The Federal Open Market Committee (FOMC) unanimously approved a .50% rate hike at its eighth and final meeting of the year, bringing the federal funds target range to 4.25% to 4.5%. The latest increase, while still historically large, is more modest than .75% increases over the last meetings. Although the 12-month change in CPI was 7.7% in October and 7.1% in November, lower than the peak of 9.1% in June, the Fed pledged to continue its restrictive monetary policy in 2023 because inflation remains far above the central bank's long run goal of 2%.

“The inflation data received so far for October and November show a welcome reduction in the monthly pace of price increases,” Fed Chair Jerome Powell said in his prepared remarks. “But it will take substantially more evidence to give confidence that inflation is on a sustained downward path. Price pressures remain evident across a broad range of goods and services. Russia’s war against Ukraine has boosted prices for energy and food and has contributed to upward pressure on inflation.”

Powell said the Fed quickly hiked interest rates by 4.25% this year because inflation was so strong and persistent. However, going forward increases should be implemented at a slower pace as policymakers shift their emphasis to determining the appropriate level for rates. The FOMC’s Summary of Economic Projections (SEP) increased estimates for the median fed funds rate to 5.1% at the end of 2023, 4.1% in 2024 and 3.1% in 2025, but Powell cautioned that those projections could move up or down depending on inflation and economic conditions.

Is the Worst Behind Us?

“After transacting for two years with the fed funds rate near zero, the Fed’s rapid rate hikes since March shocked investors and created a volatile market as investors scrambled to adjust to the new lending environment,” said Eli Weisblum, Senior Director of Capital Services at Ariel Property Advisors. “We hope that the worst is behind us and that future rate increases will be more moderate, which will give borrowers confidence that deal underwriting will be more stable and predictable next year.”

He noted that even at 4.5%, the fed funds rate is still historically low when compared to previous business cycles and dramatically lower than the last time the Fed was battling record inflation in 1981 when the rate spiked to 19.10%.

Demand Continues for Cash Flowing Assets

Weisblum said buyers continue to aggressively pursue cash flowing properties nationwide such as multifamily, retail and industrial buildings, noting that over 60% of Ariel’s pipeline consists of loans for acquisitions.

“We run a process to ensure that we match the right lender for the right property,” Weisblum said. “We have relationships with lenders that are actively looking to put out term sheets and have remained steadfast in their appetite for new business, despite the interest rate uncertainty of the last few months.”

The top 25 New York City lenders, for example, actually increased their financing activity from June to October compared to January to May of 2022, according to an analysis by Ariel Property Advisors’ Capital Services group. Eight banks remained on the top 25 lender list for 10 consecutive months, with JP Morgan Chase consistently the most active lender during this period.

Credit unions also have become reliable lending sources for commercial real estate investors that have viable business plans. For example, Ariel Property Advisors recently arranged a refinance loan with an interest rate approximately 50 basis points below market with a national credit union. The client was the owner of a 38-unit, 159,600-square-foot shopping center in the Midwest that was renovating and expanding a retail space to accommodate one of its tenants, a government agency.

Outlook for 2023

“Even with higher interest rates, investors are continuing to invest in commercial properties that are priced right and offer sufficient cash flow, knowing that they will be in a great position to refinance when the cost of debt eventually falls,” Weisblum said.

The Fed is forecasting slower economic growth and an uptick in the unemployment rate next year, but expects to make progress on its goal to lower inflation. If policymakers find that their restrictive monetary policy is succeeding, a subsequent leveling off of interest rate hikes in 2023 followed by future rate cuts would be welcome developments for investors in commercial real estate.