Commercial real estate investors, owners and occupiers all have been monitoring whether the Federal Reserve will impose interest-rate cuts in 2024 after rapidly rising rates have substantially increased the cost of doing business.
Earlier this month, the Fed signaled it needed to see more progress toward its inflation target of 2% and decided to maintain its key lending rate. At that meeting, Fed Chairman Jerome Powell said gaining greater confidence around inflation “will take longer than previously expected,” although he also said he felt inflation would move back down in 2024.
For executives in commercial real estate, waiting for those rate cuts may prolong the uncertainty being felt in the market today.
Mark Roberts, managing director of research at Dallas-based real estate investment and development firm Crow Holdings, said the underpinnings of why the Fed hasn’t cut interest rates — a strong economy and labor market — are actually good fundamentals for commercial real estate.
He added that for many buyers and sellers of real estate, a reset to the new rate environment has already begun, noting that values are down on average 22% in the past seven quarters. That’s unlocked some deal momentum, but cumulative transaction volume in the first quarter of this year was still at its lowest level since 2013, according to Altus Group. It estimated $31.6 billion transacted across major property types in the U.S. in the first three months of the year, down 28% compared to the same quarter last year.
“The other side of the coin is, what does it mean for those who utilize a lot of leverage in their investments?” Roberts said. “For leveraged buyers, it’s not necessarily the best time, and that’s why a lot of dry powder is stacking up.”
Others in commercial real estate echoed that sentiment, saying there’s a lot of capital sitting on the sidelines that hasn’t yet been deployed — waiting, in large part, for more certainty in the broader U.S. economy.
At the end of 2023, when the 10-year Treasury rate had dropped to below 4% and borrowing rates began to stabilize, there was a greater sense of optimism that that capital raised would be put to work sometime this year, said Andrew Alperstein, partner at PricewaterhouseCoopers LLP’s financial markets and real estate group. But a stronger-than-expected economy this spring has dampened some of the optimism around any forthcoming rate cuts.
Still, even if cuts were to occur later or are more modest than previously expected, Alperstein said most real estate principals have accepted that a sub-3% environment isn’t coming back anytime soon and have begun re-pricing within the new market conditions.
“There’s a reality that has set in that rates are going to be at least moderately higher for a period of time, and investors will hopefully move forward on that premise,” Alperstein said. “What we’ve also seen is that sellers have not really been wanting to sell unless they had to. Folks have been watching closely for evidence of distress sales and forced sales — and yes, we’ve seen some, but not as many as people probably thought. We’ve got an interesting couple of quarters ahead.”
Buyers right now are generally motivated because of equity that’s available, Alperstein said. And more borrowers may be forced to make decisions on their CRE-backed loans if a higher-than-longer rate environment persists.
But more deals in general will mean broader confidence in the market on what the new norm is in returns and values, Alperstein said.
“That will hopefully be a positive thing,” he said. “I think we hoped we’d get this sooner, but some of the uncertainty around rate cuts and the increase in the 10-year [Treasury rate] has slowed that progress.”
Ripple effect on leasing decisions
Although a delay in interest-rate cuts arguably has the most direct impact on commercial real estate buying and selling, it’s also factoring into how companies think about their real estate leasing decisions.
Rob Kane, senior executive vice president and co-leader of Dallas-based Lincoln Property Co.’s corporate advisory and solutions group, said the cost of capital and interest rates ripple through most every significant decision among the occupiers with which his firm works.
“If rates are higher for longer, it means continued uncertainty around decision making,” Kane said. “Internally, it means their business is more expensive to run, and I think we’re seeing, in certain cases, a lot of focus on capital containment and preservation. It’s very difficult for a [chief financial officer] to make a long-term decision when they have uncertainty around long-term rates.”
The past four years have been marked by uncertainty around real estate decisions by companies large and small, with many opting to sign short-term renewals as they figure out how much space they need in a post-pandemic world that embraces hybrid work. Some of that uncertainty has begun to ease, with a greater number of office tenants signing longer deals and relocating to newer towers, but a higher-for-longer rate environment may mean other companies will continue to prolong more-permanent space decisions.
