CRE Valuation Uncertainty Threatens Private Equity Real Estate Model

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Falling commercial real estate (CRE) valuations have been a persistent challenge, impacting refinancing and mortgage covenants. Jim Costello of MSCI Research highlighted that the uncertainty around asset valuations and limited partners’ ability to access capital are risks to the U.S. private equity real estate model, especially with gated withdrawals at some open-end CRE funds.

During the pandemic, ultra-low interest rates and increased liquidity led to a surge in CRE investments, driving up prices. However, rising inflation and higher interest rates later caused valuations to drop, affecting private equity firms. Despite using advanced models, there were significant variations in asset value assessments, creating opacity in the market.

MSCI data showed that the U.S. had the worst performance globally, with a -6.8% difference between appraised values and sale prices. This situation echoed past concerns about inflated valuations in the 1990s at Prudential Insurance. While no misconduct was implied, Costello noted that during falling valuations, managers might be incentivized to delay revealing asset value drops.

Further data showed central business district office appraisals had fallen 43%, while transaction prices dropped 51%, suggesting the need for more transparency through third-party validation methods for limited partners.

 

Source:  GlobeSt.

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Where Commercial Foreclosures Are Surging

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Commercial foreclosures are on the rise in Florida as borrowers continue to face significant challenges.

In September, the state saw 70 commercial foreclosures, up from 47 the previous year, with 538 foreclosures reported by late 2024. This marks a notable increase from the record-low figures seen in 2020, according to real estate data provider Attom.

The uptick in foreclosures is largely attributed to higher interest rates, which have increased monthly payments for many borrowers with adjustable-rate mortgages. Additionally, those with expiring low-rate loans are finding it difficult to refinance at current, higher rates. Development site owners are also struggling, as the combination of rising interest rates and elevated construction costs has made it challenging to move forward with projects as their land loan maturity dates approach.

Attom’s report highlights that while commercial foreclosures are rising nationwide, they have not yet reached the levels seen in previous years. In Florida, foreclosures peaked at over 880 in 2015.

 

Source:  OBJ

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Fed’s Unclear Interest Rate Signals Hinder CRE Trading

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Uncertainty surrounding the direction of interest rates has been a major challenge for commercial real estate (CRE) trading momentum, according to Hessam Nadji, CEO of Marcus & Millichap, during an appearance on Yahoo! Finance.

Private individual investors, high-net-worth individuals, and small partnerships, who make up the majority of CRE ownership, are highly sensitive to interest rate changes. When the market anticipates lower interest rates, sellers tend to hold off, waiting for better values. Conversely, if rates are expected to rise, the opposite occurs, Nadji explained.

“It’s critical for the Federal Reserve to communicate clearly,” he said. “Looking forward, the market is starting to accept that we won’t return to the low levels seen in the previous cycle. While inflationary pressures are easing, they aren’t disappearing, so the Fed’s ability to aggressively lower rates will be limited.”

Commercial real estate values have decreased since peaking in March 2022, and many investors are now using cash to secure properties they’ve been eyeing, with plans to arrange financing when rates fall further, according to Nadji. He also emphasized the importance of the 10-year Treasury yield in driving CRE lending, noting that its recent rise to 4.5% has significantly influenced market sentiment.

“The optimism stems from corrected valuations, steady job growth that doesn’t challenge the Fed, and a combination of these factors alongside the scarcity of new supply,” Nadji added. “Building new developments is costly, so the supply side is in alignment with current market conditions.”

Turning to the potential effects of President-elect Trump’s proposed immigration policies, Nadji identified two key concerns. First, a large migrant population traditionally supports workforce housing rentals, so deportation efforts could negatively impact gateway markets and Class B and C apartment properties. Additionally, changes to immigration policy might affect the construction labor force in the U.S. However, Nadji suggested that the actual implementation of these policies might not match the aggressive scope outlined during the campaign.

Nadji also touched on the impact of tariffs on U.S. trading partners, which could influence supply chains and material costs, including lumber, for new construction.

Overall, while older, outdated office buildings continue to face challenges, Nadji highlighted that the retail and apartment sectors are performing well. Retail, in particular, is seeing a surge in optimism, with a two-decade high driven by the return of consumers to stores and digital brands creating physical showrooms.

