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Investors Pivot to Property Debt Amid Declining Values in Commercial Real Estate

Amidst falling commercial real estate values, property debt is becoming an attractive investment option, particularly as the focus shifts to industrial and multifamily buildings rather than offices due to the rise in remote working.

Declining equity valuations: Property valuations are experiencing a downturn, with a notable 15% drop in real-estate equity valuations, attributed significantly to the increased costs borne by commercial real estate owners in short-term financing. This downturn, while disheartening for equity investors, unfolds several advantages for those venturing into real estate debt, placing a spotlight on alternative investment pathways in the sector.

The debt appeal: With lenders mitigating risks by reducing the leverage they provide and levying additional interest to compensate for heightened perceived threats, commercial real estate debt investors, particularly in newly underwritten deals, are reaping the benefits. These include more substantial equity cushions, superior returns, and amplified downside protection, marking a counterintuitive appeal in a depressed market.

Higher returns: The misconception is that CRE debt carries the same risk profile as equity, which is not the case, according to Alex Chaloff, CIO at Bernstein Private Wealth Management. Previously, commercial real estate debt offered returns of 6–8%, but the current environment is expected to yield returns approaching 11% for the next 3–5 years, making it a safer way to gain exposure to real estate compared to equity.

➥ THE TAKEAWAY

Do your homework: For investors carving out allocations to commercial real-estate debt in their portfolios, a strategic and cautious approach is paramount. Chaloff emphasizes the importance of selecting apt funds and strategies, ensuring comfort with the lockup period, and advocating for shorter-term investment options. Moreover, the evolving role of regional banks and private markets necessitates a watchful eye on the moving components of the industry.

Airbnb Lays Groundwork For Extended Stay Rentals

Airbnb's (ABNB) CEO, Brian Chesky, has announced plans to expand beyond its core travel business by offering longer-term housing rentals.

Extending the stay: Chesky believes extended stays of 1-3 months represent an untapped market, especially in a post-pandemic world where remote work allows people to work from anywhere. With only 18% of gross nights booked for stays longer than 30 days, Airbnb sees a substantial opportunity for growth in this segment.

Policy problems: Airbnb's expansion plans come amid increasing scrutiny from policymakers regarding the impact on housing markets in major cities. New York recently implemented rules restricting the ability to rent homes on Airbnb, significantly reducing listings. Chesky believes there are opportunities for mutually beneficial solutions, such as introducing a hotel tax or a housing registration system.

Sledgehammer approach: Jay Carney, Airbnb's global head of policy and comms, believes that New York's new regulations aimed at Airbnb won't effectively address the housing crisis but will lead to higher hotel room rates and make it difficult for budget-conscious tourists to visit the city. He sees the city's approach as a "sledgehammer" that will ultimately bring no meaningful change to the housing crisis.

Beyond beds: Alongside longer-term rentals, Airbnb is considering various other offerings, including rental cars and dining experiences. Chesky sees car rentals as a potential avenue for the company to explore, emphasizing that it could be the next significant venture for Airbnb, similar to its journey from home-sharing to the broader travel market.

➥ THE TAKEAWAY

Looking ahead: Chesky aims to make Airbnb more integral to people's daily lives than just a seasonal or occasional service. While challenges related to housing policies persist, the company remains committed to diversifying its services. This strategic shift aims to tap into new markets and opportunities in a post-pandemic world.

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🎧 Listen: On this episode of The TreppWire Podcast, the team covers recent economic updates, Jamie Dimon's remarks on a 7% Fed funds rate, the rise in loan delinquencies, and more.

📊 Download: According to the Q4 Credit Conditions Report from S&P Global Ratings, the confluence of elevated interest, a looming recession, and persistent inflation indicate that CRE credit problems could persist.

Flatlining Apartment Rental Rates Forecasted for the Rest of 2023

The latest report from MRI Real Estate Software predicts a cooling trend in apartment rents for the remainder of the year, reminiscent of pre-pandemic conditions, with notable shifts in leasing dynamics and concessions.

Steady as she goes: Fall is typically a slower period for the multifamily market. Rental rates peaked for the year in August, with only a marginal 1% increase compared to last year. This pattern mirrors pre-pandemic seasonal trends, suggesting rent growth is plateauing. Stability remains in renewal trends, suggesting that the multifamily market may continue to follow patterns reminiscent of 2019 for the remainder of the year.

Rising concessions: A notable development is the significant increase in concessions, with their dollar value now double that of pre-pandemic rates. As rental rates surged, concession values followed suit. Renewal rates have also caught up with new lease rates, departing from the pre-pandemic norm where renewals often exceeded lease prices.

Shifting terms: The leasing landscape has seen a shift in lease term preferences. 14-month leases reached their highest popularity in March at 7.9%, while 11-month leases dipped to a low of 2.2% by May. However, by August, the situation had reversed. Despite these changes, 12-month lease terms have remained consistent, representing about 60% of lease renewals. Month-to-month lease terms, while still popular, have experienced a decline in volume over the past year, with August seeing the lowest share at 13.3%.

➥ THE TAKEAWAY

The path forward: Before the pandemic, renewal prices often exceeded lease prices, but since then, renewal rates have fallen behind new lease rates. These trends are expected to continue through the end of the year as new lease prices decrease and renewal rates remain stable. Overall, the multifamily market is returning to normal, with pre-pandemic seasonal patterns heading towards the end of the year.

In Q2 2023, smaller US banks significantly reduced their CRE lending market share, dropping from a record high of 34.2% in Q1 to 25.1%, the sharpest quarterly decline ever. These banks had typically held a steady 17% market share from 2015 to 2019 before seeing a surge during the pandemic.

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