The commercial real estate industry has weathered the aftershocks of the pandemic, battled supercharged operating expenses brought on by inflation, and endured the pain of rising interest rates clogging up the flow of capital. The industry currently is amid a historic reset. While fundamentals for most asset classes remain favorable, the investment sales market seems to have stalled or, in some instances, been frozen altogether. Many market participants, however, believe that the market has, or is at least close, to bottoming out for deals to make sense, but this depends on location, asset type, use of debt financing, and other factors.
Depending on the investor and asset type, it is either time to buy or time to wait for the market to hit the bottom. Some investors are quietly pursuing investment opportunities under the cautious belief that asset prices are still going through a correction process. Others are sitting on the sidelines, potentially for the remainder of 2024, in anticipation for further actions from the Federal Reserve and the results of the presidential election.
Meanwhile, a number of market participants see that the period of price discovery is finally starting to settle down. This is due to sellers coming to terms with today’s pricing standards; sellers are adjusting their pricing rather than continuing to hold out for premium pricing. Some of this revising is due to how lenders are handling maturing loans. Over the past two years, many lenders have had the flexibility to ‘extend and pretend’ on performing loans. Now, however, they are tightening up on the practice – especially as bank regulators work hard to clear maturing debt off their balance sheets. Because of this, commercial real estate owners will either need to refinance maturing debt at current, likely higher, interest rates or sell their properties at the current market rates.
We have researched commercial real estate sales in Delaware for properties trading greater than $10 million dollars as summarized below. We focused on transaction volumes for the first half of the past four years. Sales evidence shows that the market continues to function, albeit at a significantly slower pace than the past three years. The trend has been downward since the high of 17 properties selling for a total of $645.6 million dollars in 2022 to only three properties selling for $72.4 million in the first half of 2024. We attribute this decline to a variety of factors, including rising interest rates, economic uncertainty, and looming distressed assets not coming to market. The 2024 drop off in sales volume can also be attributed to the difficult in underwriting the risks of the ongoing property reassessments for the state.
Any distress in commercial real estate is not due to market fundamentals, but is mostly found at the ownership level and is caused by the capital stacks being out of balance. There are growing concerns on losses of a large wave of maturing commercial real estate loans and the process of untangling distressed debt is time consuming. This can be seen in rising CMBS delinquency rates and banks unloading commercial real estate loans in large portfolio sales. Zombie assets that suffer from elevated vacancy and negative cash flow is a cause for this distress. These assets typically suffer at loan maturity, going into receivership for workout and ultimate sale at auction.
While momentum seems to be picking up in the commercial real estate markets, it is perhaps too early to say it is out of the woods. Pricing recalibrations have already taken place in many of the commercial real estate sectors. This provides investors with better clarity of market conditions with which to foster market transactions. However, any future gains in real estate prices will likely continue to be measured, not extraordinary.