Home Insights Real estate What’s after “higher for longer?”
page assignment hero

What’s after “higher for longer?”

A reversion to the mean is supportive of real estate credit

October 17, 2024 | 3 min read
Kirloes Gerges
Managing Director, Portfolio Management, Principal Real Estate Debt
Troy Kort, CFA
Portfolio Manager, Principal Real Estate Investors
Download PDF

At-a-glance

In this paper we explore whether interest rates are likely to stay higher for longer or revert to the mean—and the impact it could have on real estate credit returns.

  • Between Q4 2008 and Q4 2021, the standard benchmark interest rate averaged 0.5%. Rates have never been lower than during that period.
  • SOFR began rising at the beginning of 2022 and reached a 23-year high of 5.32% in Q4 2023. This is a period some call “higher for longer.”
  • Considering the longer historical time period (1987 to present), when the standard benchmark interest rate averaged 3.24%, the most recent SOFR and SOFR forward curve look more like a reversion to the mean.
  • The forward curve suggests the 1M Term SOFR rate will settle in the 3% range, which is good for real estate credit investors.

Where are interest rates headed? “Higher for longer” appears to be behind us, and the market is projecting a reversion to the mean—not a return to the near zero interest rate environment. While no one can predict the future, we believe that any of the likely interest rate scenarios bode well for investors.

“Higher for longer” has been the mantra in investment circles since Q4 2023, when the Secured Overnight Financing Rate (SOFR) reached a 23-year high. Taking into account only the period since 2009, higher for longer does seem like an accurate characterization of the recent interest rate environment. Looking forward, “higher for longer” will only persist if inflation reports occur that are a surprise to the upside.

The market is now pricing in a soft landing as the highest probability outcome, with a mild recession remaining a decent possibility. The Federal Reserve has started cutting rates, and the forward curve has SOFR settling around the long-term (1987 to present) standard benchmark interest rate average of 3.24%. If that’s correct, a reversion to the mean is a more accurate characterization of the rate outlook. This scenario, however, still presents opportunities for investors—higher returns than Q4 2008-Q4 2021, when SOFR averaged 0.5%. Other ancillary benefits for mean reversion include better loan metrics at origination, such as debt service coverage. Transactions should likely uptick as well as equity investors test the market and become more confident in their underwriting.

While the SOFR forward curve loses reliability beyond six to 12 months out, it is the accepted benchmark to give us a sense of where interest rates are headed. Acknowledging there are many market forces that affect SOFR, at the time of this writing (September 24, 2024), this is what we’re seeing in the market.

Higher for longer?

SOFR reached a high point of 5.32% in Q4 2023. This comes on the heels of a 13-year period (Q4 2008-Q4 2021) often referred to as “lower for longer,” during which SOFR averaged 0.5%.

Looking between now and 2030, the SOFR forward curve is expected to settle around 3%. That is lower than 2023- 2024 but still significantly higher than the Q1 2019 peak of 2.43% and the Q4 2008-Q4 2021 average of 0.5%. Based on the Q4 2008-Q4 2021 period in isolation (see Exhibit 1), “higher for longer” may be an accurate characterization of the interest rate environment for the foreseeable future, when compared to the most recent credit cycle.

EXHIBIT 1: Plotting SOFR from Q4 2008 makes the recent period look “higher for longer”

SOFR from Q4 2008 increasing till current day and staying high for the next 5 years
Source: CE Benchmark Administration Limited (IBA); Moody’s Analytics, Q2 2024.

Opportunity for attractive returns from real estate credit

If the current SOFR forward curve is accurate and interest rates revert over the next two years to their long-term mean, it is not likely to have a major impact on investor returns for the next several years. We feel the real estate credit opportunity will persist into the next several years and that investors should have confidence in real estate credit for some time to come.

Footnotes

Data is current as of the time of this writing, September 24, 2024.
Real estate
Disclosure

For Public Distribution in the United States. For Institutional, Professional, Qualified, and/or Wholesale Investor Use Only in other Permitted Jurisdictions as defined by local laws and regulations.

Risk Considerations
Investing involves risk, including possible loss of Principal. Past Performance does not guarantee future return. All financial investments involve an element of risk. Therefore, the value of the investment and the income from it will vary and the initial investment amount cannot be guaranteed. Potential investors should be aware of the risks inherent to owning and investing in real estate, including value fluctuations, capital market pricing volatility, liquidity risks, leverage, credit risk, occupancy risk and legal risk. All these risks can lead to a decline in the value of the real estate, a decline in the income produced by the real estate and declines in the value or total loss in value of securities derived from investments in real estate. Private credit involves an investment in non-publicly traded securities which are subject to illiquidity risk. Portfolios that invest in private credit may be leveraged and may engage in speculative investment practices that increase the risk of investment loss. Investments in Private Credit may also be subject to real estate-related risks, which include new regulatory or legislative developments, the attractiveness and location of properties, the financial condition of tenants, potential liability under environmental and other laws, as well as natural disasters and other factors beyond a manager’s control.

