Why Fed Cuts are Fantastic for Commercial Office- 3 Reasons Why Office Space Will Outperform: Gregory Kraut, CEO KPG Funds

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Sep 20, 2024, 08:34 ET

NEW YORK, Sept. 20, 2024 /PRNewswire/ -- There is immense opportunity for Office Space to Out-Perform as the Federal Reserve lowered interest rates. This will lead to increased values of office buildings, increased Office Space Leasing and Office Supply being taken off the market. Here's why:

1. A Unique Market Reversal with the Lowering of Interest Rates

Unlike previous downturns, this CRE market correction is characterized by resilient cash flows despite falling property values. Capitalization rates (cap rates)—a key measure of CRE investment value—have adjusted, but the real question for investors is whether they have risen enough to justify the perceived risk. Gregory Kraut, CEO of KPG Funds explains "Interest rates going lower equals higher pricing for commercial buildings. Commercial buildings trade on capitalization rates which are directly tied to interest rates. Interest rates falls and capitalization rates will drop in sync."

While some may argue that CRE appears overpriced when compared to Treasury yields, it is important to remember that investment decisions should not be made based on cap rates alone. Our analysis shows that cash flows, or net operating income (NOI), remain robust, aligning with peak levels from previous cycles. We believe this resilience in cash flows and lower interest rates, will eventually lead to a rebound in valuations.

2. Robust office market demand has returned

Office leasing demand has started to increase to pre-pandemic levels. Growth sectors of the economy are heavily reliant on low interests. We have already seen a surge in leasing volume in anticipation of the cuts and tenants now see a clear path to further job growth. We expect the IPO market to reopen which will usher in a wave of capital which will lead to employee hires. We have had several recent quarters of positive leasing activity that has been on par with pre-pandemic levels.

While vacancy rates are up in some cities, high end office buildings which KPG Funds specialize in New York City are fully leased and experiencing strong growth in NOI. This disparity presents a range of investment opportunities for those who know where to look.

KPG Funds' recent developments in Soho, the Lower East Side, and other key neighborhoods exemplify this trend. The company's focus on providing state-of-the-art facilities with amenities like wellness centers, high-tech infrastructure, and aesthetic design has positioned them as a leader in meeting the evolving needs of modern businesses.

"Companies are looking for more than just office space—they want an environment that reflects their brand, values, and commitment to their employees," says Kraut. "Our approach to developing premium office spaces is aligned with these expectations, and it is why we continue to see robust interest from tenants.

While some sectors of the commercial real estate market have faced hurdles, the story in New York City is more nuanced. Gregory Kraut, CEO of KPG Funds, believes that reports of the market's decline have been greatly exaggerated. "New York City remains a global hub for business and culture, and that foundation is not easily shaken," Kraut explains. "We're seeing continued demand for quality office spaces, especially those offering top-tier amenities and a prime location."

KPG Funds, known for transforming undervalued properties into premium office spaces, has observed a distinct "flight to quality" in the market. Businesses are prioritizing spaces that not only meet their operational needs but also offer an environment conducive to innovation, collaboration, and employee satisfaction. This trend has kept demand for luxury office spaces strong, even as other segments face challenges.

3. Office Supply: A rapidly shrinking CRE class due to recent residential conversions

Office to residential conversions is taking significant office space off the market. We are trending towards a supply constrained market in late 2025 through 2026 With interest rates falling we will see increasing supply coming off the market as companies look to expand. Kraut also notes that the conversion of commercial spaces to residential units has played a role in balancing the market. With fewer commercial properties available, those that offer high-quality, well-located office space are in greater demand. This dynamic has contributed to stabilizing prices in the premium segment, even as other areas experience volatility.

"As the market adapts, we're seeing opportunities for growth, particularly in the premium office space sector," Kraut adds. "Our strategy of focusing on quality and innovation ensures that we're well-positioned to meet this demand and continue delivering value to our tenants and investors."

Conclusion: Time to Reconsider CRE Exposure - Especially in NYC!

In our view, the recent sell-off in CRE may have run its course. As the Federal Reserve cuts interest rates, we anticipate a favorable shift in the market dynamic and an outperformance in the commercial real estate office sector. stabilized property values, continued resilience in cash flows, and improving credit conditions.

We remain optimistic about the future of commercial real estate and believe that, despite the headlines, now is a time of opportunity. Learn more at KPGFunds.com.

Media Contact:

Gregory Kraut

646-665-4508

[email protected]

SOURCE KPG Funds