Industry observers say it will take more than one rate cut to help resolve troubled office debt, but this week’s expected Fed moves could be the beginning of a sea change. iStock illustration

Interest rate cuts are on the way but the way they impact banks will likely vary, experts say.

The Federal Reserve is widely expected to lower interest rates at its next meeting on Sept. 17 and 18. With rates currently at 5.25 percent to 5.50 percent and it is projected that cuts will be to the tune of 25 to 50 basis points.

For Colliers’ Boston-based U.S. capital markets research director Aaron Jodka, these interest rate cuts have been a long time coming.

“Investors have been anxiously waiting for them to actually begin,” Jodka said, noting investors will see even a 25-basis-point cut as a sign that rates have peaked. “It should have a positive impact. It won’t be an instant, snap your fingers and all of a sudden all these deals start to transpire but it is the first step in the market recovery and the resumption of investment volume gains.”

Keith Reagan, executive director at Boston banking consultancy Darling Consulting Group, believes that the impact on banks will depend on their overall strategy and balance sheet makeup.

“There are going to be banks able to lower their funding costs faster than others,” he said. “There will be others that will be less likely to do so and more reluctant to do so for a variety of reasons. They might have [a] different strategy. They might have a different equity position. They might be in a different market with different competition.”

“That [interest rate] trajectory is a really good backdrop for investors, as well as vacancy rates and businesses,” he said. “I can borrow at a different rate, potentially borrow more in the future however it will structure, that should allow for additional growth. So lower interest rates should be a stimulant to the economy, and should ultimately drive additional demand, job growth ,and shore up fundamentals over time. It’s a part of the puzzle, it’s not the only piece, though.”

 Office Obstacles

But for the troubled or repeatedly extended office loans sitting on some banks’ books, any Fed cut this week won’t be immediately helpful in letting office property owners afford to refinance, said David O’Connell, a strategic advisor at Boston banking and payments consultancy Datos Insights.

“The rates went up in an order of magnitude measured by the hundreds of basis points,” he said. “In the last several quarters, they’ve declined by a magnitude measured in tens of basis points.”

Part of the problem is that many of the Boston class B and C properties that traded hands in recent months did so for 30 percent to 50 percent less than their pre-pandemic sale prices thanks to high vacancy rates in the office market that have hammered buildings’ income across the market.

“That means that the underlying cash flows from them have declined by roughly that amount so if the ability for a property to service its underlying loan goes down by 40 or 50 percent, 18 [basis points] on the interest rate isn’t going to do anything,” he said.

A 25- to 50-basis-point interest rate cut won’t help the office-building market, said Ian Brandon, chief commercial officer at Cambridge Savings Bank..

A Chance for Refis?

With the rise of remote or hybrid work environments during the COVID-19 pandemic, what individuals want from their employers regarding a work environment has shifted. According to Colliers research, Boston’s overall office availability rate sat at nearly 24 percent as of mid-year.

“We have seen an increase as [it] relates to the general return to the office, but the whole way in which we all view the workplace has changed. Office vacancy is still down about 30 percent from where it was pre-pandemic,” Brandon said. “ Even some of the most positive figures that I’ve seen look out to, say, 2030 [where] we’d still be about 13 percent off of where we were prior to the pandemic. It’s a result in the complete rethinking of how people now work.”

Still, this week’s expected interest rate cut should be the start of a process that will provide some relief to lenders who have office loans on their balance sheets, said Jodka.

“If I’m a borrower, and I have a loan maturing later this year and my interest rates down 25 basis points, it certainly helps if we can now start to project lower interest rates,” he said. “Depending on which source you look at, the expectation is that interest rates will continue to fall and could fall by 75 to 100 basis points over the next handful of meetings that the Fed holds barring some recession or something in exogenous shock, so to speak. The lower I can get interest rates, the easier it is to refinance, to put in the equity to ultimately make that loan whole, and so to speak, live to fight another day”

And even if banks are able to whittle down their troubled office debt in this manner, Jodka said he doesn’t expect a series of rate cuts to put banks in a position to get involved in the commercial real estate market at a higher rate. He expects that non-bank lenders to be the main driver in the market going forward.