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ValTrends Forecast Shows a 'Winter Thaw' for CRE in 2024

The deep freeze in commercial real estate (CRE) activity is seeing a winter thaw, with signs of reviving activity, according to SitusAMC's inaugural “ValTrends First Look” webinar on January 23, hosted by Senior Director of SitusAMC Insights Peter Muoio, PhD and Vice President of SitusAMC Insights Jennifer Rasmussen, PhD. The new ValTrends webinar leverages recent survey data of leading institutional and regional CRE executives to provide a forward-looking snapshot of CRE capital and space markets. Here are the highlights:

CRE mortgage rates have risen dramatically in tandem with interest rates and financing costs are expected to remain high for the foreseeable future, though spreads are contracting. The sharp spike in rates that followed aggressive tightening by the Federal Reserve peaked in October 2023 and then started to decline, amid indications that inflation is increasingly under control. But Treasuries are expected to remain elevated. At the same time, spreads began to come down late in 2023. "That's one ingredient that suggests increased 2024 transaction activity, including origination," Muoio said.  

Activity in 2023 plummeted to lows not seen since the Global Financial Crisis (GFC), with multifamily accounting for most deals. "Transaction volume across all the major property segments ended in a whimper," Muoio noted. Despite the fact that the U.S. is not in recession, uncertainty caused by the rapid rise in rates led to a sharp drop in activity across all four major property segments, similar to the pattern seen in the GFC. But with expectations that interest rates will stabilize or decline slightly in the near future, institutional investors are beginning to favor both stocks and CRE. 

Debt capital availability is expanding, and equity capital, which remains tight overall, has seen marginal improvement. Both equity and debt underwriting standards remain conservative, but there are signs of easing here as well. 

Solid industrial space-market fundamentals are winning the hearts and minds of investors. As a result, industrial earned the best property type rating for the first time in two years. Over the last few quarters, investors have overwhelmingly said they prefer to hold CRE rather than buy or sell, but this is beginning to shift as well. "There's been increased interest in selling but particularly in buying, which increased from near zero to 10% in the most recent quarter," Muoio noted. 

Niche segments offer more attractive opportunities. Medical office, self-storage, data centers, and senior and student housing have been much more resilient in terms of cap rate movements versus the major property groups, especially in the face of market trends over the last 18 months. 

Apartment demand is benefitting from home price escalation. The average home price has skyrocketed 42% since the pandemic started. That trend, coupled with high mortgage rates, has put ownership out of reach for many buyers. "The SitusAMC Insights single-family affordability index is down more than 46% from the pandemic peak, compared to a 6% decline in the apartment-renter affordability index," Rasmussen noted. "It's one of the only times since the GFC that it's been cheaper to rent than buy." On the other hand, an uptick in supply may elevate vacancies and moderate rent growth in certain markets, such as Cleveland and Houston. The national vacancy rate is expected to hit about 6% in 2024, then contract as new supply is absorbed; rent growth is expected to decelerate in 2024 before strengthening in 2025. Meanwhile, rising costs such as labor and insurance could hurt the bottom line. SitusAMC's proprietary total return forecast shows the income return remaining relatively stable, but overall apartment returns will remain negative until 2025.

A resilient labor market continues to bolster retail, but consumer debt may provide headwinds. Consumer spending and retail sales stayed relatively strong in 2023, but credit card debt hit a record, and delinquencies jumped at the end of 2023. Meanwhile, student debt payments resumed with the end of pandemic-era moratoriums. "It's definitely something that we're going to watch to see how the financial health of the consumer plays out this year," Rasmussen said. Retail is the only segment in which the total return is expected to be positive in 2024 due solely to relatively strong income returns. 

Industrial is the only property type expected to show meaningful appreciation by the end of the forecast period, as demand continues to outstrip supply. The SitusAMC forecast shows a small rise vacancies in 2024, followed by a decline, and a slight easing in rent growth. In SitusAMC's total return forecast, industrial will be negative again in 2024 before turning positive in 2025.   

Office continues to suffer. Investors surveyed recommend selling both CBD and suburban office as vacancies hit highs near 20%, and was named the worst property type by 88% of respondents. "We're seeing instances where landlords are actually returning the keys to the lenders rather than investing more capital into these assets," Rasmussen said. "You might see value declines of 40% and 50% for some of these assets compared to pre-pandemic levels." SitusAMC's fundamentals forecast shows rent declines for office through 2025, followed by modest increases. 

View the ValTrends Look Ahead webinar presentation here. Learn more about SitusAMC’s research and data offerings on our website

January 2024