Q1 2024 Commercial Real Estate Market Update

While we’re encouraged and cautiously optimistic about 2024, we see economic data implicating some near-term uncertainty as the Fed tries to moderate growth. The 10-year bond yield is up nearly 30 basis points – from 3.96% in early January to 4.24% as of March 28, 2024. Based on the Federal Open Market Committee’s (FOMC) latest decision, the Fed’s key benchmark rate will not move from its current target of 5.25%-5.50% – a 23-year high. This decision reflects the impact of stubbornly slow recent improvements in the rate of inflation, though it has slowed substantially since last year. Plateauing inflation has seemingly put a pause on rate cuts in the near term.

From a lending perspective, financing has generally been stagnant from where it was at the end of Q4 2023, and there has been no major change in the real estate capital markets. The main difference now is that there are fresh allocations to work with, so lenders are more eager to provide term sheets than they were three months ago. Deal flow remains lower than what we grew accustomed to over the last 5-10 years. However, from what we have seen at our firm, sellers’ expectations have slowly begun reflecting the current state of affairs. As a result, we’re seeing more deals getting done, but not because there are more deals on the market; rather, as a result of sellers having more moderate expectations. Additionally, potential sellers have gotten more creative offering assumable low interest rate debt or seller-financing to make transacting more feasible.

Commercial Real Estate Asset Level Performance

Commercial real estate property-level performance remains stable. Within our portfolio, there has not been an uptick in credit or collection issues, and there are no glaring signs of a slowdown from an individual asset perspective. Our stance continues to be that (office excluded) the commercial real estate slowdowns that most investors are experiencing, from a value perspective, are almost exclusively capital markets / interest rate driven.

Leasing velocity across light industrial and medical office may not be at all time highs, but prospective tenant inquiries, property tours, and RFP’s remain steady. Rental rates are continuing to increase reasonably in the medical office and light industrial asset classes. According to CommercialEdge’s latest report, “national industrial in-place rents averaged $7.74 per square foot in January, up 7.6% year-over-year”. As for medical offices, the average asking rent is expected to rise by 1.3% to $23.40 per square foot by the end of this year, per Marcus and Millichap’s recent study. The main challenge continues to be elevated construction costs which has led to higher capital expenditures (CapEx) and tenant improvement (TI) allowance spend.

Risks and Challenges

The biggest challenge in today’s commercial real estate environment boils down to interest rates and the resulting slowdown in liquidity. With higher interest rates, it’s simply more difficult for any given deal to deliver return profiles (especially yields) that we acclimated to over the past few years, even if cap rates do expand. As a result, we are seeing a major reduction in traditional market deals, and more opportunistic sales as sellers that come to the market generally need to or have to transact.

The Fed continues to signal three rate cuts for 2024, which gives cause for both optimism as well as some potential short-term pessimism. If rates do start to come down, naturally debt becomes more attractive and buyers with higher costs of capital should start to re-enter the market, creating more liquidity and putting upward pressure on pricing. However, if potential sellers are anticipating multiple rate cuts, we may see them continue to hold off on listing properties until the dust has started to settle. Additionally, with multiple rate cuts now being the expectation, there would likely be a meaningful capital markets fall-out if one, or multiple, cuts do not materialize.

Looking Ahead

Despite persistent headwinds, we are still seeing attractive deals coming to market, although in significantly less volume than years prior. Our firm continues to show positive performance as evidenced by our recent closing of Physicians Plaza, a distressed medical real estate asset with opportunistic upside located in the growing suburban area of Bartlett in the Memphis MSA. As we enter into Q2, we’re continuing to target value-add deals for our investors. As always, if you’re interested in learning more about our active investment opportunities or have any questions for our team, please reach out to us here.