As expected, Federal Reserve policymakers left the target range for the federal funds rate unchanged at between 5.25% to 5.50% at their June 11-12 meeting, the seventh straight time the Fed has held rates steady. In the Summary of Economic Projections FOMC participants reduced their forecast to only one rate cut for 2024 year depending on economic conditions and the level of inflation at the time of their remaining four meetings which will be held in July, September, November and December. They projected the median federal funds rate will be 5.1 percent at the end of this year, 4.1 percent at the end of 2025 and 3.1 percent at the end of 2026.

“We have stated that we do not expect it will be appropriate to reduce the target range for the federal funds rate until we have gained greater confidence that inflation is moving sustainably toward 2 percent,” Fed Chair Jerome Powell said, noting that the Consumer Price Index rose to 3.3% for the 12 months ending in May. “So far this year, the data have not given us that greater confidence. The most recent inflation readings have been more favorable than earlier in the year, however, and there has been modest further progress toward our inflation objective. We will need to see more good data to bolster our confidence that inflation is moving sustainably toward 2 percent.”

Borrowers Cautious but Optimistic

“Even though rates are staying higher for longer, many borrowers have shaken off the shock of the past rate hikes and are more optimistic about transacting today,” said Ben Schlegel, Director of Capital Services at Ariel Property Advisors. “Coming into 2024, most of our pipeline was for refinances but that has shifted and now about half of the deals we’re working on are for acquisitions.”

Clients are bullish in their outlook and finding opportunities in properties selling at significant discounts, making the cost of capital less relevant. However, borrowers are maintaining disciplined underwriting and for deals that pencil out, financing is available.

Schlegel cited a newly constructed cash flowing, fully occupied multifamily asset with upside located in an area with a high median income as an example of a deal that is attracting the interest of many capital providers.

Financing Trends in Today’s Market

Being creative in sourcing and structuring capital solutions is essential in today's market as is a clear understanding of the nuances of available financing options. Schlegel said the trends he’s seeing include:

• CMBS loans have come back into fashion and are now competing with agency and bank options. Pricing on CMBS has come down during the first half of 2024 and leverage has become attractive due to the loan sizing methodology focusing solely on interest only payments rather than principal and interest debt service payments. Additionally, a new five-year CMBS product is appealing to borrowers who previously shunned this option due to the restrictive prepayment penalty of defeasance on the 10-year product. Ariel recently arranged a CMBS loan that was substantially higher in proceeds than the other options in the market and, therefore, turned a cash-in refinance into a cash-neutral refinance.
• Bank loans are the most expensive capital source because the costs are high for these financial institutions. Also, banks have become very discerning about the loans they make because many already have a large portfolio of commercial real estate loans on their books, including rent stabilized assets.
• Debt funds raised a record amount of funds in the first half of 2024. They have become more competitive with banks as they have had to drop their pricing to win deals. They also continue to offer more flexible terms and they don’t require deposits, which frees up liquidity for borrowers.
• Preferred equity and mezzanine debt are solving the equity shortfall for owners who acquired properties at compressed cap rates when interest rates were at 3%. The rate increases resulted in negative leverage and rather than sell at a loss, they are resetting the capital stack and buying themselves more time to finish executing their business plans and stabilize operations so that they can eventually refinance or sell in a better rate environment. Lenders are agreeing to this new arrangement rather than taking back a property through a foreclosure proceeding.

The Fed’s announcement confirms that significant rate cuts may not take place until 2025. Fortunately, there are a wide variety of solutions available to borrowers that can be uncovered by running a process to match specific deals with the appropriate capital.