“Retail is the industry’s current darling, and apartments are thriving,” said Nadji. “Homeownership affordability is at an all-time low compared to renting, leading to exceptionally strong demand for rental apartments.”

 

Source:  GlobeSt.

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Treasury Yields May Keep Rising And That Is Worrisome

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You’ve managed to stay afloat through property challenges, avoided an immediate refinance, and waited things out. Then, the Federal Reserve made its third interest rate cut this fall, bringing hope that a little more relief might be on the way.

But recently, the Fed has signaled it will likely slow the pace and timing of rate cuts in 2025. This is unwelcome news for those seeking bridge or construction loans.

What does this mean for commercial real estate (CRE) mortgages? If T. Rowe Price Chief Investment Officer of Fixed-Income Arif Husain’s outlook holds, there may be more bad news ahead. In a recent report, Husain pointed out that U.S. fiscal expansion and potential tax cuts, coupled with a strong economy, are likely to push Treasury yields higher. He predicted that the 10-year yield could hit 5% by the first quarter of 2025, with the possibility of rising to 6%. This past Wednesday, the 10-year yield climbed to 4.5%, a level not seen since May 2024.

Rising 10-year yields signal greater risk-free long-term returns, which will likely lead lenders to increase CRE mortgage rates.

Husain identified six factors contributing to higher rates, but overall, he believes four of them will outweigh the other two.

The first four factors supporting higher rates are:

  1. U.S. fiscal expansion: With a budget equaling 7% of GDP and the Trump administration pushing for tax cuts, reducing the deficit seems nearly impossible. This will force the Treasury Department to issue large volumes of debt, which, when combined with similar actions by other countries, will flood the market. The increased supply of bonds will create pricing competition, and as bond prices drop, yields will rise.
  2. Decreased foreign interest in Treasurys: Countries like China and Japan have been reducing their holdings, leading to diminished demand. This reduced demand, alongside the increased supply of bonds, will lower bond prices and drive yields higher.
  3. A healthy U.S. economy: There is little indication of an imminent recession, meaning the economy is unlikely to cool down enough to reduce yields.
  4. Potential for inflation: While the Fed expects inflation to cool to 2% by 2027, tax cuts could inject too much capital into the system, raising prices. Additionally, tariffs could have a regressive effect, making goods more expensive.

However, there are two factors that could temper this outlook:

  1. Fed bank regulation guidance: New regulations could boost demand for Treasurys by banks, which might absorb some of the slack in demand, supporting prices and controlling yields.
  2. Political uncertainty and Fed actions: The political landscape has cleared with the upcoming election, and there are concerns about the Fed becoming less independent. This could encourage the central bank to slow or even stop quantitative tightening, potentially restarting bond purchases.

Despite these counterarguments, Husain concludes that longer-term Treasury yields are likely to rise, steepening the yield curve as the economic and fiscal conditions continue to evolve.

 

Source:  GlobeSt.

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CRE Braces For 2025 Amid Conflicting Predictions On Market Stability

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As 2025 approaches in less than two weeks, there’s growing pressure to make definitive predictions about the future of commercial real estate—its direction, timeline, and the potential winners and losers. However, this is a challenging task that may not have a clear answer. While some signals may suggest pessimism or optimism, a more measured approach involving planning and flexibility could be the best strategy.

From a pessimistic perspective, Bloomberg’s outlook reflects a sense that doom is catching up with the commercial real estate sector.

Tim Mooney, head of real estate at Värde Partners, stated, “I look at 2025 as a year of reckoning,” predicting that lenders and borrowers will realize that lower interest rates won’t provide relief.

There are certainly challenges in the market, as over 10% of CMBS loans for office buildings are delinquent. Many real estate owners have used short-term debt with interest-only payments and large balloon payments due later, which could pose significant issues as rising borrowing costs reduce valuations. Bloomberg also referenced data from MSCI showing average declines of 23% for offices and 20% for residential buildings since 2022.

