Robin Marshall
Luke Lu
- As the Fed begins an easing cycle, an important element in the easing is the transmission mechanism of interest rate cuts, notably via real estate, in the post-Covid economy.
- But divergence between commercial real estate (CRE) and house prices creates complexity for the economy and monetary policy. CRE is more sensitive to financing availability while house prices are boosted by lower supply and population growth.
- The impact of lower rates on housing and CRE may be less predictable than in previous cycles. This is both because of structural shifts in demand since Covid, between housing and CRE, and because the dynamics of the two property markets may evolve differently.
It is well known the CRE sector has suffered severe weakness since Covid, particularly in the office sector, which has been hit hard by the increase in working from home (WFH) and the decline in occupancy rates.[1]
CRE a major casualty in the GFC, as well as housing
Despite the common narrative that the GFC was caused by a sub-prime mortgage crash, CRE prices actually fell more than residential housing prices during the GFC, as a dysfunctional financial system effectively shut down financing for CRE loans and the deep recession crushed demand. This created the worst CRE downturn since the S&L crisis in the early-1990s, as Exhibit 1 shows.
Exhibit 1: CRE and house prices
CRE now faces another major structural downturn
Exhibit 1 also shows that in the early stages of Covid, CRE prices fell, as economic uncertainty reduced demand and the retail and hotel sectors were effectively shut down, while in contrast, house prices barely moved. And this divergence continued in 2022-23, when the Fed began raising rates in March 2022.
US house prices have escaped largely unscathed, exposing fundamental differences between the two sectors
Since Covid, US house prices have benefited from increased demand for WFH and low supply, as homeowners on low coupon fixed rate mortgages were effectively locked into existing mortgages, as rates rose, and refinancings collapsed. In contrast, CRE has suffered not only from refinancing difficulty due to higher interest rates, but also the structural shifts on e-commerce and working-from-home.
[1] See More trouble in the office – can the Fed save the CMBS maturity wall?, LSEG, August 2024.
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