It’s become common for companies to take less square footage in higher-quality office buildings, Kane said. He added that while some tenants will opt to delay their decision-making in an effort to cull spending during a higher-for-longer market, others will try to seize opportunity now.
“There are a significant number of companies … that will be able to make decisions and are going through the process to take advantage of the volatility to trade into higher-quality assets,” Kane said. “I think you’re going to continue to see that playing out across the country.”
That, in turn, will have wide-ranging effects on lenders and owners, Kane said, including accelerating the amount of distress facing lower-quality properties, which tenants are leaving in favor of newer buildings.
Impact on new construction
Since the Fed began increasing interest rates in 2022, new construction across major commercial real estate sectors has slowed.
Industrial construction starts dropped for the sixth consecutive quarter, to less than 40 million square feet breaking ground in Q1. For 2024, CBRE Group Inc. previously forecast that multifamily starts would fall by 45% this year from their pre-pandemic average and by 70% from their 2022 peak.
Office, the most challenged commercial real estate sector, has seen new-construction groundbreakings decline for five consecutive quarters, according to Jones Lang LaSalle Inc. In Q1, JLL recorded less than 300,000 square feet of office construction starts, the lowest total in nearly 40 years of data.
As the cost of financing remains higher than where it’s been recently, and traditional CRE lenders remain more tepid in their lending to the sector, that’ll continue to dampen the future pipeline for most property types, including traditionally hot ones like multifamily and industrial.
“The returns that developers need to target are just not going to be achievable with the cost of financing and the cost of construction and the availability of financing,” Alperstein said. “As we look out 24 months, there’s going to be a window of time there where there will be very little new supply hitting the market, and that will most likely be positive for the fundamentals of multifamily, industrial and even some retail.”
Roberts said persistently higher interest rates will mean the next real estate cycle will shift into a new equilibrium in supply and demand, where structural occupancy rates will be higher than where they’ve been in recent years,
In industrial real estate, for example, the long-term occupancy rate in the past 20 years has hovered about 93%, but the long-term average will start to move higher, closer to 97%, Roberts said. That overall is a good thing, to sustain the warehouse market’s investment environment, he added.
Some owners and developers will continue to turn to new or alternative financing mechanisms to get deals done — including new construction, experts say.
“There is capital out there for creative financing,” said Brent Maier, real estate advisory leader at Baker Tilly. “It comes down to relationships and the appetite for cost. If you go to a nontraditional lender, sometimes that money can be more expensive, but if you have a good asset or a good deal, it generally pencils out if it is attractive.”
Source: SFBJ
Bond Investors Worry About Government Debt And That’s Bad For CRE
Pressure has been building over inflation expectations. When will the Federal Reserve cut interest rates? How long before CRE could return to, if not to a zero-rate policy, then closer to the pre-pandemic situation?
But another storm is on the horizon, one that some have been warning about although they’ve been largely ignored. The issue is the level of government debt, which is up to almost $34.6 trillion according to the non-partisan nonprofit Peter G. Peterson Foundation. The reason is structural factors, such as a large aging segment of the population, rising healthcare costs, and government spending that doesn’t bring in enough taxes to pay for what Congress authorizes.
Deficit spending requires more borrowing through government debt instruments as Reuters reports.
The mechanism that worries them is straightforward. There are three methods the U.S. government can use to obtain revenue to pay for its obligations. One is through taxes, but the amount brought in isn’t close to what is needed. The second is by printing money, which would eventually generate inflation. Third is borrowing, the approach the U.S. has used for generations.
Borrowing dynamics follow basic economics keeping one dynamic in mind — bond prices and bond yields move inversely. The more demand there is from those who want to lend the U.S. money by buying bonds, the lower the yield the government has to offer. The more debt the government wants to sell — that is, the more supply— the higher yields need to be to attract buyers. Also, the more the U.S. presents as a risky borrower, the greater the yield lenders/buyers will demand, and the more the government has to borrow, the riskier it seems.
