Let’s take a look at the state of commercial real estate in 2024 against a backdrop of 2023. With a focus on staving off inflation, the FED repeatedly increased rates in 2023. As an era of ready capital ended, the commercial real estate space has and will continue to face hard realities. Not all CRE categories are as hard hit, but some, like office space, face a potential crisis in the coming year. 

A Portrait of Pending CRE Crisis

At the top level, the challenge across all commercial real estate categories is a collision between property value, interest rates, and cash flow. While many categories such as multifamily, hospitality and retail have sound fundamentals, many loans are coming due and must be refinanced. Over the last decade, many property owners opted for interest-only loans, banking on property appreciation and continued low rates to enable refinancing the initial principle, or nearly all of the initial principle at the same rates. Investors that did not fare well, neither retaining a buffer for a higher future interest rates nor seeing an increased equity in their property, may face significant challenges in refinancing their properties in the year to come.

A Potential Respite for CRE Financing on the Horizon

The Federal Reserve halted interest rate increases and signaled interest in lowering rates earlier than anticipated in 2024. That may offer more property buyers the opportunity to successfully refinance their debt. Let’s take a look at five of the primary classes of investment property and how they are currently positioned.

Office Property Financing

Three years after COVID emerged as a global crisis, office space still remains the most risky and most underutilized category in commercial real estate. Early thoughts of converting office space to multifamily residential properties to ease housing demand remain unrealized due to the constraints of the buildings themselves. Large office blocks fail to meet requirements for access to natural light and fresh air, and modifying properties by opening up central courtyards has proven cost prohibitive. Employees retain the upper hand in labor strapped environments, and there is little interest in a full return to the workplace. The collision of low revenue, high valuation, and loans coming due will be felt most in the office sector. At the same time, not all markets are the same. New York City, Los Angeles, Chicago, Houston and other major metropolitan cities face the greatest strain, while class A properties with premium amenities continue to be the best performers. Regional cities may have operated under more conservative financing and owners may hold more equity, hold greater cash reserves, or have less available office space as compared to demand, especially in expanding markets. Even so, price competition can leave many landlords with reduced revenue as compared with 2019. Hybrid models, such as co-working, especially when the space can be niched to a specific industry, can be still be profitable with today’s hybrid workforce. Before investing in office real estate, buyers should carefully evaluate their market, current demand, new construction, price competition, and opportunities for innovative synergies in office use or design.

Industrial Real Estate Financing

Industrial property remains strong, especially as demand for same day or overnight delivery expands. With on-shoring of production, demand for manufacturing facilities has also increased, but sees steady rather than exponential growth in most regions. Consider demand for manufacturing, distribution and custom shops as part of your market assessment if pursuing acquisition of industrial space.

Multifamily Real Estate Financing

Many housing markets are under pressure with insufficient units, especially in low and moderate income categories. Housing prices have increased accordingly, and many families are seeing cost of housing exceeding 30% of income. That means demand is high, but price pressure is limiting owner’s ability to increase revenue. Even so, a recent HUD report anticipates a 10% increase in fair market rent in 2024. If you are focused in the multifamily sector, evaluate HUD reports and market conditions to determine opportunities in redevelopment, new construction, and acquisitions in your market.

Hospitality Real Estate Financing

Hotels and resorts benefited in 2023 from a rebound in travel as well as increased regulation of short-term rentals. Fewer units in major cities, along with a resurgence in business travel and attendance at trade shows, have contributed to increases in pricing. But inflation has forced many potential travelers to postpone vacations, pushing out forecasts of full recovery to 2025. Deals are still proceeding in the hospitality market, and new properties are not anticipated to decrease performance of existing properties.

Retail Real Estate Financing

Shopping centers, especially neighborhood markets, are anticipated to provide consistent revenue and moderate rental price increases with relatively low turnover. Though commerce continues to grow, the greatest correction in the market has already occurred over the past two decades. Retail executives anticipate e-commerce to continue its role in gross revenue support, easing pressure on fixed locations by offering additional revenue outside of the local footprint. New construction in the retail sector remains limited, and property class conversions and careful selection of locations continues to be a priority.

CRE Financing Moving Into 2024

Commercial real estate remains in flux. Investors must continue to consider fundamentals, but now also need to contend with interest rate hikes and fluctuating property valuations as part of their profit forecasting. Because of this uncertainty, strategic planning and detailed research are paramount for new entrants or those seeking acquisitions. Businesses also need sound partners when it comes to sourcing capital for properties that are up for refinancing in the near term. The current correction is being described as the “deflating of a balloon,” rather than “popping a bubble.” While property owners will face stress, and some properties will be foreclosed, the ability to source the right capital will be a primary success factor throughout the coming year. Our team is dedicated to solving commercial real estate financing challenges for our clients in 2024. Whether you are looking at new acquisitions or refinancing your current properties, we are here to help you get funded and move on with conducting business.