However, this data, from March 2023, is now outdated, as the market has changed significantly since then. The comparisons to 2022 also fail to account for the inflated values from that period, driven by a flood of capital seeking higher returns than fixed-income investments. Furthermore, CMBS data represents only one aspect of the broader commercial real estate landscape.

On the other hand, recent data offers a more optimistic view. A report from Moody’s highlighted an increase in bank loan modifications, often referred to as the “extend-and-pretend” practice. For U.S. banks with over $100 billion in assets, the percentage of loan modifications rose in the third quarter of 2024. Specifically, banks with assets between $100 billion and $700 billion saw a 61% increase in modifications, and even smaller banks experienced substantial jumps. While this reflects added risk, it does not suggest a market on the brink of collapse.

Additionally, Valley National Bank recently sold nearly $1 billion in CRE loans to Brookfield Asset Management at only a 1% discount, a move that doesn’t suggest desperation. Nathan Stovall from S&P Global Market Intelligence noted that while there has been some purging of portfolios, the losses are modest, with only 5% to 10% haircuts on portfolios.

While some property owners may need assistance in 2025, this will not apply to the entire market. Much of the negative news is based on percentages of total loans, not the number of loans or properties themselves. There is still plenty of potential in commercial real estate, making next year an ideal time for careful planning and attention to economic developments.

 

Source: GlobeSt.

 

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Net Lease Investors Eye Cross-Border Opportunities And New Property Types In 2025

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The net lease market is set for change in 2025, with investors focusing on geographic expansion, new property types, and economic factors. While the U.S. remains a key market, international opportunities, especially in Mexico, are gaining attention. Tyler Swann, managing director of investments at W. P. Carey, highlights increased sale-leaseback and build-to-suit opportunities as more manufacturers set up in Mexico.

Swann is also exploring markets like Canada and new property types. “Data centers are drawing more interest due to high capital needs,” he says, while emphasizing W. P. Carey’s focus on long-term leases with single tenants. Healthcare properties in prime locations are another potential investment for 2025.

Interest rate volatility remains a key concern, impacting asset pricing and strategies. Swann notes that despite uncertainty, public REITs like W. P. Carey are less sensitive to rate fluctuations, allowing them to close deals in volatile environments.

 

Source:  GlobeSt.

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Bank CRE Loan Modifications Keep Climbing

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According to a recent report from Moody’s Ratings, banks have continued making loan modifications into the third quarter of 2024. Over the past nine months, the median percentage of commercial real estate (CRE) loans to non-owner-occupied (NOO) borrowers—measured by the number of loans rather than the total dollar value—rose by 65 basis points for total NOO CRE loans.

The Federal Reserve’s recent rate cuts have provided “little opportunity for refinancing at reduced rates,” making it likely that loan extensions will continue to help prevent loans from becoming delinquent and avoid banks having to write them down, as noted by Moody’s.

Stephen Lynch, vice president and senior credit officer at Moody’s, shared with GlobeSt.com that the firm examined data from around 65 rated banks in the first round of the report, but only 39 banks disclosed relevant information. The banks did not typically report the exact number of loans modified. When disclosed, it was often a small number of loans modified, as noted by Lynch.

Moody’s reviewed financial reports for U.S. banks with more than $100 billion in assets, along with any banks that had a notable level of CRE relative to their tangible common equity. The data covered the first nine months of 2024, through September 30.

The report showed a 35% increase in the median percentage of loans modified from 48 basis points in the first half of 2024 to 65 basis points over the first nine months. This was a smaller jump than the previous year, when the change from six months to nine months saw a 50% increase, from 18 basis points to 36 basis points.

Banks with more than $100 billion in assets showed some notable differences in loan modification trends. Those with assets between $100 billion and $700 billion, and those with less than $100 billion, experienced varying results. The middle group, with assets ranging from $100 billion to $700 billion, had a 61% increase, rising from 120 basis points to 193 basis points. The largest banks saw a smaller increase of 14%, from 69 to 79 basis points. Meanwhile, the smallest banks experienced the largest percentage increase—217%—from 10 to 32 basis points.

