Commercial property owners shifting to operations, notes RECI

John Oharenko

 Chicago, IL – Chicago-based Real Estate Capital Institute (RECI) reports that as the prospect of a slower yet reasonably healthy economy emerges.  And the Fed announced that rate drops are likely for this year.  Commercial property owners have shifted more attention to operations for much of this year. 

 The Real Estate Capital Institute's® Director, John Oharenko, predicts, "It's always prudent to be cautious, as CRE investors attempt to understand the economic direction of 2024.  The overall fundamentals of the nation's commercial real estate economy are generally healthy, so the risks are prudent and manageable."

Since most investors took advantage of locking into lower interest rates, often below 4%, their focus remains on improving cash flow performance vs. capital markets.  Yet, transaction volume will selectively increase based on the following market conditions:

 

Economic Uncertainty:  Risk and reward spans every era of investing.  This year, investors will focus on the upcoming elections, inflation, international instability, unregulated immigration, energy prices, labor shortages, etc.  On a local and regional level, property owners face slackened demand and uneven rent growth, rising supplies (e.g., multifamily and industrial), increasing expenses (e.g., insurance and property taxes), and competitive obsolescence. 

 As for universal risks, for example, few investors believe that mortgages will reach last year's 8% high.  Many economists predict that the Fed will drop interest rates perhaps two to three times. 

 

 The Fed's two-percent annual inflation target seems to be within reach, as GDP growth simmered to about 2.5% in 2023.  However, international risks, including Moscow's invasion of Ukraine and the Middle East crisis, remain a wildcard – particularly for food and energy prices.

Local and regional risks for real estate investors pose some unique challenges.  Few owners expect property taxes or insurance costs to decrease.  Municipalities need funds as the federal government continues to cut spending. 

Depending on the region, climate change and other related weather incidents plague insurers.  Alternatively, rent growth should continue to aid certain sectors, namely multifamily, as affordable home ownership remains further out of reach for many Americans.

 

Asset Repricing:  Ample funds remain on the sidelines for properly priced realty projects.  As investors adjust to the four-percent ten-year treasury benchmark, forming the denominator for "safe" investing, the profit strategy focus shifts to an acceptable return on equity at this level. 

 

 In the case of CRE, steady cash flow, combined with rent growth and inflation protection, adds 200 to 500 basis points or more in risk-adjusted yield premiums.  Meaningful pricing discounts must occur to hit such yield targets compared to the peak pricing levels of early 2022. 

 

For instance, 10% -15 % for apartment and industrial properties, 15% -25 % for retail assets, and above 25% for office properties that suffer from declining demand in many areas of the country.

 

Motivated Parties:  Distraught investors tired of suffering unacceptable profit margins over longer timeframes comprise the bulk of motivated sellers.  Now, they're looking to unload such investments.  Projects typically held beyond two to five years or more beyond the projected holding period fall into this category, as market conditions were substantially different when these investments originated.  

 

Just as importantly, lenders carrying debt on challenged properties are running out of patience, not only from the profitability standpoint but also due to pressure from nervous bank regulators demanding to unload such loans or requiring higher loan loss reserves. 

In particular, local and regional banks carrying higher priced short-term floating rate debt that burdens project economic performance fall into this category.

 

The Real Estate Capital Institute® is a volunteer-based research organization that tracks realty rates data for debt and equity yields.

 

CONTACT: 

 

John Oharenko, Executive Director

director@reci.com / www.reci.com

 

^The   Real Estate Capital Institute^®

Chicago, Illinois USA 60622