Benchmark 10-year Treasury yields, now at around 4.4%, could go up to 8%-10% over the next several years, Ella Hoxha, head of fixed income at Newton Investment Management, who favors short-term maturities in Treasurys, told Reuters. “Longer term, it’s not sustainable.”
Meanwhile in some quarters concerns are reaching nightmare proportions. Jeffrey Gundlach, the CEO of investment management company DoubleLine Capital, is afraid the growing debt burden of the US government could eventually lead to a restructuring of US government debt, which would be unprecedented.
The world would likely see debt restructuring as an admission of problems and greater risk, increasing yields even more.
The bottom line for CRE: higher yields on the 10-year and SOFR — and both are strongly correlated and baselines of loan rates — would force real estate borrowing rates up.
Source: GlobeSt.
Commercial Property Insurance To Reach $6K Per Building Per Month
The U.S. is reported to lead the world in extreme weather catastrophes, and their damaging impact on commercial property is also clobbering insurance companies, leading to staggering rises in the cost of premiums in vulnerable states.
Low-risk states will not be spared. Their premiums could shoot up from $,1,935 per building per month now to $3,299 by 2030 at a 7.9% CAGR. The average premium for commercial buildings outside these states is projected to rise from $2,726 in 2023 to $4,890 in 2030 at a CAGR of 8.7%.
In 2000, the average premium for commercial buildings in a high-risk state was around $1,000. However, exposure to natural hazards in the last five years has pushed premiums on structures in the 10 highest risk states up 108% and 31% year-over-year.
It’s perhaps not surprising that California emerged as the nation’s state at greatest risk with an annual expected loss score of 100 % thanks to its exposure to drought, earthquake, heat waves, landslides, riverine flooding, and wildfire. Florida came second, scoring 98.21% due to coastal flooding, cold waves, hurricanes, lightning, and tornados. Texas ranked third (96.43%), followed by North Carolina (91.07%), Washington (89.29), South Carolina (87.5), Illinois (85.71), New Jersey (83.93), Georgia (82.14) and Missouri (80.36).
In addition to current costs of natural disasters that insurers are expected to cover, insurers have been playing catch-up from increased losses in recent years, Deloitte noted. From 1Q 2021 through 4Q 2022, the rate of growth of premiums trailed the rate of inflation. But beginning in 2023 the situation reversed, and premium increases outran inflation for three out of four quarters.
Source: GlobeSt.
These Banks Are Overexposed To CRE
Flagstar Bank and Zion Bancorporation are chief among the 67 banks in the US that are at increased risk of failure due to their commercial real estate exposures, according to a data analysis from a finance expert at Florida Atlantic University.
Flagstar Bank reported $113 billion in assets with a total CRE of $51 billion. The bank, however, only had $9.3 billion in total equity, making its total CRE exposure 553% of its total equity.
Similarly, Zion Bancorp had a total CRE of 440% of its total equity; the bank reported $87 billion in assets and total CRE of $26 billion, but only $5.8 billion in total equity.
For comparison, the Q1 2024 industry-average benchmark for total CRE exposure was 139% of total equity.
All together there are 67 banks with exposure to commercial real estate greater than 300% of their total equity, as reported in their first quarter 2024 regulatory data.
FAU measures the risk to exposure from commercial real estate using publicly available data released quarterly from the Federal Financial Institutions Examination Council Central Data Repository. Bank regulators view any ratio over 300% as excess exposure to CRE, which puts the bank at greater risk of failure.
Banks with less than $10 billion in total assets are facing similar risks due to their commercial real estate exposure. Among banks of any size, 1,871 have total CRE exposures greater than 300%, 1,112 have exposures greater than 400%, 551 have exposures greater than 500% and 243 have exposures greater than 600%.
Source: GlobeSt.
Here’s Another Capital Source Drying Up
In CRE lending, it has been depository banks mentioned as pulling back, worried about falling value of properties that would affect loan values that could undercut the bank’s assets and create regulatory danger.
