Real Estate Is in Trouble. A Couple Rate Cuts Won't Save It
Let me explain why some minor reductions in the Fed Funds rate will not cure what ails residential and commercial real estate.
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Investors are pining for the year's first cut in the Fed Funds rate when the Federal Open Market Committee convenes in a few weeks. And with just over an 85% probability that the central bank will reduce rates at the meeting -- according to the current CME Watch reading -- they likely get what they want. But, unfortunately, a few cuts to the Fed Funds rate are not what is going to cure what ails two of the weakest components of the current economy: The residential and commercial real estate markets.
Trepp came out with its August monthly report around CRE last week. The delinquency rates for commercial-backed mortgage securities, or CMBS, continue to worsen overall. Industrial properties remain the one commercial property type that continues to have very few concerns. Delinquency rates against retail properties have improved recently but still are above 6%. Arrears rates in hospitality have stabilized but remain over 6.5%.
The situation for multi-family is starting to get more worrisome as delinquency rates shot up again last month and are nearing 7% rapidly. This is more than double the rate of 12 months ago. Then we have the real sinkhole in the CRE space, office properties. The CMBS delinquency rate rose once again to over 11.6%, an all-time record. Higher than any point in the Great Financial Crisis. Vacancy rates are improving in some major cities like the Big Apple, but remain problematic in cities like Chicago. How quickly AI starts to impact the white-collar workforce and office demand remains a major question mark. Unfortunately, with approximately $2 trillion in CRE debt needing to be refinanced at significantly higher average rates in the next three years or so; a quarter-percentage point, or half percentage point, Fed Funds reduction will only be of marginal help.
Then we have the much bigger residential real estate sector. Housing continues to deteriorate at an accelerating pace and housing affordability remains near historical lows. The average price of a new home was at a discount to the existing home average price in June and July. Something that hasn’t happened for at least a quarter century, not even during the Housing Bust.
And that doesn’t capture the impacts of the huge incentives like free upgrades and mortgage rate buydowns home builders are being forced to employ to move growing inventories. Lennar’s LEN incentive costs have come in slightly above 13% of overall sales in the first half of 2025. This is more than quintuple the rate during the boom years following the pandemic, and the highest the giant home builder has employed since 2009, right in the middle of that huge economic contraction.
Mortgage rates are likely to get little relief from a couple of cuts to the Fed Funds rate. In fact, they are solidly higher than where they were back in September of 2024, when Chairman Powell reduced rates by a half of a point right before the election. It is hard to see how average existing home prices don’t start to outright fall in the quarters ahead.
And outside of job losses, few things more negatively impact consumer confidence than Americans watching the value of one of their primary assets consistently decline. So, investors hoping that a few reductions in interest rates are going to be a panacea for the economy and the markets are likely to be disappointed in the months ahead.
At the time of publication, Jensen had no position in any security mentioned.
