By Gay Cororaton, MIAMI REALTORS Chief Economist
After taking a heavy beating in 2023, 2024 is poised to emerge as a recovery year for the commercial real estate market, with opportunities across asset classes and geographic markets. Fundamentals remain strong across most asset classes, with trouble concentrated in the office sector, and in a few markets. This is the main message I gave at my webinar presentation at the annual Tax Lien Association yesterday.
Download the presentation below.
Interest rate stabilization as inflation wanes, soft landing in 2024
Interest rates have stabilized with above 50% likelihood that the Fed will implement a rate cut in June. Chair Powell stated in his semi-annual testimony before the US Congress on March 6 that “our policy rate is likely at its peak for this tightening cycle.”
The Fed is treading cautiously on cutting rates. In February, the core personal consumption index rose 0.4% and was up 2.8% year-over-year. The job market is strong, with 275,000 payroll jobs created in February, following creating but 353,000 jobs in January. This pace is higher than the average monthly increase in 2017-2019 was below 200,000. Job openings are still outpacing job seekers, with 1.4 openings per job seeker.
However, the financial strain on households from higher inflation and slowing wages will tend to slow down consumer spending and hence, inflation. The softening of rent growth with more deliveries than absorption in 2024 will tamp down inflation as well.
As interest rates fall, cap rates will tend to fall as well, supporting rising valuations for most asset classes, except the office market which is still weighed down by high vacancy rates and occupiers giving up space with office foot traffic still trending at around 50% to 60% of the pre-pandemic level.
Commercial lending falls, but hedge funds have about $300 billion in dry powder
Financial markets got jittery again in October as interest rates started to climb and as delinquency rates continued to tick up.
After stabilizing in July 2023, the latest Federal Reserve Board data shows that commercial mortgages (transactions) fell to a seasonally annualized rate of $54.3 billion, down a staggering 83% from the peak of $313.7 billion in April 2022 as the Fed was just ramping up its monetary tightening. The biggest players are US depository institutions (59% of commercial mortgage assets), life insurance companies (13% ) and issuers of asset-backed securities (12%).
However, multifamily mortgages (transactions) are holding up well, with annualized lending of $103.2 billion as of October 2023 , although 41% lower than the peak ($177 billion) in April 2022.
However, for a viable project, financing is available. As of October 2023, hedge funds had $282 billion in liquid assets (“dry powder”) held as checkable, time, and savings deposits, other cash and cash equivalents, money market fund shares, and security repurchase agreements. CBRE estimates about $250 billion of dry powder with about $175 billion that can be deployed to value-add and opportunistic projects.
Commercial real estate fundamentals are sound, with trouble concentrated in office assets and in a few markets
The trouble in the commercial real estate market is concentrated in the office sector which continues to experience declining occupancy with foot traffic about 60% of the pre-pandemic level. But the office market should not be viewed in one big brush, as the problems of negative absorption, high vacancy rate, and soft rent growth are concentrated in a few markets.
Since the pandemic, about 300 million square feet (MSF) of office space has been given up, with 77 MSF given up in 2023. In 2023, among major metro areas, the largest negative net absorption is in the major office markets of San Francisco (-6.9 MSF), Chicago (-4.3 MSF), NY Downtown (-1.4 MSF), Washington DC (-0.9 MSF), Los Angeles (-0.9 MSF). However, the Miami Metro area gained nearly 90,000 SF of occupancy.
In the multifamily market, the softening of rent growth is not due to lack of demand, but to high supply, as housing permits and starts ramped up in 2021-2022 amid low mortgage rates. That imbalance is short-term, with rent growth likely to firm up in 2025 onwards. Single-family rentals will remain in demand as interest rates stay elevated, at least in 2024-2025
In the retail market, there will continue to be a fallout in markets where office vacancies are higher (e.g. recent close of Macy’s in San Francisco), but overall, the retail outlook is solid due to low vacancy rates and not a lot of construction underway. Major retail brands and stores like Walmart Target, Best Buy are continuing to get as closer to the customer geographically and in time delivery by pushing last-mile distribution, creating a great omni-channel experience for customers, and changing their product lines in line with customer needs (health care, sustainable products).
The customer preference for fast, efficient delivery will continue to bolster demand for industrial space, especially in markets with strong population growth, such as Southeast Florida which continues to see elevated levels of migration compared to the pre-pandemic level.
