The Federal Reserve’s recent interest rate cuts have sent a surge of excitement through the commercial real estate market. Rates have returned to 2018 lows, however, Metro Group Realty Finance says that the Fed’s interest rate reductions have little to do with financing activity, because most commercial real estate lending is indexed over the five- and 10-year treasury bills.
“The recent Federal Reserve reduction in the Federal Funds Rate has little to do with velocity of investment or financing of commercial real estate,” Patrick Ward, President for Metro Group Realty Finance. “The cost of capital for commercial real estate lending, for the most part, is indexed over the five- and ten-year treasury bills. The treasury bills are a global instrument affected by worldwide geopolitical events, not necessarily United States monetary policy. The spread ranges from a low of 1.6% to 2.50% for most properties and continues upward above 2.50% based on the risk profile of the property.”
Financing activity is tied to these factors, which have put rates in a range od 3.6% to 4.25%. “This is still considered an attractive cost of capital, and in many cases, provide positive leverage,” says Ward. “For example, we recently funded a $15 million loan on a large multi-tenant industrial building in the city of Commerce. The loan was a conservative loan-to-value, so we were able to provide a loan price at 1.42% over the ten-year treasury. By taking advantage of the low interest rate environment, we locked rate when the ten-year T-bill was at 1.70% for an all-in rate of 3.12% fixed for ten-years.”
As a result, Metro Group doesn’t expect the Fed’s reduction in interest rates to have a major impact on loan volumes and financing in 2020; however, the low interest rate environment will continue to fuel strong activity. “Every source of capital that we work with has ample capacity and is expecting increased allocation of proceeds for commercial real estate lending in 2020,” says Ward. “The Mortgage Bankers Association Economic Forecast projects a slight decrease in volume to 1.90 trillion from 2019 projected volume of 2.06 trillion.”