Fed Fund Rate Cuts Could Be Potentially Problematic for CRE

During the past several Federal Open Market Committee meetings, markets and economic pundits have waited with bated breath to see if the Federal Reserve would FINALLY cut the federal funds rate.

And when rates remain steady, plenty of headlines emerge discussing what the latest actions mean for the economy and commercial real estate. Regarding the latter, the consensus has been that higher federal fund rates mean ongoing higher costs of capital. Then there’s the opposite, which is lower rates helps push down the cost of borrowing.

But a just-released report from Newmark offers a different take. “The commonly express desire for rate cuts is misplaced because it ignores what usually comes with a lower cost of capital,” the report said.

Put another way, “Fed rate cuts are often in response to a need to inject capital into the system as investors hold back investments,” Joseph Biasi, Newmark’s Head of Commercial Capital Markets Research, told Connect CRE.

“Less capital means higher cap rates as the asks move up and the bids seek more liquid stores of value. As a result, capital returns suffer.”

As such, stable interest rates are better at supporting commercial real estate strategies than are rate cuts.

More Explanations

This isn’t to say that rate cuts are horrible. Such cuts can lead to lower debt costs. And cheaper debt means investors can use more leverage. “This boosts equity returns and puts more capital to work, supporting prices,” the report said.

If those rate cuts operated in a vacuum, the decreasing rates would reverse the higher costs of capital that occur during rate hikes.

However, rate cuts don’t happen in a vacuum. Because the Fed’s mandate is stable inflation and maximum employment, “meaningful easing generally arrives when the labor market is deteriorating,” the report said.

Biasi said most investors understand that, while declining rates can be helpful, economic performance is actually the driver of demand. However, misconceptions occur when considering the relationship between declining rates and economic performance.

“Outside of stagflation, where inflation increases, but economic growth is poor, the Fed generally raises rates into a hot economy and cuts into a cold economy,” Biasi said. “Rate movements are largely caused by economic conditions.”

He went on to say that the market has been hoping for rate cuts and strong economic growth at the same time, adding that the closest the U.S. has come to that ideal was within the past year, “albeit with a cloud of economic uncertainty overhanging the market.”

A Look Back

Sometimes a “big picture” look can support commentary. Biasi said there were four main periods within the past 36 years during which the federal funds rate was cut.

“In the early 1990s and late 2000s, we cut directly into recessions,” he said. “Obviously, CRE performance suffered during those two periods.” The economy declined, returns fell, and debt and equity switched to what Biasi dubbed a “risk-off” mode.

Meanwhile, the 2001 and 2020 easing cycles were more nuanced. “The actual recessions in both of those cases were fairly mild or short,” Biasi said. “But you could argue that the rate cuts were too aggressive and contributed to the 2008 recession and the aggressive rate hikes we saw in 2023.”

Rate Cuts and Transaction Volume

Biasi said that lower interest rates can drive transaction volume. But when the economy declines, and rates are cut, investors tend to move away from risk. They put their capital into liquid assets that hold value.

“The lack of available investment capital is exactly why real estate returns suffer when the Fed cuts rates,” he said. “Acquisition capital becomes scarce at the same time CRE sellers would like cash.”

While current rates are higher than they were between 2008 and 2019, “overall CRE transaction volume in the first quarter of 2026 was 21% higher than the 2017-2019 average,” Biasi commented.

What Investors Should Watch

Biasi suggested that the best use of CRE investors’ time might be to monitor employment and inflation signals rather than focus on actual rate cuts or hikes. “The Fed has a dual mandate,” he added. “Maximum employment and price stability. If the unemployment rate moves up or inflation dips below the 2% target, that tends to be a sign that the Fed might cut rates.”

Biasi also recommended keeping an eye on inflation expectations.

“If inflation expectations drift upward, market participants could push up buying decisions, driving real inflation, and forcing the Fed to raise rates even further than they would have had to before,” he added.

The report said it’s difficult to predict how long the current energy-driven inflation will persist. Inflation remains cyclical, but structural factors shouldn’t be ignored.

“The same structural movements that have brought interest rates down have long-reaching implications for CRE demand,” the report added.