Perhaps a better question isn’t when will they drop or raise the rate again, or by how much, but rather why will they do either, or consciously decide to do nothing.
The by-now-well-known (accepted) reason is to support the stock market, of course. But that’s old hat – everybody knows that, and as such there’s no particular advantage to any one investor. (Incidentally, nothing in the Congressional Act authorizing the creation & mandate of the Fed is support of the stock market mentioned.) But that doesn’t concern you … you’re reading this for information and insight into managing your CRE (commercial real estate) financing … perhaps to finance a new acquisition, refinance an existing property, or do a sale-leaseback in lieu of conventional financing.
So let’s consider the economic cycle, for this by their own admission is what the tea leaf readers at the Fed take their cues from to set and execute policy. Standard thinking is: weak economy => rate cuts => economic stimulus => rising GDP and a stronger economy. But there’s some untimeliness afoot when connecting these dots with CRE and CRE financing. It’s not that they’re unrelated, but they’re asynchronous – some would say random. The unreliable element is timing, that serendipity variable we all try to get a handle on but never seem to be able to. I yield to one of my favorite philosophers who waxed poetic on the subject:
“I find it very difficult to make predictions, especially about the future.”
Yogi Berra
(Not familiar with Yogi? Try Googling him. He’s of sufficient fame that you’ll find several hits for him.)
But more to the point – let’s draw some relationships.
The value of CRE is primarily determined by its income stream.
The value of CRE is often (and simply) gauged by the “cap rate”, i.e., the income stream in dollars expressed as a percent of the value (price). This is an inverse relationship, i.e., if the interest rates go down, and income (NOI – net operating income) remains the same, the price goes up, and vise-versa.
But let’s consider why the Fed may be dropping rates that ¼ point. Ostensibly this is to support a slowing economy and perhaps, they hope, prevent a recession. If the economy weakens as expected, however, we might expect business to slow down, CRE vacancies may be expected to increase, meaning that the net income to the property owner should be expected to decrease. And if rent decreases shouldn’t the property value go down? Of course. But wait … how can the value of the property go up because rates are reduced, but also go down because income decreases? The answer, of course, is the timing of the movements. But which comes first, the price movement or the interest rate movement? Experienced investors will tell us price moves first in reaction to lower rates. Experienced tenants, however, will tell us rents move first in anticipation of a slowing economy.
Unlike the stock market which is immediately transparent for all to see, the CRE and financing markets are much more opaque. This lack of immediate transparency causes the delays in movement between relationships. And the delays themselves cause misinformation, interpretation of information, speculation, false steps along the decision path, and unfortunately some bad decisions.
So how do you, the CRE investor/landlord/finance manager, track this information and divine the future to know where you are at any point in time so as to make accurate, foresightful, and yes, timely decisions?
Yes, the Fed is just the tip. It’s what’s downstream that causes our consternation.
Aha-a-a-a, you say! Technology to the rescue.
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Today’s post is written by Michael Green, Commercial Loan Originator for Counsel Mortgage Group, LLC.
Copyright © 2019 Counsel Mortgage Group®, LLC.