Federal Reserve interest rate cuts may help reverse the trend for commercial real estate. However, investors should tread carefully if entering the market. A half-point cut in central bank policymakers last month “signals the beginning of the end of the worst CRE downturn since the Global Financial Crisis,” Wells Fargo said in a Sept. 25 note. “Lower interest rates aren’t a magic bullet, but less restrictive monetary policy is setting the stage for a commercial real estate recovery,” wrote senior economist Charlie Dougherty. “Falling long-term interest rates appear to be easing upward pressure on top rates and slowing declines in property valuations. Meanwhile, heightened expectations for a smooth economic landing are giving the green light for capital to move away,” he said. added. There are some bumps in the road. On Monday, the yield on the 10-year note rose above 4% for the first time since August after Friday’s better-than-expected jobs report. Bond yields move inversely to prices. One basis unit equals 0.01%. Fed funds futures trade suggests a roughly 84% chance of a rate cut at the Fed’s next meeting in November, while no one expects another half-point cut, according to the CME FedWatch Tool. Of course, there’s no shortage of hurdles ahead in the market, particularly for office space, Dougherty said. “Thus, lower interest rates will prevent the spread of anxiety and shorten the roadblocks,” he added. Lower refinance rates for borrowers Companies that extended mortgage deals through the higher interest rate environment will see some relief and eventually be able to refinance at lower rates, said Douglas Gimple, senior portfolio specialist at Diamond Hill. His firm’s Short-Duration Bond Fund (DHEIX) has about 25% of its portfolio in non-agency commercial mortgage-backed securities, as of Sept. 30. Gimple said. “It’s not going to happen overnight, as we know that when the Fed takes action — whether higher or lower — it takes some time to work through the system.” He believes investors can find value now by focusing on a bottom-up process. “If you can find the rough diamonds that have been hit from a pricing standpoint because of their relationship with commercial real estate, then you can find some really good opportunities,” he said. “You just have to be careful.” Know what you’re buying Investors need to understand what their managers are buying, or if they’re investing themselves, understand what they’re buying, he said. Gimple is particularly fond of single-asset, single-borrower CMBS and commercial real estate loan obligations. The former, as the name suggests, involves an asset — such as a high-end hotel — or an individual borrower, which may be a multi-location hotel chain. The latter are short-term, floating-rate deals and are typically entered into by a company to upgrade a property, such as installing a swimming pool or energy-efficient air conditioning in an apartment complex, he said. Any investment will also always depend on the transaction, Gimple said. For example, he’s not buying office space in Los Angeles or New York, but he might look at a deal in the suburbs. He would look at offices that are class A, which are usually the most modern and have an occupancy rate of 95% with a variety of passengers. Inside hotels or lodging, he looks at “trophy” properties in areas like Miami or Hawaii. “It’s not really about the hotel, it’s about the location,” Gimple said. It also looks at single-family rentals and industrials, as well as retail to some extent. Any CMBS holdings should simply be part of a diversified fixed-income portfolio that includes credit and government bonds, he said. “It depends on the risk appetite that will determine what kind of allocation they should look at,” Gimple noted. “You’re being disinterested as an investor if you’re just avoiding an entire part of the market because you read the headlines. There are still opportunities.”