While the sharp rise in loan modifications among the smallest banks might raise concerns, they also had the smallest share of modified loans. In contrast, the largest banks had the smallest increase in loan modifications and the smallest overall percentage of modifications, possibly due to the larger size of their loans. The middle-sized banks, however, had the largest share of loan modifications at 193 basis points and the second-largest percentage increase.

Lynch emphasized that these trends are important to monitor alongside other key factors, such as capital, profitability, asset quality, funding, and liquidity, which are also critical to assessing the health of banks.

 

Source:  GlobeSt.

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South Florida Commercial Foreclosures Increase In 2024

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South Florida has seen a surge in commercial foreclosure lawsuits this year, as the industry grapples with multiple challenges.

According to the Business Journal’s 2024 Biggest Foreclosures list, there were 25 commercial foreclosure lawsuits filed in the past 12 months, each involving at least $2 million. These cases, filed up until October 30, include only those that were not dismissed or settled. Additionally, four more lawsuits exceeding $2 million were filed but were too small to be included on the list. This marks a significant increase from the 2023 list, which featured just 17 lawsuits, with a smaller proportion seeking large sums. Last year, only one case exceeded $30 million, while this year, six cases have surpassed that threshold.

A key factor contributing to this rise is the ongoing impact of high interest rates. Many borrowers with adjustable-rate mortgages are facing increased payments, and refinancing loans at higher rates has become more difficult, particularly for those with low-rate loans set to expire. For property developers, the combination of high interest rates and rising construction costs has made it harder to move forward with projects, especially as the maturity dates of land loans approach. Financial troubles at some parent companies of loan sponsors have also added to the pressure.

In terms of property types, office buildings were the most common target for foreclosure lawsuits, making up eight of the top 25 cases. Development sites followed with seven lawsuits, while multifamily properties accounted for four.

Not every foreclosure lawsuit results in the loss of property. Of the top 25 lawsuits, only four have resulted in borrowers losing control of their properties. Many other cases have been resolved through settlements or dismissals, allowing the borrowers to retain ownership. These include cases involving Jade on Bay LLC for apartments in North Miami, West Boynton Auto Services for an automotive building, BWSR Real Estate and former Miami Dolphins player Brandon Marshall for an athletic club in Weston, Orengo Investments for apartments in Opa-Locka, and Boynton Partners for condos in Boynton Beach.

 

Source:  SFBJ

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CRE Optimism Abounds For 2025, But Distress Challenges Remains

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As 2024 draws to a close, the mood in the commercial real estate (CRE) market has shifted toward optimism, fueled by favorable macroeconomic trends, supportive financial policies, and signs that a new growth cycle is underway, according to Crexi’s Q3 National Commercial Real Estate Report.

“Our industry is incredibly resilient, and sentiment has improved over the past quarter, despite some ongoing challenges,” said Eli Randel, chief operating officer of Crexi. “Market sentiment is as influential as the numbers themselves, and we’re optimistic about an even stronger 2025.”

The Federal Reserve’s interest rate cuts are expected to have a significant impact on the CRE sector, particularly by reducing borrowing costs, stimulating refinancing activity, and encouraging new investments. While economic uncertainty persists, Crexi notes that signs suggest the market has reached its bottom, with early indications of growth in CRE. Along with strong buyer engagement on its auction platform, the firm reports that bid-ask spreads have narrowed since the second quarter, marketing periods have shortened, and capital raising efforts are beginning to recover.

In Q3, overall buying activity increased across all asset types, with industrial rising by 5.5%, office by 5.93%, retail by 4.87%, and multifamily by 4.97%. Offers for properties also saw an uptick, signaling that serious buyers are making moves. On the leasing side, tenant activity showed a slight decline across most sectors, with industrial tenant activity experiencing the largest drop.

Key highlights from Crexi’s report include:

  • The median annual asking rent per square foot for industrial properties remained stable at $13.20 from Q2 to Q3 2024. However, the median annual effective rent per square foot rose from $9.50 to $12, suggesting a possible reduction in leasing incentives, which reflects landlord confidence in the industrial sector.
  • Office tenant activity indicators fell by 2.63% quarter-over-quarter but saw a 1.59% year-over-year increase. This annual rise may indicate that companies are reassessing their space needs, balancing remote work with in-person collaboration as the value of office presence becomes clearer.
  • The median annual asking price per square foot for retail properties saw a slight decrease, dropping from $282.60 in Q2 2024 to $287.37 in Q3 2024. This could be attributed to minor market adjustments, even as retail demand remains strong.
  • Multifamily median annual asking prices remained steady at about $170 per square foot, while the median closed price per square foot increased from $208.17 to $212.71, suggesting strong buyer demand is driving sale prices higher despite sellers holding firm on their pricing.

