Commercial real estate (CRE) investors have patiently waited for the tide to turn. Many have weathered the storm of rising interest rates, held off refinancing when costs soared, and navigated challenging lending environments. The Federal Reserve’s recent rate cuts — three this fall alone — seemed like a light at the end of the tunnel. Yet, for those hoping for more relief in 2025, the road ahead just became more uncertain.
The Fed has signaled it will slow the pace of rate cuts next year, leaving bridge and construction loans as expensive propositions. For those holding out for lower costs on CRE mortgages, the situation may soon worsen. According to T. Rowe Price Chief Investment Officer of Fixed-Income Arif Husain, Treasury yields are expected to climb higher — potentially reaching 5% in early 2025 and possibly 6% thereafter.
Already, the 10-year Treasury yield has hit 4.5%, its highest level since May 2024. Rising Treasury yields, which are often seen as a barometer of risk-free long-term returns, have a direct impact on CRE mortgage rates. As yields climb, lenders are compelled to increase borrowing costs to maintain competitive returns. For CRE investors, this could mean tighter margins and more challenges in executing deals or refinancing loans.
Why Are Treasury Yields Rising?
A combination of six key factors is driving the current trajectory of Treasury yields, with most pointing toward sustained increases:
Expanding U.S. Fiscal Deficit
The U.S. federal budget deficit, now at 7% of GDP, continues to grow. The incoming Trump administration has pledged tax cuts that could further widen the gap, leaving little room to reduce the deficit. As a result, the Treasury Department must issue significant amounts of new debt, flooding the market with bonds. This increase in supply forces bond prices down, driving yields higher.
Decreasing Foreign Demand for Treasurys
Countries like China and Japan, historically large buyers of U.S. Treasurys, have been reducing their holdings. With fewer foreign buyers, demand for Treasurys weakens. As demand falls and supply rises, bond prices decline, further boosting yields.
A Resilient U.S. Economy
Unlike in prior years, the U.S. economy shows few signs of an imminent recession. Strong economic activity supports higher yields as investors anticipate continued growth, which can sustain inflation and higher borrowing costs.
Inflation Concerns
While inflation has cooled in recent months, there’s a risk it could reignite. Tax cuts from the Trump administration might inject excess capital into the economy, while tariffs could act as a regressive tax, raising the cost of goods. The Federal Reserve projects that inflation may not fully stabilize at its 2% target until 2027.
Two factors could mitigate this upward pressure, but they are unlikely to reverse the overall trend:
●Increased Bank Demand for Treasurys Recent guidance from the Federal Reserve on bank regulations may encourage financial institutions to buy more Treasurys, helping absorb some of the supply and tempering yield increases.
●Potential Federal Reserve Intervention Speculation about reduced Fed independence under the Trump administration could lead to changes in monetary policy. If the Fed slows or halts quantitative tightening — or even resumes bond purchases — it could support bond prices and help keep yields in check.
Implications for Commercial Real Estate
For CRE investors, rising Treasury yields spell trouble. Higher yields lead directly to increased borrowing costs, affecting everything from acquisitions to refinancing. The steepening yield curve could also signal a shift in lender behavior, as they prioritize higher-yielding government securities over riskier CRE loans.
Bridge loans and construction financing, already expensive, may become even less accessible. Investors holding maturing loans may face limited refinancing options, forcing them to either inject additional equity or sell assets at a discount.
The uncertainty surrounding inflation and fiscal policy further complicates the CRE recovery. Investors betting on continued Fed rate cuts or a softening lending market may find themselves out of step with reality.
Navigating the Road Ahead
While the rising yield environment presents challenges, investors can take steps to mitigate risks:
●Focus on Stable Asset Classes: Properties in sectors like industrial and multifamily, which continue to show strong demand, may weather the storm better than retail or office spaces.
●Lock in Rates Early: Refinancing sooner rather than later could save money if Treasury yields continue to rise.
●Explore Alternative Financing: With traditional lenders tightening standards, private equity and other non-bank sources may offer more flexible terms.
●Monitor Economic Indicators: Staying informed about inflation, fiscal policy, and Fed activity will help investors anticipate changes in the lending environment.
The road to recovery for commercial real estate remains complicated, and rising Treasury yields add another layer of uncertainty. But by staying vigilant and adapting to shifting market dynamics, investors can position themselves for success in a challenging environment.
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