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Cuts And Costs
Rate Expectations For 2024
By Jerry LaMartina

he self-storage market sentiment consensus holds that the interest rates roller coaster should take a slight dip late in the second quarter of 2024. That’s the word from Chris Sonne, executive vice president and specialty practice co-leader for self-storage for Newmark Valuation in its Irvine, Calif., office. Other self-storage experts agree that lower rates are up ahead.

Newmark surveys 50 key market players every quarter, Sonne says. Most of those recently surveyed expect the federal funds rate to decline in May or June, starting probably with a decrease of 25 basis points, or one-quarter of 1 percent.

The federal funds rate is the interest rate banks charge one another for overnight lending from cash reserves so borrowing banks can meet reserve requirements. The Federal Reserve’s Federal Open Market Committee issued a statement Jan. 31, 2024, saying it would maintain the fed funds rate’s target range at 5.25 percent to 5.5 percent. The FOMC also continues to seek maximum employment and 2 percent inflation over the longer term.

Rate Expectations For 2024
Neal Gussis, executive director of capital markets for SPMI Capital, Strat Property Management Inc.’s capital markets division, says he expects the Fed “will hold to its words” that it wants to ease and sustain inflation to a 2 percent year-over-year increase and that it expects to cut the fed funds rate three times in 2024. Cuts will affect the cost of loans based on the Wall Street prime, the secured overnight financing rate, and the Bloomberg short-term bank yield. These all move nearly parallel to the fed funds rate.

January’s core inflation rate, which excludes energy and food costs, remained at 3.9 percent, though the market had expected it to decrease, Gussis says. January’s new jobs report exceeded expectations. The unemployment rate stayed at 3.7 percent.

“It’s not hard to interpret that the economic indicators give little motivation for the Fed to lower rates during their next meeting or two,” says Gussis. “In terms of taking action to cut the fed funds rates, I do believe they will make efforts in the latter part of 2024 to keep their promises of three 0.25 percent cuts, or 0.75 percent, by year’s end. There are many industries, including the banking industry and real estate industry, that the inflated rates have greater impact upon.”

Gussis anticipates the yield inversion for the five-year to 10-year treasury curve will normalize slightly in 2024, putting the five-year yield lower than the 10-year yield. He predicts those rates will increase and decrease between 3.5 percent and 4.5 percent. Fixed-rate mortgages are typically based on the lender cost of funds and the relative risk of investment compared to U.S. treasuries. He expects most mortgage rates to be in the low 6 percent range to the mid-7 percent range.

Shawn Hill, principal with The BSC Group, based in Chicago, also expects rates to gradually decline throughout 2024. The Fed’s expected cuts to the fed funds rate should mean lower costs for variable-rate borrowers as the secured overnight financing rate and prime benchmark indexes both decrease.

“We also saw meaningful downward movement in the five- and 10-year treasury indexes in the fourth quarter, and credit spreads have also started to trend down,” Hill says. “All of this bodes well for not only self-storage but all commercial real estate borrowers if it plays out as expected. However, there is always the potential that something existential could disrupt the markets.”

The expected federal funds rate will have two aspects, according to Sonne. “Some people think the expectation is already baked into things,” he says. “But I think it’ll have a really strong effect, kind of psychologically the impact of the market momentum in general that things are on the right track, particularly if asking rates—what people are advertising on the internet—go back to a normal cadence. They’ve been so far below what existing rents are, and so everybody’s looking to March or April [for where asking rents will be and for the market’s response]. Are we going to have very low asking rents? Or are we going to have a return to normal? … If that happens, and we have lower interest rates, we’ve got a lot of good news for self-storage.”

Steve Libert, a co-founding principal of Chicago-based CCM Commercial Mortgage, says that if the Fed lowers its fed funds rate, then short-term rates should fall throughout 2024. The market expects the Fed to decrease short-term rates in June. He predicts the Fed might lower the rates by 1 percent with multiple rate cuts.

“We’re going to see a little bit of a drop this year compared to a major increase at breakneck speed,” says Libert. “When the pandemic hit, the Fed dropped the funds rate to almost zero. Then the pandemic fed inflation, caused by stimulus money and supply chain shortages. Toward the end of pandemic, the Fed took the funds rate from almost zero to 5.25 percent.”

When the pandemic brought record-low rates, self-storage owners were able to finance facilities for 3 percent to 4 percent, Libert says. He financed a couple of them just below 3 percent with 10-year money. He says that “was like catching lightning in a bottle.” Libert thinks some owners believe rates will return to that level sometime soon. But, barring a financial crisis or disruptive world event, he says rates won’t fall that low for self-storage owners “for a long time.”

The current rates range from 6.5 percent to 7.5 percent to refinance or sell facilities that are mature and stabilized, but loans for construction financing are more expensive and harder to get because new facilities need time to lease up and generate cash flow to service their debt.

“Those rates seem high only because we’re looking in the rearview mirror at 3 and 4 percent rates,” Libert says. “And rates went up so quickly. They may come down into the 5s if we’re lucky.”

On the operating side of the equation, because self-storage’s condition is closely tied to the housing market, when that market improves, self-storage demand, rental rates, and occupancies will follow suit, Libert adds.

Rate-Rise Mitigation
Gussis notes that borrowers with variable-rate loans pay higher interest rates. They can mitigate that by converting to a fixed-rate loan, lowering their loan amount, looking into a swap instrument in the treasury management group of their bank, or trying to get a commercial mortgage-backed security loan. Borrowers should also look for prepayment flexibility to keep the cost of prepayment predictable and manageable if they try to refinance when rates are more attractive.

“As with almost anything in life, there is usually not a perfect loan that gives you the best of all terms, so borrowers need to choose what the rankings are of the loan terms that are of most importance,” says Gussis.

Hill says the best way to mitigate negative effects of interest rates is to “be strategic in your decision-making regarding the duration and structure of debt that is used to support your transactions.” Capitalization rates for storage have risen in the past year but remain lower than interest rates. Negative leverage can only last so long.

“If you are planning to buy or refinance a property, be conservatively certain in your debt underwriting to ensure that the leverage and upside in the deal [are strong],” says Hill.

Borrowers sometimes seek a six-month extension as opposed to a total refinancing, Sonne says. Some extensions require less paperwork and no appraisal. People will sometimes accept that with higher interest rates they’ll have negative cash flow for a year or two. This can make deals “work and flow,” though they have to put more money into the project.

Libert says buyers and sellers simply must adjust their expectations when interest rates rise.

Bearish Or Bullish?
Sonne, Gussis, Hill, and Libert all express optimism about self-storage’s prospects, even if interest rates stay high. The sector has proven its recession resistance more than any other class of commercial real estate.

Self-storage “has weathered many a storm, and barring some unforeseen black swan, I think the worst of this one is behind us,” Hill says.

Jerry LaMartina is a freelance reporter and editor based in Shawnee, Kansas.