Commercial real estate is a cyclical and capital-intensive business, and has long been known for its strength and volatility. Over the years, it has been susceptible to various changes have influenced its overall condition. Sensitivity to interest rates, overbuilding, shifting economic conditions, financial crises, and demographic trends amongst others all have played significant roles in accelerating or stunting its growth.
In 2023, the U.S. commercial real estate sales volume was down over 60 percent compared to the record high of 2022. Commercial mortgage loan volume was also down over 50 percent. Property owners were faced with elevated interest rates, increasing vacancy rates, and slowing rent growth. In addition, transaction activity was also down. The office sector remained under pressure due to structural changes, and new construction deliveries in the industrial and multifamily sectors impacted their fundamentals.
As the commercial real estate industry turns the page to 2024, there is optimism as market participants work to find their way back onto firmer ground. The coming 12 to 24 months are expected to be important as refinancing stresses are dealt with, real estate firms reposition themselves, and investors try to time the bottom of the market with their deploys of capital. Trepp reports that CMBS delinquency volume (i.e., loans more than 30 days late) ballooned by 47 percent through November to $27.46 billion, or 4.58 percent of loans – a level last reached in 2021.
Changes in property operating costs, market pricing, and financing have put many investments in positions very different from when they were consummated, some for the better and some for the worse. The backdrop of rising vacancy rates, cooling rent growth, and rising operating expenses have muted cash flow expectations for many commercial properties. The keys to successful navigation of these factors have been tied to proactive asset management and the availability of reasonable cost capital. There is optimism that the Fed will lower rates by as much as 125bp. This falling cost of debt could bolster deal flow in 2024.
The U.S. enjoyed a resilient economy with positive job creation and steady consumer spending in 2023. The University of Michigan’s survey of consumer sentiment in January was at its strongest level since summer 2021. The consensus outlook is for a slowing economy with a soft-landing scenario and low recession risk. Investment sentiment is up and market conditions are expected to improve in 2024.
High interest rates and speculation about if or when the Fed will reduce rates have dominated the capital markets for months. Some believe that commercial real estate owners will focus on income preservation instead of interest rates in 2024. If the Federal Reserve pivots and lowers rates in 2024, it would help close the bid/ask spread and kickstart price discovery in certain property markets. It would also restore market confidence and lead to an increase transaction activity.
Positive economic indicators like inflation flattening, rising retail sales, and a resilient labor market suggest the economy is healthy. Downward Fed Fund rate adjustments will push down the cost of debt and psychologically give commercial real estate participants clarity to recalibrate to market conditions. If a major recession can be avoided and capital market finds some assemblance of stability, 2024 could see a shift in sentiment that leads to a revival of commercial real estate demand.