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Commercial real estate transactions slowed considerably in 2023, amid high interest rates, declining values and pricing uncertainty.
Investment volume declined by 42% in 2023 from the prior year, according to CBRE Group Inc. (NYSE: CBRE). The Dallas-based commercial real estate firm is expecting deal volume to be down again in 2024, but by a more modest 5% year over year.
Richard Barkham, global chief economist and global head of research at CBRE, said there’s been “enormous excitement” since the 10-year Treasury yield recently dropped, to about 4%. Combined with the Federal Reserve’s signaling of some interest-rate cuts next year, that should propel more commercial real estate transactions in 2024.
“There are still some issues we will need to contend with,” Barkham said, adding the Fed still wants to see a lower rate of inflation, and economies in the rest of the world are also slowing. “We’ve found it very difficult to forecast and be accurate on inflation. It’s not impossible we’ll get another inflation upside surprise,” he added.
CBRE is forecasting an average 10-year Treasury yield of 3.3% between 2025 and 2028. That will likely result in more deal volume in the medium term rather than in 2024, though transactions are likely to start picking up in the second half of 2024, Barkham said.
CBRE isn’t predicting a recession in 2024 but expects the economy to slow, with a projected unemployment rate of 4.5% — up modestly from the rate of 3.7% last month — and the inflation rate to cool to about 2.7% by the end of 2024.
Next year will also have a closely watched U.S. presidential election. Barkham said he wasn’t sure what impact that will have on commercial real estate activity but, he added, during very contested elections, the market tends to slow about three months before Election Day.
Rebecca Rockey, deputy chief economist and global head of forecasting at Cushman & Wakefield plc (NYSE: CWK), in an email said last week’s Fed announcement was largely expected and doesn’t meaningfully shift the Chicago-based commercial real estate firm’s perspective for 2024. There’s also still uncertainty about inflation and no guaranteed path for the federal funds rate, she added.
“So, as the Fed stated, it is too soon to declare victory,” Rockey continued. “I think there is a temptation to place too much emphasis on the Fed pause and pivot. Certainly, it will add much needed clarity, but the fact remains that we are in the midst of a broader adjustment process to higher costs of capital, and that will persist well after the Fed’s pivot and throughout their cutting cycle.”
Still, she said, Cushman is predicting commercial real estate transaction momentum to gain steam through next year and into 2025 as the economy and interest-rate picture becomes clearer. That’ll allow for greater conviction in underwriting income and exit assumptions, Rockey said.
Tim Bodner, real estate deals leader at PricewaterhouseCoopers LLP, said there’s new optimism among real estate investors since the Fed’s announcement last week. The economy is also holding up fairly well, with inflation coming down and the consumer and labor market overall resilient, he added.
“All of these things provide a really nice backdrop for … the commercial real estate market,” Bodner said.
But it’s inevitable a looming wave of debt maturities will need to be addressed, and most who track the commercial real estate industry closely expect an uptick in distress and foreclosures in 2024. Moody’s Analytics Inc. estimates there will be $182 billion in commercial real estate debt maturing next year.
The office market will continue to be closely watched next year, in particular as debt matures on troubled properties.
Bodner said challenges observed in the office market right now are similar to what’s been seen in the mall sector in recent decades. There are also a number of properties that don’t have the right capital structure, Bodner added, which will trigger distress — and it won’t be immune to just office.
So far, loans facing issues at maturity in commercial real estate have largely been dealt with through loan extensions and modifications. Barkham said it’s likely banks are going to be a little more firm next year in how they handle financially strained properties after mostly soft pedaling in 2023.
“The banks always go easy in the periods of real uncertainty but, oddly enough, as (there is) greater certainty about the trajectory about the economy and about a soft landing, I think they’re going to want to deal with some of those loans that are very underwater,” Barkham said, adding a marked uptick in office building foreclosures is likely next year.
Rockey said office is likely to struggle because underwriting absorption or rents is very difficult for that sector in today’s market, and pricing is still disconnected from the higher rate environment.
“However, opportunistic capital is eager to see distressed or discounted sales even in this sector,” she added. “It just needs to be the right price.”
While more deals in the distressed space is expected among commercial real estate economists, there’s not likely to be an avalanche of transactions in that world, Bodner said.
Investors ‘look selectively’ at CRE deals
Some major commercial real estate players are sharpening their pencils to figure out which deals will make sense in 2024.
Alfonso Munk, Americas chief investment officer at Houston-based Hines, said during the recent economic and real estate turmoil, his firm has selectively continued to invest, particularly in property types like retail, medical office and student housing.
But Hines has historically been a major traditional office player, with Munk estimating the firm manages close to $30 billion in office assets. The firm has pulled back significantly on its investment in office, having only bought one office property in the U.S. in 2023, an 11-story building in downtown Washington, D.C., for nearly $60 million in April.
“I think you’ll see a re-shift, like we saw in retail, where the demand is going to be there, but it’s going to be focusing on the best office (buildings) and locations,” Munk said.
And despite the buzz last week around the Fed’s intention of cutting interest rates next year, Munk said Hines isn’t yet counting on rates going down in its underwriting assumptions, which means a lot of deals still won’t pencil.
He said he’s also closely tracking the labor market in 2024, as well as which markets are starting to get crowded and could be at risk of being oversupplied — places like south Florida; Austin, Texas; and Denver, according to Munk.
But metros like Tampa, St. Petersburg and Orlando in Florida; Charlotte, Raleigh and Durham in North Carolina; and Dallas are interesting because of their employment growth and infrastructure investments, such as the Brightline train that connects Miami and Orlando, Munk said.
“We look selectively at markets,” he continued. “You have to go where the barriers to supply are, (where there’s) not as much hype and you can still find value.”
Financial institutions still largely don’t want to own or manage a lot of real estate, and that might prompt lenders to continue to extend loans, even on troubled assets, he added.