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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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Multifamily Momentum Trends Up on Lower Debt Costs, Higher Cap Rates

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The multifamily real estate market is experiencing a positive shift, fueled by lower debt costs and increased cap rates. Many buyers who had been waiting on the sidelines due to financing challenges and softer market conditions are now starting to re-enter the fray, according to Marcus & Millichap’s third-quarter national report on the multifamily sector.

From July 2023 to June 2024, the average cap rate for multifamily transactions climbed to 5.8%, marking an increase of 110 basis points from last year’s record low. This is the highest cap rate seen since 2014. At the same time, sale prices are beginning to stabilize, as reduced uncertainty in financing allows buyers and sellers to negotiate more effectively.

Vacancy rates remained stable nationwide in the first half of 2024, following a 90 basis point increase the previous year. Primary markets, particularly urban centers, have exhibited the most consistent vacancy rates over the past year. Additionally, institutional investment activity appears to be rebounding, with dollar volume rising significantly in July and August.

While some areas are experiencing mild supply pressure—especially outside the Sun Belt—markets like Chicago, Cincinnati, Cleveland, Milwaukee, Pittsburgh, and St. Louis have seen rent growth supported by inventory expansion below 2%.

In the first two quarters of 2024, the multifamily sector achieved a net absorption of nearly 260,000 apartments, surpassing last year’s total by 35,000 units. This growth in household formation, combined with easing inflation, helped keep national vacancy rates steady at 5.8% at the start of the second half of 2024. However, this rate remains 40 basis points higher than the long-term average for the second quarter, as a historic level of construction continues to meet strong demand.

Currently, there are about 1 million multifamily units under construction across the country, which may create short-term supply pressures. Nonetheless, project starts have dropped by more than 18% year over year in July, and permit requests have decreased by 15%, indicating that development activity may have peaked.

To remain competitive, many property operators have begun offering concessions, with the percentage of apartments providing discounts rising to 14.1% in August 2024, up over 500 basis points from the previous year. While concession activity among Class A properties has stabilized after peaking in March, discounts are still prevalent in Class B and C apartments.

The upward momentum in the market has led to a 4% increase in annual rents for lease renewals, contrasting with a 0.8% decrease for new tenants. Many renters are opting to remain in their current homes due to challenges in first-time homeownership; only 26% of U.S. households qualified for a median-priced home loan from Freddie Mac in the second quarter of 2024, compared to a decade-long average of approximately 46%. The apartment renewal conversion rate also saw a rise, reaching 54.9% in August 2024, up 150 basis points year over year.

 

Source:  GlobeSt.

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Skyrocketing Multifamily Expenses Are More Than Insurance

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A year ago, Moody’s research said expenses like insurance, utilities, and property taxes could experience inflation that exceeds revenue growth, straining net operating incomes.

The situation hasn’t improved in 2024, according to Moody’s latest analysis. Multifamily valuations are tied to revenue growth and management of operational expenses. Costs have become a critical factor for owners given that annual effective revenue growth is expected to stay below 2% this year. Growth of expenses over revenues puts pressure on NOI, which is key to valuations. And valuations support the ability to refinance.

“On top of this, some property owners are struggling to get coverage or maintain the requisite coverage in their loan agreements, which leads to rippling implications for lenders,” they wrote.

As expenses have increased, landlords have raised rents so revenue can balance out expenses and the average operating expense ratio has remained at about 45% in recent years, including pre-pandemic. That leaves renters to bear the burden, Moody’s wrote. And when rents push up faster than in the past, so does the shelter portion of inflation, which then helps keep overall inflation higher than the Federal Reserve’s target range, meaning that interest rates also remain elevated. With higher delivery of new multifamily inventory, expecting rent growth to continue with greater supply and less demand is unrealistic.

 

Source:  GlobeSt.

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Multifamily’s Tough Times Will Be A Boon For Bargain Buyers

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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.

“Debt levels relative to equity are higher in multifamily than in some other segments, a loan maturity wall looms, and interest rate caps are expiring, putting many owners in the position of refinancing at a time when their properties are worth less than their acquisition basis and interest rates are much higher,” Rosenberg wrote.

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.

“Floating-rate interest payments rose faster than income from rent and fees,” the firm said. Falling valuations aided in negatively affecting debt service coverage ratios, making many properties fiscally unsustainable to the lender. Also, utilities and property taxes have continued to climb, adding to multifamily difficulties.