According to Trepp, though, this is more than an issue for just banks. The major mortgage REITs saw their collective loan portfolios shrink by nearly 11% over the past year, as most had sharply curtailed lending and turned their sights to their problem loans, it found. The reason is that mortgage REITs typically fund relatively short-term loans with floating coupons that are designed to either improve or stabilize commercial properties, Trepp explained.
REITs aren’t regulated the way depository institutions are, but there seems to be a market equivalent of regulation. Trepp has tracked 14 different REITs that originate loans. In 2021, that group had made $49.83 billion in loans. By 2022, the total was down to $30.9 billion. The annual total fell to $4.69 billion in 2023.
The biggest seven drops in loan portfolios — that number because it captures all that saw double-digit declines — were TPG Real Estate Finance Trust (-35.83%); Ladder Capital (-18.80%); Blackstone Mortgage Trust (-18.12%); BrightSpire Capital (-16.52%); InPoint Commercial Real Estate Income (-13.30%); Granite Point Mortgage Trust (-12.60%); and ACRES Commercial Realty (-11.57%).
The second tier of cuts comprise CIM Real Estate Finance Trust (-8.38%); Ares Commercial Real Estate (-7.54%); Franklin BSP Realty Trust (-5.66%); Starwood Property Trust (-5.28%); Apollo Commercial Real Estate Finance (-3.71%); and KKR Real Estate Finance Trust (-1.87%).
The only REIT that saw growth from 2022 to 2023 was FS Credit Real Estate Income Trust, with 9.73%.
In terms of scale, the portfolios total at the end of 2023 is virtually unimportant in the entire commercial mortgage landscape of $5.6 trillion. It also isn’t representative. However, it is notable and “a solid indicator of the troubles property owners might have faced when looking for financing” that “helps explain the sharp reduction in property sales activity.” If investors can’t get financing, they’re not going to buy. And with the short end of Treasurys with yields around 5.5%, it’s a safe route to profit.
When conditions change, the companies will reenter the market. But for now, the REITs will concentrate on reducing troublesome loans and keep their cash for opportunistic investment.
Source: GlobeSt.
These Investors Are Shunning CRE
“Once-in-a-generation” is the way some big CRE fund managers have described current investment opportunities — even in office, which as a class has offered questions and doubt. Some of the funds have brought in billions for debt investment.
However, when it comes to owning property, many global investors are pulling back and showing their inner bear. Starwood Real Estate Investment Trust, which started seeing a big wave of redemption requests in late 2022, has drawn more than $1.3 billion of its $1.55 billion unsecured credit facility since the beginning of 2023 following heavy redemption requests, the Financial Times reported. Before 2023, the REIT hadn’t tapped its credit line. At the current rate, it will run out of credit and cash in the second half of this year unless it borrows more or sells more property assets, the FT says. In 2023, investors withdrew $2.6 billion from Starwood and $12.4 billion from Blackstone’s BREIT.
Part of the issue is liquidity, a point Starwood CEO Barry Sternlicht made 18 months ago during its initial big redemption crisis.
In general, CRE isn’t the best mechanism for liquidity, as shedding assets takes time. When interest rates are likely to be higher for longer than many predicted, there’s concern about being caught in maturing investments that need refinancing but can’t afford it.
There are also attending dynamics. The 10-year Treasury, even though yields have dropped since better inflation news earlier this week, still offers well over 4.3% at low risk. And money going into equities has rebounded, with the Dow Jones Industrial Average flirting with an all-time high of 40,000.
Bank of America’s fund manager survey, as reported by Investing.com, was the most bullish since November 2021. Cash levels are 4%, a three-year low. Eighty percent of the respondents still expected rate cuts in the second half of 2024 and no recession. “Furthermore, the survey shows fund managers expect the first drop in global GDP and EPS expectations since Sep 2023 as US macro pessimism jumps, although a soft landing is still the consensus,” the site wrote.
But a bull attitude in the survey doesn’t extend to CRE, the FT separately wrote. A net 28% of managers were underweight the real estate sector in May, down 13 percentage points on the previous month, according to Bank of America’s latest global fund manager survey, it reported. Allocations are at a 15-year low, which might not be surprising as CRE has thrived on a low-interest, high-leverage macroeconomic diet.
