Rate relief - What today’s interest rate decision means for commercial real estate

The Bank of Canada cuts its overnight lending rate to 4.5%

Will this second 25 basis point interest rate cut inspire confidence across a cautiously muted market? This is the question that has dominated the headlines put forth by Canadian media outlets leading up to today’s interest rate announcement from the Bank of Canada (BoC).

The BoC’s decision to lower the overnight interest rate by 25 basis points to 4.75% on June 5th marked the first cut in four years and the first sign of relief from the ‘higher for longer’ interest rate environment that brought the commercial real estate (CRE) market to a collective pause. While this decision provided some boost in sentiment across consumers and investors alike, optimism remained cautious in anticipation of July’s announcement. For weeks, signs have seemingly pointed to another cut – predictions that were further bolstered by Statistics Canada’s report that Canada’s consumer price index decelerated in June to an annual rate of 2.7%. With inflation cooling from its previous rate of 2.9% in May, unemployment increasing to 6.4%, and the Bank of Canada’s business outlook survey indicating subdued expectations for inflation, a second rate cut seemed imminent.

The BoC’s decision to lower its overnight lending rate by an additional 25 basis points today sends an important message: the BoC is continuing its easing cycle ahead of major central banks. If this trend continues as expected, additional cuts before the end of the year should provide Canadian consumers with long-awaited rate relief and inject confidence back into the market.

Will this cut mark a turning point for CRE in Canada?

Following June’s rate cut announcement, the BoC indicated that further cuts could be expected if efforts to curb inflation remained on target. In June, headline inflation came in at 2.7%, and although that remained at the higher end of the BoC’s 1.0-3.0% target range, the core measure (excluding food, energy, tobacco, and mortgage rates) came in at 1.6%. Along with an increase in unemployment, Canada’s retail sector showed a 0.8% decrease in sales compared to the previous month, further indicating a softening economy and a wary consumer landscape in the face of high costs for goods, services, and housing. In this environment, back-to-back rate cuts provide welcome relief – but is that relief of the tangible variety, or psychological?

“Rate cuts from the Bank of Canada are important signals to the market, but typically these decisions have minor economic consequences in the short-term,” explains Peter Norman, Head of Economic Consulting at Altus Group. “The broader implications of interest rate decisions – whether positive or negative – take months to materialize in the market. Initially, the impact of these rate cuts is a psychological one.”

The BoC’s June rate cut did not initiate a frenzy of activity in the market; if anything, we observed an uptick in inventory while transaction activity remained muted. Similarly, this second interest rate cut is meaningful not because it will immediately spur action across the housing and CRE market, but because it signals that rates are trending down. While there is sure to be some activity led by capital-rich investors who are eager to make deals before the market inevitably picks up again, most investors and aspiring homeowners appear to be waiting for rates to lower and stabilize further before initiating any transactions.

“An interest rate cut changes expectations for where interest rates are going, which influences the decision-making process,” adds Norman. “Whether you’re thinking about embarking on a commercial real estate transaction, or you’re deciding whether to move forward on a project, your decisions right now will be largely predicated on psychology. So, the pace of rate cuts is important – subsequent rate cuts signals the Bank of Canada is no longer holding and are moving quickly towards bringing interest rates back into balance, which inspires optimism in the market moving forward.”

What’s important for commercial real estate is a stable interest rate environment, and now that the market knows the hold is over, we can reasonably conclude that we are moving towards a new, stable point.

Will the Bank of Canada continue to cut?

By in large, the market seems to anticipate an additional rate cut in the fall, as long as inflation continues to decline. According to Reuters, two more rate cuts could be expected in 2024, although only a “slim majority of economists” are forecasting a policy rate of 4.00% by the end of this year. At the same time, the MNP Consumer Debt Index dropped six points from the previous quarter to 85 points, with two-thirds of respondents saying they desperately need interest rates to go down. Much of this interest rate anxiety may be attributed to encroaching fixed-mortgage rate renewals – next year, roughly $300 billion of mortgages at chartered banks will reportedly come up for renewal, which could spell trouble for homeowners if rates do not continue on a downward trajectory.

“The Bank of Canada’s decisions later this year will be undeniably influenced by what’s happening in the US,” notes Raymond Wong, Head of Data Solutions at Altus Group. “If our interest rate decisions don’t align with the US, our dollar is at risk. Right now, the US has favourable data for rate cuts, but the upcoming election may impact economic policy over the next 6 months which, in turn, influences our outlook as well. An inflationary environment in the US puts upward pressure on bond yields in the US, which limits Canada’s ability to continue cutting rates.”

In the wake of today’s decision, expectations remain cautiously optimistic as we look ahead to the rest of the year. The easing cycle is gradual, but it’s moving in a favourable direction for CRE investors waiting in the wings for a more stable and enticing transaction landscape that is likely to shape early next year.

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