“Over $250 billion in multifamily loan debt matures in 2024 alone, and some owners will face a gap upon refinancing,” they wrote. “Likewise, as interest rate caps typically last for three years, many owners are looking at a sharp increase in the cost of debt.”

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.

“Consider what would happen to a multifamily property purchased in February 2024 at a 5.5% cap rate (a measure of the one-year yield on a property calculated by dividing NOI by asset value) with 50% leverage,” they wrote. “Assume that NOI grows at a 3% CAGR. As interest rates come down, it might be possible to sell at a cap rate of 5.0% five years later, in 2029. That equates to an internal rate of return of roughly 14.5% over five years, which is attractive for a historically stable, in-demand asset class.”

 

Source:  GlobeSt.

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We Are No Longer In A ‘Rising Tide Lifts All Boats’ Market

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It’s going to be tough for apartment operators to maintain occupancies in a slowing economy, although property fundamentals should hold up in 2024 among a few challenges, according to a new report from Yardi Matrix.

Among the challenges are the wave of deliveries, limiting expense growth, rising mortgage rates, and dealing with more expensive and less liquid capital markets.

“We are no longer in a rising-tide lifts-all-boats market,” Yardi Matrix said.

“The traditional property acquisition pipeline will likely remain stalled through most of the year, so near-term opportunities will be concentrated in debt investments and providing capital for property restructurings.”

One big and growing issue will be maturity defaults as loans come due and properties qualify for proceeds that are less than the existing mortgages, according to the report.

On the other hand, the challenges are not insurmountable for owners with a long-term perspective, but they will take skill and expertise to navigate, according to the report.

The higher-for-longer interest rate scenario will bring a market reset with higher acquisition yields, higher financing costs, and lower leverage and values.

“We expect rent growth will be positive in 2024 but diminished by slowing absorption, supply growth, and declining affordability after extraordinary gains in 2021-22,” Yardi Matrix said.

It said rent growth will be found in the Midwest, Northeast, and smaller Southern and Mountain areas where demand remains consistent, and deliveries are subdued.

Strong demand and weak supply growth in markets like New York and Chicago should lead to strong recoveries while the Sun Belt and West markets will see a temporary pause in rent increases. The long-term prospects there remain bullish, however.

The rise in construction financing is putting a lid on new starts and 2024 is expected to be a peak year for deliveries.

Insurance labor, materials, and maintenance will continue to take a bite out of budgets.

Yardi Matrix believes that activity is likely to remain weak in 2024 “but could rebound later in the year if rate hikes have ended.”

It’s not just that property values are down, but that buyers and sellers can’t agree on how much.

Meanwhile, lenders will continue to be cautious, and borrowers are reluctant to lock in loans at high rates, according to the report.

 

Source:  GlobeSt.

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Multifamily Industry Grappling With Surging Insurance Costs

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First came supply-chain-fueled higher construction costs. Then came inflation and interest-rate hikes imposed by the Federal Reserve.

Multifamily property operators are seeing their property insurance premiums rise at a time when the cost to build and finance a commercial real estate project remains elevated, even though most material prices have stabilized.

The recent spike in insurance costs arguably could have the most significant ripple effects within the multifamily industry, as higher rates will likely prompt multifamily landlords to pass those additional costs to tenants. But for income-restricted housing or rent-controlled apartment markets, according to those in the industry, the options to offset those higher costs are more limited.

A recent survey by the National Multifamily Housing Council, a trade group representing rental-housing owners and developers, found property insurance costs have risen 26% on average among respondents during the past year. Hurricane Ian had a tremendous impact on rising premiums, but internal insurance dynamics, industry consolidation, carriers departing some markets and climate change are also to blame for the higher costs.

Beyond the cost of operating an apartment property or portfolio, higher insurance premiums are starting to affect property valuations and disrupt transactions.

Michael Power, a chartered property casualty underwriter at New York-based FHS Risk Management, said during an NMHC webinar that in years past, adequate insurable replacement values weren’t necessarily enforced by the insurance industry. There’s been a monumental change on that front this year, he said, with everyone now required to directly report adequate insurable rebuilding costs for all buildings.

“That is having a huge impact on premiums because it’s driving up the total insurable value of your assets. … It creates a compound effect on premiums,” Power said.

 

Source:  The Business Journals

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A $1 Trillion-Plus Wall Of Multifamily Debt Will Mature By 2027

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Although loans backing office properties are the most scrutinized these days, a wall of debt is also maturing within the multifamily sector in the coming years.