“Fundamentals remain relatively solid, with supply for most property types largely under control,” said Randel. “However, certain markets and property types may be slow to recover, or may not recover at all. As more favorable pricing emerges, there could be an increase in distressed transactions, providing an opportunity to clean up balance sheets and offload troubled assets.”

Crexi also notes that approximately $2 trillion in CRE loans are set to mature over the next two years, with office properties accounting for nearly one-third of this maturing debt, followed by multifamily, retail, and industrial assets.

 

Source: GlobeSt.

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CRE Investors Evaluate Distress Signals

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A rise in distressed assets often signals that a real estate market is starting to overheat. According to experts at Kidder Mathews, the largest independent commercial real estate firm on the West Coast, a closer look at specific trends can provide clues about the future of commercial real estate prices and what to expect.

Challenges in Multifamily Investments

Apartments have long been a favored investment, but tighter margins and economic headwinds are creating challenges, particularly in the value-add multifamily segment. This has raised concerns about a potential increase in distressed assets.

Nathan Thinnes, Senior Vice President at Kidder Mathews, notes that “property liens are the canary in the coalmine.” He explains that vendors are often the first to be unpaid, and there has been a noticeable rise in accrued liens, especially in the multifamily sector. Over the past decade, syndicators have driven up prices in the value-add multifamily segment to levels 10 times higher than those seen during previous cycles. Combined with rising housing costs and an affordability crisis, this has resulted in higher eviction rates and increased vacancies, leading to bad debt. Thinnes highlights that higher interest rates are also forcing operators with high asset bases to struggle with cash flow.

Kidder Mathews Vice President of Research Gary Baragona states that office properties make up nearly 50% of distressed assets, with retail at 20% and apartments at 14%, according to Real Capital Analytics. He adds that the rate of distressed asset growth has slowed since late 2022, with the total value of distressed commercial real estate now roughly half of what it was during the peak of 2010.

Pricing Uncertainty in a Changing Market

In response to the Federal Reserve’s decision to lower interest rates in September, investors are grappling with new questions about the pricing of real estate assets, especially as distressed properties enter the market.

Thinnes explains that many assets, particularly commodity office buildings and value-add multifamily properties, will likely go through foreclosure, which could result in lower, more manageable asset prices.

Peter Beauchamp, Senior Vice President at Kidder Mathews, observes that the slower-than-expected rise in distressed assets is partly due to lenders being more willing to offer loan modifications or extensions based on the asset class. With an estimated $300 billion in commercial real estate loans maturing soon, it’s uncertain how quickly these loans will be worked through. Beauchamp also notes that upcoming changes in administration could delay the release of these assets if regulatory restrictions are eased.

Valuation Adjustments and Lending Conditions

Randy Clemson, Executive Vice President of Valuation Advisory Services at Kidder Mathews, points out that while there is still limited distressed work in the appraisal space, one notable exception is multi-tenant office buildings and back-office facilities, which have seen value drops of up to 75% in some cases. Due to the negative impact of appraisals on loan values, special servicers typically avoid ordering them unless absolutely necessary. Instead, asset managers tend to rely on broker price opinions and extend loan terms by 12 months.

Additionally, while the Federal Reserve has lowered rates, bank lending rates have not followed suit, and the 10-year Treasury yield has risen by more than 80 basis points since September. This has contributed to a lack of cap rate decreases, which are essential for improving the profitability of real estate investments.

Darren Tappen, Senior Vice President at Kidder Mathews, suggests that any hopes for a more favorable cap rate environment to assist in workout solutions are diminishing. However, he emphasizes that capital remains available for a market reset, as does the support of Kidder Mathews.

 

Source:  GlobeSt.

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