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Stop Worrying About a Fed U-Turn and Focus on Scenario Planning

Commercial real estate’s fascination with the central bank and its Federal Open Market Committee’s interest rate decisions is understandable. From the upward march of interest rates to their crest and down again to rate cuts, everyone wants to know when financing costs might change.

But there’s been growing uncertainty, like rising 10-year yields. Some economists revising inflation predictions for Trump’s second term, warnings over the debt ceiling, and a rising special service rate.

Across business and the economy broadly, James Mackintosh at The Wall Street Journal wrote that investors are weighing the question of how the Fed might respond, including whether a U-turn could lead to rate increases. The question they posed was not of what the coming Trump administration might do, but how the Fed might respond to conditions, based on how the agency has responded in the past

But trying to predict what might happen is more like a parlor game pastime than a practical course of action for owners, developers, and investors. A better response would be to develop thorough scenario planning and a series of alternative strategies for options that address different outcomes.

Scenario planning involves maintaining multiple courses of action, if necessary, depending on future conditions. The most basic version involves documentation of three different business cases — conservative, likely, and optimistic. At a time of volatility, this allows you to navigate uncertainty and shifting market conditions,

As software vendor Lobby CRE describes it, scenario planning can help enhance decision-making by providing a framework to analyze the implications of different conditions and choices.

Often scenario planning focuses on what a company might do differently, or how varying responses to regular courses of action might play out. First, you identify key variables that you think could affect performance, whether of a single property or a portfolio of assets. Then set the assumptions for those variables, like assuming rental rates will rise by 3% in the year or that insurance costs could jump by 15%.

You can also, though, choose key variables that are more macroeconomic in nature, like inflation and interest rate changes. Look at how these figures would affect refinancing, net operating income, cash flow, and more.

Create scenarios where the Fed lowers interest rates a couple more times, keeps everything flat, or even raises rates once or twice. With advanced modeling software, this becomes relatively easy to model and calculate across each scenario. It may seem like busywork but once set up, it is swift in execution and allows a CRE company to operate as conditions change without obsessive focus on constant small shifts.

Reprinted with permission from the Thursday, 16 January 2025 06:45:14 EST online edition of GlobeSt © 2025 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-256-2472 or reprints@alm.com.