And while multifamily continues to be seen as one of the safer asset classes, already, there’ve been recent examples of loan defaults on multifamily portfolios, including four properties in Houston totaling 3,200 units that went to foreclosure last month.

Aaron Jodka, director of national capital-markets research at Colliers International Group Inc., said the multifamily market right now is an interesting test case — while rents aren’t growing as fast as they were 18 months ago, many markets continue to see positive growth and occupancy remains strong.

Looking strictly at the apartment market, nationally, net absorption was 19,243 in the first quarter of 2023, and occupancy stood at 94.7% in March, a drop from the peak of 97.6% in February 2022 but about the same as the average observed in the decade before the pandemic, according to RealPage Inc. Same-store effective asking rents for new apartment leases increased 0.3% in Q1.

But buyers and sellers continue to be at a stalemate, including within multifamily, a darling of the real estate investment world in recent years, Jodka said.

From the early 2000s through the global financial crisis and shortly thereafter, multifamily drove about 24% of all investment sales activity, according to Colliers. Between 2012 and 2020, that sector received about 33% of activity.

By 2020 to 2022, multifamily represented 43% of all investment.

“We’re increasingly seeing larger and larger investment flows, which means we have more and more maturities coming, as you’ve had additional volume,” Jodka said.

In particular, borrowers that recently financed multifamily deals with short-term floating-rate debt without anticipating the significant run-up in interest rates are facing higher loan payments now and could run into issues at refinancing, he added.

And a significant amount of loan maturities within multifamily are coming due soon. The Mortgage Bankers Association estimates, overall, there’s $2.6 trillion of loan maturities through 2027, with multifamily making up 38%.

Those who track the commercial real estate market say, like any property type, multifamily is likely to see a greater amount of distress in the coming months and years, but financing challenges are likely to be more episodic than widespread. Capital sources, both on the debt and equity side, are also likelier to provide capital to multifamily more broadly than other asset classes, and there continues to be a tremendous amount of uninvested capital sitting on the sidelines, Jodka said.

 

Source:  SFBJ

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Ten Commonly Overlooked Investment Opportunities In Commercial Real Estate

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As the stock market continues to show volatility, many people are looking into other types of investment opportunities.

Compared to stock investing, commercial real estate has the potential to provide tax advantages and serve as a safeguard against inflation and market fluctuations.

Fortunately, there are many ways to invest in commercial real estate, and you can tailor your approach to fit your comfort level, budget and lifestyle—all while creating a dynamic portfolio.

Let’s look at 10 of the most commonly overlooked investment opportunities in commercial real estate.

1. Flex Warehouses

Industrial commercial real estate currently offers some of the best returns on the market. As organizations continue to work out complex supply chain issues, flex warehouses are becoming a crucial tool.

This type of warehousing offers a combination of storage and office space. It’s a way to deliver versatility for companies that need to store inventory and have a customer-facing area.

2. Parking Lots

With more than 282 million cars on U.S. roads, finding a parking spot is often a challenge. Parking lots are a low-maintenance commercial investment, and you can choose to operate the lot or lease it to a third-party operator. Dynamic pricing can capture the ebb and flow of demand to increase the return on investment.

3. Real Estate Investment Trusts

Real estate investment trusts, or REITs, are a great way to start off in commercial real estate investing. They allow you to skip the hands-on approach of dealing with a property.

Investing in a real estate investment trust (REIT) can offer a reliable source of income. Similar to real estate stocks, investors can buy and sell REITs on the market.

4. Self-Storage

Self-storage has outperformed other commercial real estate sectors for many years. Yet I see many people still overlooking self-storage. These properties can offer consistent, good returns even during downturns and recessions.

Remember to think strategically about the location, for this is critical when opting for this type of investment. In some areas, investors have seen some retraction due to oversaturation.

5. Cell Towers

Many people, especially those new to commercial investing, don’t realize that cell towers are a prime opportunity. They can become a source of steady income over time. As cell service expands into rural areas, investors can provide a much-needed service and a long-term return to their portfolios.

6. Senior Living Facilities

Senior living facilities are another commonly overlooked commercial property. As the number of U.S. adults 65 and older increases, more people are looking for long-term living in senior-specific residences. This creates a great investment opportunity for senior living facilities.

7. Mobile Home Parks

A growing number of homeowners are turning to flexible and budget-friendly mobile homes. And mobile homeowners have to park them somewhere. These areas can become a reliable source of passive income for investors. Lot rates have also increased in many markets recently, so now may be the perfect time to invest.

