As the Federal Reserve reaches a point of inflection regarding future policy decisions, commercial real estate markets are watching closely. Potential rate cuts will affect borrowing costs, cap rates and sentiment.
But the real force keeping today’s markets “stuck” isn’t Chairman Jerome Powell’s next move—it’s psychology. Cap rates and deal volume are shaped more by confidence, fear and groupthink than by Fed policy. Waiting on the Fed risks paralysis; those who understand sentiment are best positioned to act.
The Fed as a Backdrop
Still, the Fed sets the stage. Its dual mandate—price stability and maximum employment—makes policy inherently complex. July’s CPI held at 2.7% year-over-year while core CPI rose to 3.1% on sticky services costs. PPI rose at its fastest pace in three years, even as payroll growth slowed and unemployment edged higher. Tariffs add another layer, keeping wholesale prices hotter than consumer prices and complicating the timing for cuts.
Even the Fed’s 2% inflation target should be revisited. Born in the 1990s (established by the Bank of Canada and later adopted by the Fed) as an anchor for expectations, it was never meant as a hard rule. Treating it as sacrosanct risks keeping policy overly restrictive even as inflation moderates risks keeping policy overly restrictive even as inflation moderates.
Inside the Fed, rare dissent has emerged: Governors Christopher Waller and Michelle Bowman both broke ranks in July, each calling for a 25-basis-point cut but for different reasons. Waller urged looking past tariffs, warning labor markets can “turn fast” if policy stays too tight, while Bowman pointed to slower growth and fragile employment.
With the Fed’s direction unsettled—inflation still above target, labor risks rising, internal dissent mounting and Powell nearing the end of his term—CRE investors should treat policy as backdrop: influential, but not the deciding factor in whether deals get done.
Market Psychology
Commercial real estate cycles rest on market fundamentals, but their turns are often accelerated or prolonged by the collective perceptions of buyers and sellers. When enough market participants expect values to rise or fall, that belief can become self-fulfilling—a form of groupthink amplified by fear or optimism. Unlike stocks or bonds, commercial real estate markets are more vulnerable to these swings in sentiment.
While value-add investors sometimes push against the current by forcing appreciation through operations, most hesitate when confidence fades. Deals will always reflect distinct motivations—tax planning, business needs or unique investment criteria—leaving transaction-level pricing uneven without sustained market conviction. What has changed is the speed at which conditions shift. In today’s data-saturated environment, markets can pivot on a headline or a few words from Powell. Confidence, more than fundamentals, increasingly sets the tone—a fragile dynamic unlikely to reverse. Filtering through the noise of armchair economists and LinkedIn “experts” is harder than ever, but discipline in sticking to fundamentals and sound theses is what will set commercial real estate professionals apart.
Cap Rates and Stuck Markets
The effect of psychology is clear in deal activity. Altus Group reports 33,200 CRE parcels traded in Q1 2025 for $69.3 billion—down 8% year-over-year in transaction counts and 12% in dollar volume, though quarterly declines slowed to just 2%–5%. By comparison, activity peaked at 74,178 parcels and $318.4 billion in Q4 2021, sliding to $90.9 billion by Q1 2023.
Yet capital isn’t idle. More than $350 billion in dry powder sits on the sidelines, including $63 billion raised three to five years ago and now facing deployment deadlines. With investor redemptions mounting, funds must put money to work or risk losses. The fundamentals for deals exist—it’s sentiment, not just rates, keeping markets stuck.
That’s because cap rates are shaped more by capital flows and psychology than by Fed funds. A cap rate blends debt costs and equity returns. Both are influenced by interest rates, but neither is directly tied to Fed policy. Fed moves mostly hit the short end of the yield curve, pressuring floating-rate borrowers immediately and fixed-rate borrowers only at refinancing.
History reinforces this disconnect. Correlations between cap rates and Fed funds swing from positive to negative depending on the cycle. Institutional investors often move first, bidding more aggressively if they expect compression—not necessarily because borrowing costs changed, but because they believe others will follow. Psychology, in other words, rivals policy as the immediate driver of valuation.
What Rate Cuts Really Do
If the Fed does cut, the math is modest. A property producing $100,000 in NOI is worth $1.25 million at an 8% cap rate. If cap rates compress to 7.5%, the value rises to $1.33 million—an $83,000 gain. Helpful, but hardly transformative compared to the weight of tenant health, operating expense inflation and lease rollover. Defaults, for instance, are driven by cash flow health, not by a 25- or 50-basis-point swing.
The bigger effect is psychological. Cuts signal liquidity and relief, prompting investors to act. Often, markets price in the expectation before cuts arrive—meaning the sentiment boost hits first.
The Investor’s Playbook
Winning strategies don’t depend on Fed guessing. They rest on fundamentals:
- Cash flows and tenants. A resilient tenant mix matters more than a moderate swing in borrowing costs.
- Local supply and demand. Vacancy, absorption and new deliveries drive NOI growth.
- Scenario planning. Underwrite exit cap rates with discipline. Test what happens if they expand 50–100 basis points.
- Debt management: Structure financing with flexibility—don’t rely on rate cuts to save overleverage.
In short, successful commercial real estate investing today is not about predicting the Fed’s next move—it’s about disciplined fundamentals. For example, an investment group might target “industrial, high-bay, Class B properties in tertiary suburban markets with below-market rents.” That thesis doesn’t rely on Fed action. It rests on improving occupancy, managing rollover and capturing yield in overlooked submarkets. In uncertain times, discipline and local knowledge consistently outperform chasing the crowd.
Be the Motivator
The market isn’t broken—it’s just selective. Higher rates, stickier operating expenses and tougher underwriting make deals harder, but not impossible. A correction still looms, yet transactions are happening at the right price.
The takeaway for commercial real estate is clear: Don’t wait for the Fed to “jumpstart” your business. Markets move when participants choose to move. Be the motivator—the psychological difference-maker who unsticks deals and pushes transactions forward.
Waiting is not a strategy. Conviction is. And conviction means helping clients and partners see the whole picture, giving them the confidence to act when others hesitate.