Fundamentals Supersede Fed’s Interest Rate Cut

Don’t expect the Fed’s recent rate cut to shake up the market too much. Interest rates have remained low for the last several years and with compressed cap rates throughout California and the nation, investors won’t likely rush into new transaction simply due to the rate cut. At the moment, fundamentals are driving investment decisions more than rates.

“Fundamentals are front and center right now,” David Pascale, SVP of George Smith Partners, tells GlobeSt.com. “Because cap rates are so low, a lot of deals are dependent on increasing income and blue-skies in the future. A project has to pencil on its own, and investors aren’t going to jump into a transaction because rates are low. Rates have been low for a long time.”

For real estate investors, the interest rate cut hasn’t had and isn’t expected to have an impact on investment activity. Instead, it is a continuation of the current market conditions. “The rate cut has lowered the floating rate index and has made capital cheaper for real estate investors; however, it isn’t having a material impact on cap rates because it was expected,” says Pascale. “Cap rates have compressed nationwide to a point where it is almost impossible to get positive leverage on any well located stabilized asset even in today’s low interest rate environment.”

While the recent interest rate cut didn’t come as a total surprise—many people were expecting the quarter-point cut—it was a total reversal in the Fed’s strategy last year. “The Fed is always trying to avoid mistakes of the past.  There have been times that they have kept rates high for too long and choked off recoveries or started recessions,” says Pascale. “After a series of nine rate increases starting in 2015, they decided to do an insurance cut or mid-cycle adjustment by lowering the discount rate a quarter point.”

The Fed is also seeing some warning signs on the horizon, and the decrease in rates was a response to both domestic and global trends. “We are starting to see the stimulus effects of the 2017 tax cut start to wane,” says Pascale. “There was an initial burst of growth attributable to the cuts, and that is starting to wind down. There are also some troublesome signs in Europe, particularly in Germany’s industrial output. These storm clouds, including the tariffs and potential trade wars, are worrying the Fed as far as their future outlook.”

While the Fed had telegraphed the cut, many investors were expecting more than the quarter-point cut, and so far the markets have not responded well to the difference. “The Fed had so heavily telegraphed a cut that it was priced into markets along with further rate cuts,” says Pascale. “When something like that is priced in and then taken away, the market often reacts negatively as all assets then need to be marked to market.”

However, with some stormy economic indicators, it could be hard to predict the Fed’s future moves. “Many were expecting either a half-point cut or an indication that more cuts were on the way,” says Pascale. “The Fed gave a single rate cut and implied it was an isolated event, not the first of many. The markets have reacted very negatively. The volatility has been exacerbated by the latest trade disputes and tariffs. I think that it is important because it seems like some of the escalating trade tensions are forcing the Fed’s hand to keep cutting rates. I expect to see one more quarter point rate cut this year.”