Uncertain signals from the Federal Reserve regarding the direction of interest rates are weighing heavily on the commercial real estate (CRE) market, disrupting the momentum of transactions. Hessam Nadji, CEO of Marcus & Millichap, underscored this point during a recent appearance on Yahoo! Finance, where he delved into how fluctuating interest rate expectations are shaping investor behavior and market dynamics.
Private individual investors, high-net-worth individuals, and small partnerships—who make up the bulk of CRE ownership—are particularly sensitive to interest rate trends. Nadji explained that the market’s expectations about rates play a critical role in the timing of transactions. “If the marketplace expects interest rates to come down, sellers tend to wait for more favorable values,” he said. “If rates are going to go up, it’s the reverse.”
This push-and-pull creates a delicate balance for the Federal Reserve. Mixed messaging about future rate hikes or cuts can paralyze decision-making in the CRE market. Nadji emphasized the importance of clear communication from the Fed, particularly as the market adjusts to the reality that interest rates are unlikely to return to the historically low levels of the previous cycle.
While inflationary pressures are receding, Nadji suggested they won’t vanish entirely, limiting the Fed’s ability to aggressively cut rates. This uncertainty, coupled with rising interest rates, has led to a decline in CRE values since their peak in March 2022. However, savvy investors are seizing opportunities in this environment.
“Many investors are paying cash to secure properties they have been watching, with plans to put financing in place when interest rates come down further,” Nadji noted. This strategy highlights a sense of cautious optimism, particularly as valuations correct and new supply remains constrained due to the high costs of development.
The 10-year Treasury yield, which serves as a benchmark for CRE lending, has also been a critical factor in recent market sentiment. A recent increase to 4.5% has added pressure on valuations and lending activity. Despite this, Nadji pointed to several factors fueling optimism in certain CRE segments.
A Market in Transition
Nadji highlighted three key drivers of optimism: valuation corrections, steady—albeit moderated—job growth, and limited new supply. Construction costs, exacerbated by inflation and higher interest rates, have made new development prohibitively expensive. “The supply side is cooperating,” Nadji observed, as existing properties gain value simply because competition from new inventory is limited.
This dynamic is playing out differently across various asset classes. Apartments and retail properties are thriving, while older, functionally obsolete office buildings continue to struggle. Nadji described retail as “the darling of the industry” right now, with optimism at a two-decade high. As shoppers return to brick-and-mortar stores and digital-native brands establish physical showrooms, retail properties are enjoying a resurgence.
Apartments, too, are benefiting from strong renter demand. Rising home prices and a lack of affordability have driven many would-be buyers into the rental market. “Affordability is at an all-time low when it comes to buying vs. renting,” Nadji said. “That points to unbelievably strong renter demand on the apartment side of the market.”
Challenges on the Horizon
Despite these bright spots, potential headwinds remain. Nadji addressed the potential impact of immigration policy on CRE. Workforce housing, which caters to a large migrant population, could face challenges if stricter deportation policies are implemented. This would particularly affect gateway markets and Class B and C apartment properties, which rely heavily on immigrant renters.
The construction industry, too, could be affected by immigration policies, as immigrant labor comprises a significant portion of the workforce. Combined with tariff discussions that could raise material costs, including lumber, these factors could further inhibit new construction.
Looking Ahead
The CRE market remains in flux, balancing optimism in key sectors with uncertainty over interest rates and broader economic policies. Nadji underscored the importance of clear communication from the Federal Reserve in helping stabilize market sentiment.
As investors navigate these crosscurrents, the fundamentals of supply, demand, and affordability will remain pivotal. Apartments and retail properties are well-positioned to weather the storm, while sectors like office will need to adapt to new realities.
Ultimately, the CRE market is adapting to a new normal, where rising rates and constrained supply create opportunities for those with patience, cash reserves, and a long-term perspective. While the road ahead is uncertain, the resilience of certain asset classes and the strategic maneuvers of investors signal a market that is down but far from out.
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