further help yearly inflation calculations.
CRE Outlook in a Shifting Rate Environment
Taking into account uncertain labor market dynamics and inflation, market fundamentals across most CRE property types and geographies have held up well. While rent growth around the world has generally slowed and vacancy compression has largely stalled or reversed, the CRE industry still remains in a favorable position.
That favorable position largely occurred thanks to relatively limited supply growth, outside of a few problematic pockets. But demand has not imploded – it has simply eased after a period of inordinate strength. This has kept CRE fundamentals generally healthy, which should continue to support positive income returns throughout 2025.
The Fed’s cautious stance on rate cuts also suggests a prolonged period of higher borrowing costs. While the federal funds rate is still expected to decline in line with initial projections, the pace of reductions remains uncertain, particularly if labor market conditions soften. A policy miscalibration – maintaining elevated rates due to overstated inflation concerns – could dampen investment sentiment and transaction activity.
Nevertheless, CRE fundamentals remain resilient despite a “waiting-to-cut” interest rate cutting environment. While considering the mixed messages from the Fed, real estate investors and developers must remain attuned to macroeconomic trends, balancing inflation expectations against emerging labor market risks. If they do, the sector should continue to uncover growth opportunities over the next several years.
