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Will 2024 Unfreeze and Revitalize the Stalled Commercial Real Estate Market?

In 2023, the commercial real estate sector endured many challenges, from rising interest rates to ongoing pandemic shifts. As the year ends, it stands at a pivotal moment, with industry leaders hoping for recovery in 2024.

The Current State of CRE: 2023 was marked by dynamic and challenging conditions. The scarcity of capital and resources and economic uncertainties heavily impacted the sector. Key factors contributing to this volatility included aggressive interest rate hikes by the Federal Reserve, persistent inflation, and the lingering effects of COVID-19 on office occupancy and the housing market. The regional banking crisis further drained liquidity, complicating the situation.

What’s next for rates? Experts anticipate that 2024 could be a turning point, contingent on interest rate trends. The Fed’s policies, particularly regarding interest rates, are crucial to the CRE market's recovery. With debt origination volumes declining and office transactions at low levels, there's an urgent need for stability and clarity in interest rates to facilitate market recovery and lending.

Office sector challenges: Falling demand is set to have a major impact on office values for the foreseeable future. High vacancy rates and changing work habits contribute to this uncertainty. Innovations and adjustments to new work models are necessary, but the path to recovery appears long, with significant adjustments needed in both valuation and operational strategies.

From darling to distress: Heading into 2024, the multifamily real estate sector faces a complex landscape. High rents and occupancy rates clash with the challenges posed by rising interest rates and increased capital costs, leading to reduced property values. The sector, buoyed by strong demand amidst a housing crisis, now confronts compressed margins and potentially declining net operating incomes due to surging supply and escalating operational expenses.

➥ THE TAKEAWAY

Where we go from here: The era of easy profits in CRE, fueled by low-interest rates and cap rate compression, is ending. For years, falling interest rates led to lower cap rates, boosting real estate values and returns. However, this trend is reversing due to tighter financing conditions and uncertain property values. Moving forward, real estate investors must focus on genuinely creating value rather than relying on the financial mechanisms that previously drove the market. This change signals a new era in CRE where skillful, value-driven investment strategies will become paramount for success.

Landlords Push Back Against WeWork's Lease Rejection Strategy As Rents Heat Up

In the ongoing bankruptcy proceedings of WeWork, several landlords are challenging the coworking company's request to reject numerous leases.

Lease rejections: Landlords, including prominent New York City firms like Kato International and Walter & Samuels, have filed objections to WeWork's lease rejection timeline. This is a critical response to WeWork's strategy, allowing it up to 210 days to reject leases under bankruptcy protection. Landlords argue that WeWork should be liable for rent until properties are formally surrendered, rather than just at the lease rejection request date.

Balancing act: WeWork's lease cancellations are a delicate balance, as they simultaneously affect landlords' income and the company's potential recovery post-bankruptcy. Analyst Evan DuFaux notes that the bankruptcy case's outcome may hinge on landlords' lease renegotiation and rejection strategies. While WeWork had considered closing many of its locations in the U.S. and Canada, the company claims to have made progress in negotiations with landlords, although exact details remain unclear.

➥ THE TAKEAWAY

Why it matters: Landlords affected by WeWork's lease rejections are proactively strategizing for the future of their properties. Many consider transforming their spaces into residential units or launching coworking ventures. However, there are significant implications for CMBS loans linked to these properties and uncertainties surrounding the viability of Class-B and C buildings that previously housed WeWork. With WeWork indicating the possibility of exiting over 100 more leases and renegotiating terms with around 400 landlords, the commercial real estate landscape is set for substantial changes.

• Rental Concessions: As the apartment supply increases, landlords are offering more concessions, with 30% of rental listings now including these perks to attract tenants in a competitive market​.

• The Naughty List: A federal probe into Eric Adams' campaign fundraising highlights a fast-track fire inspection list featuring prominent real estate projects from Rockrose, Durst, and Related Companies.

• Ken Griffin Loves Miami: Steve Ross is negotiating to sell his stakes in the Miami Dolphins and related assets to billionaire Ken Griffin, though the deal isn't finalized.

• Office Downturn: In the first half of 2023, office property values plummeted by 48.7%, significantly impacted by changing work conditions and the Biden administration's tech hub strategy.

• Intangible Assets: California's Supreme Court upheld a ruling that may compel cities to refund property tax overcharges, starting with San Francisco's refund to a Blackstone unit for the Westin St. Francis hotel.

• ETFs With a Twist: Simplify Asset Management, known for options-based products, recently launched the Simplify MBS ETF (MTBA), targeting Fannie Mae-backed mortgage securities.

• Housing Boost: Columbus proposes expanding its residential tax abatement program citywide to stimulate housing construction amid economic challenges.

• SFR Hits the Breaks: Single-family rental rent growth slowed for the 17th month, hitting a three-year low but still up 2.6% nationally, reports CoreLogic.

RealPage Economist Challenges Census Data, Says Over 40% Decline in Multifamily Construction

Recent U.S. Census Bureau data indicates a 12% year-to-date decrease in multifamily construction starts in 2023 compared to 2022. However, Jay Parsons, Chief Economist at RealPage, explains why he believes the decline could be over 40%, indicating a steeper downturn than initially thought.

Details in the data: Private sector data providers, like RealPage, report much larger decreases in multifamily construction starts than the U.S. Census Bureau, which only surveys a small sample of permit holders. This difference suggests that the Census data may be smoothing out significant declines, potentially underestimating the downturn in 2022 and overestimating in 2023.

Architects report lower demand: The American Institute of Architects has observed a 15-month continuous decline in billings for multifamily projects, indicating a significant drop in demand for new apartment designs, which correlates with the increase in interest rates.

Construction financing challenges: According to the National Multifamily Housing Council's surveys, approximately 90% of apartment developers reported project delays in 2023, primarily due to difficulties in obtaining construction financing. These financing issues suggest potential indefinite delays in projects.

Stricter loan standards by banks: The Federal Reserve's Senior Loan Officer Survey aligns with the NMHC findings, showing that banks have consistently tightened lending standards for new construction. Banks, facing regulatory pressure to conserve cash, are limiting their commercial real estate lending.

Shifting focus: Developers are facing challenges in securing equity investment due to lower loan-to-cost ratios and falling asset values. Investors are now more interested in acquiring existing properties than funding new developments.

➥ THE TAKEAWAY

Multifamily outlook: Despite high construction volumes in 2021-2022, more projects are completed than starting. This trend could lead to a significant shift in the multifamily market post-2024, with potential increases in demand outstripping supply, decreasing vacancy rates, and rebounding rents. However, a resurgence in construction starts is unlikely before 2026, requiring favorable conditions like lower interest rates and stabilized asset values.

CMBS Special Servicing Rates by Major Property Types

In October, the Trepp CMBS Special Servicing Rate saw a decrease of 7 basis points, marking the first reduction of the year following eight months of continuous increases. You can access the full report here.