Monday Morning Scoop - On The Horizon For CRE In 2024: All Eyes On Interest Rates, Ailing Office, Multifamily Supply Surge

On The Horizon For CRE In 2024: All Eyes On Interest Rates, Ailing Office, Multifamily Supply Surge

With several favorable economic indicators boosting the optimism of commercial real estate professionals, the new year is expected to ease some of the strain the industry faced in tumultuous 2023. But with damage done to property and financial markets, as well as major investors, anything resembling a recovery this year is likely to be slow and bumpy.

The picture heading into 2024 is more hopeful than it was just one year ago, with the Federal Reserve’s indication that it could lower interest rates in the coming months after standing still on the rate at its last three meetings. Yields for the 10-year Treasury are on a downward trajectory, and return-to-office mandates have slowly brought hybrid employees back to their workplaces.

Still, distress will persist in the office market, even as the cost of capital dips, according to roughly a dozen experts interviewed by Bisnow. And multifamily, a darling of the early pandemic years, is likely to see some softening as a record rush of new supply hits the market. Meanwhile, new issues like insurance costs and climate risk to property are becoming greater concerns for property owners of all types.

The Cost Of Capital To Drop (A Bit)

Getting financing for a development or a deal will get a bit cheaper, and there will be a revival in capital markets activity, particularly in the second half of the year, CBRE Global Chief Economist and Global Head of Research Richard Barkham told Bisnow.

Ten-year Treasury yields stand at 3.9%, and CBRE expects them to fall over the course of 2024 to somewhere between 3.3% and 3.6%, Barkham said. 

CBRE isn’t alone in that prediction.

“Strong sponsors will likely weather what is expected to be a short-term storm heading into a lower-interest-rate environment with significant dry powder on the sidelines,” Newmark Executive Managing Director Anthony Valenzuela said. “The bond market has quickly abandoned the ‘higher for longer’ sentiment that was prevalent in October, and the Mortgage Bankers Association is forecasting the 10-year Treasury yield to reach 3.7% in 2024.” 

Whatever the pace of interest rate cuts and Treasury yields, the prospect of a recession still looms over the industry. A CRE industry conditions and sentiment survey taken by the Altus Group in late 2023 found that 77% of respondents expect a recession within the next six months, but 80% said it will be a shallow one.

The survey also found that there will still be significant constraints from both equity and debt sources. Equity capital sources, such as high net worth individuals, family offices and private funds, will remain more available, while banks and securitizations will remain constrained.

Continued Distress For The Office Sector

No matter what happens to financing costs or how quickly, the market must contend with billions of dollars in distressed properties across the country and their broader impact on the economy. 

Nearly $10B in newly distressed loans were recorded nationwide in the third quarter, according to MSCI. More than $32B in office-backed debt is distressed, with another $50B at risk of becoming distressed this year.

“In my mind, if you have anyone significantly underwater, they may just want to hand the keys back,” Gabe Rivera, co-head of securitized products at PGIM Fixed Income, told Morningstar. “No one is throwing good money after bad.”

Shocks like the one the world experienced when the pandemic hit can impact economies for up to six years, BGO Chief Economist Ryan Severino said, and only once that impact comes to a stop can microeconomies reach a new equilibrium.

“With the onset of the pandemic in March 2020, that could mean another two to three years before the office market stabilizes into its new equilibrium,” Severino said, adding that the fate of obsolete space won’t be fully known for some time.

“The industry possesses a notable propensity to overreact to situations such as this,” Severino added. “For investors willing to do the serious homework, opportunity should abound, particularly for the more risk-tolerant.”

Conversion Still Isn’t An Office Panacea

Redeveloping offices into something else, especially residential, might get a bit easier in 2024, but its myriad challenges will keep conversions from eating up a large portion of the country’s vacant office space.

“We, along with the rest of the development community, have learned that converting underutilized office space to residential use types is harder than advertised,” Project Management Advisors Project Director Micah Solit said.

Cities like San Francisco and New York are working to make it easier for developers to repurpose underperforming office product, but those rule changes don’t fix the practical and financial problems that come with conversion, Solit said.

Architecture firm RDC Senior Principal Sean Slater is bullish on office conversions to mixed-use retail as opposed to residential-only conversions.

“Mixed-use is the past, present and future,” Slater said.

Still others are hopeful that offices will return to their intended use as return-to-office efforts continue.

“An important trend that we will see come to fruition this year is the resurgence of demand and activity in the office sector,” VTS Chief Strategy Officer Ryan Masiello said.

Building on the positive momentum in 2023, Masiello said he expects a significant uptick in large-tenant demand, or those occupying over 100K SF, and thriving markets such as New York City have already seen an approximately 50% increase in demand from these tenants.

Multifamily Mojo Not Returning In 2024

“Much of the nation, especially coastal urban hubs like New York, San Francisco and Los Angeles, continues to experience a crisis in housing availability and affordability,” Solit said. “We expect continued political support and legislation to ease housing approval burdens, though for now, that hasn’t moved the needle from the development perspective.”

Higher interest rates coupled with slower rent growth have made new development prohibitive, with new starts trending down through 2023, and many cities can expect new supply to peak in 2024, Solit said. 

After a slower 2023, multifamily investors are expected to up their game in 2024. The Altus Group survey predicts more transactions in the next six months. A majority of respondents plan to transact this year, with larger firms — those with $5B or more — planning to sell and smaller firms planning to buy.

As the gap between average monthly mortgage payments and average monthly rent payments widens, more people will choose to rent, Project Management Advisors Project Director Peter Jones said. That includes young couples and even young families. As a result, there has been a trend in more two-bedroom units being incorporated into developments that cater to that demographic.

Insurance Costs Continue To Swell As Climate Concerns Creep

The cost of insurance for commercial properties, which accelerated in 2023, will continue to do so this year, insurance giant WTW predicts. The company forecasts catastrophe-exposed property insurance rates — for properties near the ocean, for example — will rise between 10% and 25% in 2024.

But even less exposed properties could see renewal rates grow by as much as 10% in 2024, WTW predicts, so most insurance buyers can expect to pay more for their coverage.

Insurance costs are a relatively new source of concern for property owners, but as natural disasters increase in frequency and severity, more insurers are either raising rates or pulling coverage from markets altogether, causing rates to rise. An October article from the Urban Land Institute called attention to the problem, which it said has reached “crisis levels.”

Climate concerns, along with pressure from employees and other stakeholders, will keep environmental, social and corporate governance investing and design at the fore in the new year as well.

In 2023, interest in sustainable, net-zero structures saw heightened attention from clients, stakeholders and government leaders, and it is expected to continue, Skanska USA Building General Manager Sean Szatkowski said.

“An increased application of geothermal energy, adaptive reuse and resilient materials is anticipated, and the construction industry has the opportunity to be at the forefront of such innovation to achieve both clients, partners and government entities’ sustainability goals,” Szatkowski said.

By: Dees Stribling
Source: BisNow