8. Commercial Multifamily Units

While residential multifamily properties only include two to four units, commercial multifamily properties include five or more. The increase in units can provide a larger stream of income, which could make this real estate opportunity a star performer in your portfolio.

Before investing in a commercial multifamily property, remember to do your due diligence. For instance, check the financial audit and property market reports, determine how the property will be managed and review service contracts, such as trash removal and lawn care.

9. Coin-Operated Laundry Shops

Getting into commercial real estate doesn’t always mean financing six-figure properties immediately. I find that coin-operated laundries are a simple way of investing in real estate for beginners.

One option is to convert an unused or overlooked space into an existing property. With this option, you can start small and even finance or lease equipment to avoid high out-of-pocket costs.

10. Undeveloped Land

All commercial real estate properties involve land. But sometimes, the investment opportunity is undeveloped land.

Investing in undeveloped land can be a little daunting if you’re unsure what your next step will be. Many commercial brokerages offer consulting or development partnerships to help you get the most out of your commercial land investment.

Adding Depth To Your Investment Portfolio

Investing in one or more forms of commercial real estate is an excellent way to improve your portfolio, and it can provide you with the versatility to withstand market and economic volatility.

A good tip is to explore commonly overlooked investment prospects, as they can offer entry points and create the right mix for your portfolio. One of the best ways to help you connect with these types of opportunities is by partnering with a brokerage.

 

Source:  Forbes

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Development In Every CRE Sector Is Slowing Except Multifamily

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Looking out to 2024, a recent Marcus & Millichap report expects commercial real estate development to slow, based on “elevated” interest rates.

Additionally, construction materials costs remain elevated on a historical basis (up 33.5% above pre-pandemic levels), despite a retreat in shipping costs and the average prices of steel and gasoline in recent quarters. Wage growth was up 5.8 percent in 2022.

Projects that have already broken ground or locked in financing are moving forward, but banks have been executing fewer construction loans relative to previous years. Lenders are tightening their underwriting in response to increased risk exposure. Loans that are secured loans are at rates well-above measures recorded prior to the health crisis.

Industrial sector development is needed, but it slowed in Q4 by 40% compared to the first three quarters and further slowing is likely. Amazon’s decision to halt its ambitious warehouse starts for the next three years is another indication.

The total amount of square footage set to be delivered for both office and retail properties is projected to increase year-over-year in 2023, but new proposals in these sectors are showing signs of deceleration.

“The limited competition from new supply should aid performance metrics at existing retail and office properties,” according to the report.

The apartment sector is an outlier, as it continues to see record inventory growth, according to the report – completions in 2023 are expected to reach the 400,000-unit mark for the first time in over 30 years.

Marcus & Millichap finds that multifamily project starts during February of this year reached the second-highest monthly measure in three decades.

 

Source:  GlobeSt.

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February’s CRE Sales Volume Up Nearly 34% From January

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Retail led an unbalanced sales volume month in February for commercial real estate’s asset classes, according to a report last week from Colliers.

Overall, February’s volume totaling $25.1 billion was up nearly 34% from January sales levels, an above-average month-to-month increase.

Retail was the most heavily traded asset class in February, with $9.1 billion of activity, buoyed by the take-private deal of STORES Capital REIT. (Without it, the volume would have been $2 billion, and it would have fallen to a similar extent as other asset classes).

Office volume in commercial and business centers (CBD) was short of the $1 billion mark for the second month in a row – and the first time since 2010.

CBD office cap rates are up 70 basis points over the past year, and MSCI notes pricing is down 2.2%, though “recent cap rate movement would suggest a far more rapid price adjustment.”

Industrial volume got back to where it was in 2015-18 by increasing 63% from January. The STORE Capital REIT deal was the main reason why.

MSCI reported a 4.4% annual drop based on January to February pricing.

Multifamily sales volume is moving downward at a faster pace, with February’s $4.8 billion traded was the lowest monthly total since February 2012. A darling for so long, it is now the third-least-traded asset class for the first time since January 2015.

MSCI’s repeat sale index shows an 8.7% annual price decline, the sharpest of any asset class.

Hospitality sales volume was volatile as it was down 53% compared to last year but up month-over-month.

MSCI reports the strongest price appreciation of any asset class over the past year at 5.4%, and unlike other asset classes, when annualizing monthly statistics, hospitality shows a 2.1% gain on $2 billion in trades for the month.

 

Source:  GlobeSt.

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