The unprecedented rate hikes of the last two years have left the commercial real estate market reeling. Investment declined a whopping 42% from 2022 to 2023 alone. Property values fell 11% over the last year, wiping out almost $600 in CRE equity. Thus, it’s not surprising that many greeted the FED’s announcement of rate cuts for 2024 with great relief. Global commercial real estate services firm Cushman & Wakefield predicts that CRE transactions will gain steam next year. Tim Bodner from PricewaterhouseCoopers LLP says that expected rate cuts will fuel market optimism, especially since inflation is coming down and the economy is performing fairly well. Before the FED’s announcement, Lawrence Yun, the Chief Economist of the National Association of Realtors, stated that he expects commercial property rates to stabilize for most CRE sectors in the coming year should the FED cut interest rates.
At the same time, the commercial real estate market is still facing many challenges. First, the announcement of possible rate cuts doesn’t mean the cuts are imminent. The markets are pricing even odds that the cuts will start in May, almost halfway through the next year. A lot can happen before the first expected cut, especially since inflation is expected to be 2.8% by the end of this year, significantly higher than the FED’s 2% goal. Cushman & Wakefield acknowledges that there is still uncertainty about inflation. Richard Barkham, CBRE’s global chief economist and global head of research, has made it clear that “it’s not impossible we’ll get another inflation upside surprise”. Indeed, Standard & Poor’s warned earlier this year that an increase in tensions in the Middle East could hurt global markets and increase inflation. As the FED’s stated goal in raising rates was to lower inflation, a spike could lead to a pause in rate cuts or, in an extreme scenario, cause the FED to raise rates.
What’s more, the market is facing headwinds that lower rates won’t necessarily solve. Office vacancy rates, which were at 11.5% in Q1 2020, are now over 16.5%, thanks in large part to the shift to virtual and hybrid work arrangements. Negative office-based job growth is also putting pressure on this commercial real estate sector. This has led Capital Economics to predict that vacancy rates will rise to over 20% by the end of 2025 and remain there for several years following. Investors in the apartment sector will also likely face problems in 2024. Rental affordability remains high and an increase in newly-built apartment complexes coming onto the market will put pressure on existing apartments already struggling to find tenants. Furthermore, over $180 billion in commercial real estate debt will mature next year. Even lower interest rates won’t necessarily make it possible for investors to refinance debt originally taken out when rates were at record lows before the COVID-19 pandemic. CRE foreclosures will likely rise in the coming year, putting further pressure on commercial real estate sectors already struggling to regain lost value. On the other hand, investors haven’t lost hope in the commercial real estate market even as it faces challenges on multiple fronts. Many investors are keeping track of discount office space sales with the knowledge that high-quality space has the potential to turn a good profit. Others are paying close attention to local labor markets to find cities where commercial real estate demand is reasonably high, but supply isn’t likely to outstrip that demand in the near future. Investors are also paying attention to industrial real estate. Construction of new space in this sector is down by 26% in the nation’s largest markets, while e-commerce and reshoring continue to drive demand for space that can be used for manufacturing, production, fabrication, and product storage.
The FED’s announcement of rate cuts in the coming year is, without a doubt, great news for the commercial real estate market. It will encourage banks to loosen lending standards to increase the availability of credit for investment. It will make it easier for borrowers to refinance loans than it has been in the last two years. Even so, headwinds remain. Those who are considering investing in the commercial real estate market will need to do careful, thorough research to find potentially profitable locations and properties.
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