Source: GlobeSt.
Florida Governor Signs Beefed Up Live Local Act
Florida Gov. Ron DeSantis has signed a bill that amends the state’s Live Local Act, doubling down on the original law’s intent to clear red tape, spur new residential and mixed-use development and bring down housing costs.
The Live Local Act originally passed at the beginning of 2023, providing major funding and tax incentives for developers to build mixed-use and multifamily projects, overriding some local zoning regulations and banning rent control across the state outright.
But while the law was considered a major step toward addressing the state’s housing affordability crisis, local governments pushed back, implementing development moratoriums or dragging their feet on building approvals that under the new law were now strictly a matter of administrative routine without public hearings.
Disagreements over the law led the Florida legislature to double down, passing what’s being called a “glitch bill” by legislators to address the problems that arose from the original law. The new legislation, signed Thursday by DeSantis, clarifies uncertainties in the law that local municipalities had used to prevent development or extract concessions from developers.
The clarifications prevent municipalities from restricting projects up to 150% of the currently allowed floor area ratio; provides height protections for single-family neighborhoods; removes parking requirements for transit-oriented developments while reducing parking requirements by 20% for developments within half-a-mile of a transit hub; and added tax exemptions for land and common areas included in developments, not just the residential units. The law now also extends to for-sale condo units, in addition to apartments.
The new law also prohibits Live Local Act projects within airport flight paths, noise zones, and those that exceed airport height restrictions.
The Live Local Act is “the most comprehensive change to Florida’s zoning laws in decades,” said Anthony De Yurre, a land use and zoning attorney with law firm Bilzin Sumberg, in a prepared statement. De Yurre, who helped craft much of the legislation, added that developers have been “waiting for these revisions and clarifications to tweak their projects or update” their plans. “The final bill enhances the probability of Live Local Act projects getting approved, financed and built,” De Yurre said.
The new law goes into effect immediately.
Source: CoStar
Higher-For-Longer Rate Environment Means More Uncertainty For CRE
Commercial real estate investors, owners and occupiers all have been monitoring whether the Federal Reserve will impose interest-rate cuts in 2024 after rapidly rising rates have substantially increased the cost of doing business.
Earlier this month, the Fed signaled it needed to see more progress toward its inflation target of 2% and decided to maintain its key lending rate. At that meeting, Fed Chairman Jerome Powell said gaining greater confidence around inflation “will take longer than previously expected,” although he also said he felt inflation would move back down in 2024.
For executives in commercial real estate, waiting for those rate cuts may prolong the uncertainty being felt in the market today.
Mark Roberts, managing director of research at Dallas-based real estate investment and development firm Crow Holdings, said the underpinnings of why the Fed hasn’t cut interest rates — a strong economy and labor market — are actually good fundamentals for commercial real estate.
He added that for many buyers and sellers of real estate, a reset to the new rate environment has already begun, noting that values are down on average 22% in the past seven quarters. That’s unlocked some deal momentum, but cumulative transaction volume in the first quarter of this year was still at its lowest level since 2013, according to Altus Group. It estimated $31.6 billion transacted across major property types in the U.S. in the first three months of the year, down 28% compared to the same quarter last year.
Others in commercial real estate echoed that sentiment, saying there’s a lot of capital sitting on the sidelines that hasn’t yet been deployed — waiting, in large part, for more certainty in the broader U.S. economy.
At the end of 2023, when the 10-year Treasury rate had dropped to below 4% and borrowing rates began to stabilize, there was a greater sense of optimism that that capital raised would be put to work sometime this year, said Andrew Alperstein, partner at PricewaterhouseCoopers LLP’s financial markets and real estate group. But a stronger-than-expected economy this spring has dampened some of the optimism around any forthcoming rate cuts.
Still, even if cuts were to occur later or are more modest than previously expected, Alperstein said most real estate principals have accepted that a sub-3% environment isn’t coming back anytime soon and have begun re-pricing within the new market conditions.