Important information
This material covers general information only and does not take account of any investor’s investment objectives or financial situation and should not be construed as specific investment advice, a recommendation, or be relied on in any way as a guarantee, promise, forecast or prediction of future events regarding an investment or the markets in general. The opinions and predictions expressed are subject to change without prior notice. The information presented has been derived from sources believed to be accurate; however, we do not independently verify or guarantee its accuracy or validity. Any reference to a specific investment or security does not constitute a recommendation to buy, sell, or hold such investment or security, nor an indication that the investment manager or its affiliates has recommended a specific security for any client account.

Subject to any contrary provisions of applicable law, the investment manager and its affiliates, and their officers, directors, employees, agents, disclaim any express or implied warranty of reliability or accuracy and any responsibility arising in any way (including by reason of negligence) for errors or omissions in the information or data provided. All figures shown in this document are in U.S. dollars unless otherwise noted.

This material may contain ‘forward looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

Integration of sustainability considerations and/or environmental, social and governance (ESG) factors is qualitative and subjective by nature. There is no guarantee that the criteria used, or judgment exercised, will reflect the beliefs or values of any particular investor. There is no assurance that any strategy or integration of sustainability considerations and/or ESG factors will be successful or profitable. This material is not intended for distribution to or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.

This document is issued in:

  • The United States by Principal Global Investors, LLC, which is regulated by the U.S. Securities and Exchange Commission.
  • Europe by Principal Global Investors (Ireland) Limited, 70 Sir John Rogerson’s Quay, Dublin 2, D02 R296, Ireland. Principal Global Investors (Ireland) Limited is regulated by the Central Bank of Ireland. Clients that do not directly contract with Principal Global Investors (Europe) Limited (“PGIE”) or Principal Global Investors (Ireland) Limited (“PGII”) will not benefit from the protections offered by the rules and regulations of the Financial Conduct Authority or the Central Bank of Ireland, including those enacted under MiFID II. Further, where clients do contract with PGIE or PGII, PGIE or PGII may delegate management authority to affiliates that are not authorised and regulated within Europe and in any such case, the client may not benefit from all protections offered by the rules and regulations of the Financial Conduct Authority, or the Central Bank of Ireland. In Europe, this document is directed exclusively at Professional Clients and Eligible Counterparties and should not be relied upon by Retail Clients (all as defined by the MiFID).
  • United Kingdom by Principal Global Investors (Europe) Limited, Level 1, 1 Wood Street, London, EC2V 7 JB, registered in England, No. 03819986, which is authorized and regulated by the Financial Conduct Authority (“FCA”).
  • This document is marketing material and is issued in Switzerland by Principal Global Investors (Switzerland) GmbH.
  • United Arab Emirates by Principal Investor Management (DIFC) Limited, an entity registered in the Dubai International Financial Centre and authorized by the Dubai Financial Services Authority as an Authorised Firm, in its capacity as distributor / promoter of the products and services of Principal Asset Management. This document is delivered on an individual basis to the recipient and should not be passed on or otherwise distributed by the recipient to any other person or organisation.
  • Singapore by Principal Global Investors (Singapore) Limited (ACRA Reg. No. 199603735H), which is regulated by the Monetary Authority of Singapore and is directed exclusively at institutional investors as defined by the Securities and Futures Act 2001. This advertisement or publication has not been reviewed by the Monetary Authority of Singapore.
  • Australia by Principal Global Investors (Australia) Limited (ABN 45 102 488 068, AFS Licence No. 225385), which is regulated by the Australian Securities and Investments Commission and is only directed at wholesale clients as defined under Corporations Act 2001.
  • Hong Kong SAR (China) by Principal Asset Management Company (Asia) Limited, which is regulated by the Securities and Futures Commission. This document has not been reviewed by the Securities and Futures Commission.
  • Other APAC Countries/Jurisdictions, this material is issued for institutional investors only (or professional/sophisticated/qualified investors, as such term may apply in local jurisdictions) and is delivered on an individual basis to the recipient and should not be passed on, used by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.

Principal Global Investors, LLC (PGI) is registered with the U.S. Commodity Futures Trading Commission (CFTC) as a commodity trading advisor (CTA), a commodity pool operator (CPO) and is a member of the National Futures Association (NFA). PGI advises qualified eligible persons (QEPs) under CFTC Regulation 4.7.

Principal Funds are distributed by Principal Funds Distributor, Inc.

© 2024 Principal Financial Services, Inc. Principal®, Principal Financial Group®, Principal Asset Management, and Principal and the logomark design are registered trademarks and service marks of Principal Financial Services, Inc., a Principal Financial Group company, in various countries around the world and may be used only with the permission of Principal Financial Services, Inc. Principal Asset Management℠ is a trade name of Principal Global Investors, LLC. Principal Real Estate is a trade name of Principal Real Estate Investors, LLC, an affiliate of Principal Global Investors.

3863228 -122025
About the author