2023 was a challenging year for commercial real estate investors. A credit crunch and rising interest rates made it difficult if not impossible for some investors to obtain financing or refinancing. Rising construction costs forced some developers to pause or even halt ongoing projects. Some of the same challenges remain this year, as the FED has yet to cut interest rates and construction costs aren’t declining. Even so, many real estate experts and investors see cause for optimism.
Stuart Saft from Holland & Knight LLP has first-hand experience working with condo development and conversion as well as with hospitality and resort real estate. He rightly points out that interest rates this year aren’t likely to be as big of a problem as they were in 2023 because the FED has already signaled that a reduction in rates is coming later this year. Other experts, including Jennifer Chavez from Sheppard, Mullin, Richter & Hampton LLP and Peter Fisch from Paul, Weiss, Rifkind, Wharton & Garrison LLP, back this assertion. The prospect of lower rates could not come at a better time as a rising commercial foreclosure rate (up 97% year-on-year from January 2023) offers investors multiple opportunities to purchase commercial buildings at record-low prices. Indeed, Saft explains that his deal flow for January 2024 was busier than it had been since last summer, and Chavez notes that nearly all her clients’ business plans call for an increase in CRE deal activity this year.
What’s more, as the impact of COVID-19 on the commercial real estate market begins to wear off, investors and lenders alike can see clearly which commercial real estate investments have the highest profit potential. The office sector, which was one of the hardest-hit CRE sectors post-pandemic, is unlikely to make a full recovery; however, experts point out that top-tier office space is still in high demand, a trend that is likely to remain in place for the foreseeable future. Well-located, modern buildings constructed after the 1990s are likely to perform best, while edifices constructed before the 1990s will need to be updated or even completely repurposed in order to turn a profit. Strip malls are also likely to perform well this year, especially if they are anchored by a well-known grocery store. While the COVID-19 pandemic saw a drastic decline in brick-and-mortar businesses, many retail companies have discovered that selling goods solely on e-commerce platforms isn’t the best way to turn maximum profits. A multi-channel presence is a must for a business to succeed and, as Kathleen Wu from Hunton Andrews Kurth LLP explains, demand is set to outstrip supply because retail construction in this sector has significantly decreased and a lot of strip mall space was demolished in 2023. At the same time, light industrial space that can be used for warehouses and fulfillment centers should also perform well this year due to a continued increase in online shopping.
Investors should note that the outlook isn’t all rosy. Experts warn that “black swan events” could disrupt the commercial real estate market, causing stagnation or even a decline in activity. Saft cautions that an expansion of international conflicts and/or a major economic dislocation could impact commercial real estate performance. Chavez explains that an increase in commercial loan defaults could lessen CRE activity. There is also the possibility that the FED won’t lower rates as quickly as investors expect, and/or won’t lower rates enough to fully revitalize the market. Those who are considering investing in real estate in 2024 should choose a sector and geographic location with extreme care. Geographic location, zoning laws, state regulations, development costs, and insurance costs should all be taken into account to ensure an investment has a high profit potential. What’s more, decisions should not be made based on expected happenings in the market but rather on current market conditions. With caution and care, there is the potential to make windfall profits in CRE investment; however, it can be all too easy for an investor to get in over his or her head due to unforeseen or changing circumstances.
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