Buyers right now are generally motivated because of equity that’s available, Alperstein said. And more borrowers may be forced to make decisions on their CRE-backed loans if a higher-than-longer rate environment persists.
But more deals in general will mean broader confidence in the market on what the new norm is in returns and values, Alperstein said.
Ripple effect on leasing decisions
Although a delay in interest-rate cuts arguably has the most direct impact on commercial real estate buying and selling, it’s also factoring into how companies think about their real estate leasing decisions.
Rob Kane, senior executive vice president and co-leader of Dallas-based Lincoln Property Co.’s corporate advisory and solutions group, said the cost of capital and interest rates ripple through most every significant decision among the occupiers with which his firm works.
The past four years have been marked by uncertainty around real estate decisions by companies large and small, with many opting to sign short-term renewals as they figure out how much space they need in a post-pandemic world that embraces hybrid work. Some of that uncertainty has begun to ease, with a greater number of office tenants signing longer deals and relocating to newer towers, but a higher-for-longer rate environment may mean other companies will continue to prolong more-permanent space decisions.
It’s become common for companies to take less square footage in higher-quality office buildings, Kane said. He added that while some tenants will opt to delay their decision-making in an effort to cull spending during a higher-for-longer market, others will try to seize opportunity now.
That, in turn, will have wide-ranging effects on lenders and owners, Kane said, including accelerating the amount of distress facing lower-quality properties, which tenants are leaving in favor of newer buildings.
Impact on new construction
Since the Fed began increasing interest rates in 2022, new construction across major commercial real estate sectors has slowed.
Industrial construction starts dropped for the sixth consecutive quarter, to less than 40 million square feet breaking ground in Q1. For 2024, CBRE Group Inc. previously forecast that multifamily starts would fall by 45% this year from their pre-pandemic average and by 70% from their 2022 peak.
Office, the most challenged commercial real estate sector, has seen new-construction groundbreakings decline for five consecutive quarters, according to Jones Lang LaSalle Inc. In Q1, JLL recorded less than 300,000 square feet of office construction starts, the lowest total in nearly 40 years of data.
As the cost of financing remains higher than where it’s been recently, and traditional CRE lenders remain more tepid in their lending to the sector, that’ll continue to dampen the future pipeline for most property types, including traditionally hot ones like multifamily and industrial.
Roberts said persistently higher interest rates will mean the next real estate cycle will shift into a new equilibrium in supply and demand, where structural occupancy rates will be higher than where they’ve been in recent years,
In industrial real estate, for example, the long-term occupancy rate in the past 20 years has hovered about 93%, but the long-term average will start to move higher, closer to 97%, Roberts said. That overall is a good thing, to sustain the warehouse market’s investment environment, he added.
Some owners and developers will continue to turn to new or alternative financing mechanisms to get deals done — including new construction, experts say.
Source: SFBJ
More Hints That The Fed Might Not Cut Rates At All This Year
The Federal Reserve usually speaks as one. But it’s a big organization with many individuals, including those with their own reputations and areas of responsibility. And some have been coming out to question how many, or if any, interest rate cuts will be on the table for 2024 at all.
Neel Kashkari, president and CEO of the Federal Reserve Bank of Minneapolis, is the most recent voice wondering what degree of cuts might be possible. He wrote about the multiple factors that were making any prediction difficult. Disinflation has “stalled,” underlying economic demand has remained strong, and monetary policy is “much tighter” than before the pandemic.
In a discussion at the 2024 Milken Institute Global Conference in Los Angeles, California, replying to questions from New York Times’ economic reporter Jeanna Smialek, he said, “Inflation seems to have gone sideways while economic growth has remained resilient. It’s led me to question is monetary policy having as much downward pressure on demand as I would have otherwise expected.”
He pointed to the housing market, which has remained “remarkably resilient” given 30-year mortgage rates up to about 7.5%. He acknowledged questions about whether the so-called neutral interest rate — the short-term interest rate when the country sees full employment and stable inflation — might be higher than what the Fed has expected. It’s a point that Vanguard has raised.
If the neutral rate was higher than Fed estimates, “Instead of two feet down on the brakes, maybe only one, or possibly not much at all,” Kashkari said.
There are multiple scenarios he offered going forward, “the most likely” being that “we stay put for an extended period of time, until we get clarity on is disinflation in fact continuing, or has it, in fact, stalled out.”
If disinflation starts again or the country sees “marked weakening in the labor market,” there might be interest rate cuts this year, Kashkari said. “Or if we got convinced eventually that inflation is embedded or entrenched now at 3% and that we need to go higher, we would do that if we needed to.” “That’s not my most likely scenario, but I can’t rule it out.
Back in January, Christopher Walker, a Fed governor, notedthat economic news at the time was good.
“But will it last?” Walker asked. “Time will tell whether inflation can be sustained on its recent path and allow us to conclude that we have achieved the FOMC’s price-stability goal. Time will tell if this can happen while the labor market still performs above expectations. The data we have received the last few months is allowing the Committee to consider cutting the policy rate in 2024. However, concerns about the sustainability of these data trends requires changes in the path of policy to be carefully calibrated and not rushed.”
Source: GlobeSt.
Interest Rate Cap Costs Are Surging Again
A lot of financing and refinancing strategies among CRE owners have become waiting games. Hold until interest rates eventually go down — putting off loan maturities or new purchases as much as possible — until they can get themselves out of trouble.
One of the types of tools for floating rate interest loans have been interest rate caps, which offer some protection against the increase of interest rates when some benchmark like SOFR crosses a threshold. At least until the rate cap fees started jumping in 2020 and the costs started to crush transactionsby May. Things continued to get worse by October. And then … they kept getting worse. In 2023, the rate cap cost increases were crushing even more CRE transactions.
Concerns eventually started to ease as inflation seemed to be coming under control and there was a growing thought that the Federal Reserve would start cutting rates. Three times during 2024. Granted, that three cuts of probably 25 basis points each would be less than now, but the total 75-basis point amount wouldn’t be terribly compelling.
However, the thought of future rate cuts provided hope. Not now.
An improvement of cap rates had begun because the risk of the provider having to cover higher interest rates looked as though it would slow and then abate. Not now, because the expectation for rate cuts is becoming more pessimistic.
But there are other estimates. Chatham Financial’s interest rate cap calculator looking at 3% constant SOFR strike rate on $100 million is almost $4.61 million, making that $2.1 million estimate look good in comparison.
Source: GlobeSt.
Multifamily’s Tough Times Will Be A Boon For Bargain Buyers
The multifamily fall from grace over the last couple of years was unexpected by most at the market’s pandemic highs. The increase in interest rates have hit hard, as have some other factors.
But according to Ralph Rosenberg, partner and global head of real estate at global investment firm KKR, problematic conditions should start tapering off after 2025, leaving strong possibilities for rent growth and opportunities to “buy high-quality properties below replacement cost while achieving attractive long-term yields.”
The factors confounding multifamily certainly start with interest rates.
He notes that multifamily is one of the most leveraged of CRE investments. That makes refinancing challenging. There is a loan maturity wall, reduced availability of financing, and high debt loads.
That’s only one part. As GlobeSt.com has previously reported, 2023 saw a record number of apartment unit deliveries added to inventory and 2024 is expected to top that by half again. These aren’t evenly distributed across the country, but the concentration in places even with high increases in population is still enough to depress prices, occupancy rates, and rent growth.
In addition, operational costs have increased.
KKR expects a tough couple of years in a deleveraging cycle. Owners and investors who can hold on during this period face different conditions coming out. There is the chance of lower interest rates, although the degree and pace of any reductions are up in the air now. Demand for units will grow as the rising expenses and difficulty of continuation of building make it virtually impossible to keep pace with additional units. Currently, supply growth forecasts for many metropolitan areas are below the 2018-to-2022 five-year average, and that wasn’t adequate to satisfy market needs.
Buyers with sufficient resources will find many opportunities.
Source: GlobeSt.