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CRE Market Commentary from LightBox

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LightBox Insights
January 30, 2024 7 mins

As we approach the end of January, the LightBox team thought it was fitting to take a look at how 2024 has started; see how the recent economic data has impacted sentiment; and make some predictions of how the remainder of the year might play out.

Certainly, the narrative surrounding the market was extremely negative heading into 2024 and that only got worse with several headlines reiterating the doom loop for cities and offices and several high profile, disappointing sales prints. Even the mainstream media piled on with 60 Minutes featuring a piece on the US office market which underscored the problems in that segment.

Those closer to the ground, were more optimistic that 2024 could surprise to the upside. In the Lightbox CRE Predictions report, several experts pointed out that the second half of 2024 could see a nice rebound as falling rates, tighter risk spreads, and seller capitulation could trigger a nice bounce in transaction volume.

To be sure, no one was suggesting H2 2024 would be like 2021 in terms of sales volume and price appreciation. But there was a consistent notion that a bump in transaction velocity could come sooner rather than later.

January Economic Data: Good News So Far

Thus far, January economic data has given CRE professionals more reason for optimism. 

Nirvana for the CRE markets is a combination of strong economic numbers, but prints that are not so strong as to trigger a huge uptick in lending rates.

In January, retail sales, GDP, consumer sentiment, and pending home sales all beat expectations handily, adding more grist to the mill for those that believe the US can avoid a recession in 2024. 

The better-than-expected numbers did push bond yields higher at the long end of the curve – but the increase was relatively benign. The yield on the 10-year tumbled late last year from 5% to about 3.85%, The strong economic data in January pushed the yield on the 10-year back up to 4.15% but that remained well below the October 2023 plateau.

With the 10-year still 85 basis points below that fall 2023 peak, there has been some pressure taken off property owners needing to refinance and more sales could “pencil” as a result of the lower Treasury yields.

Helping keep bond yields contained has been ongoing evidence that the inflation continues to be squeezed out the system. December’s Personal Consumption Expenditure data – which was in line with expectations – once again revealed that inflationary pressure is ebbing.

(Not to be overlooked is a continued compression of risk premiums.  Over the last 90 days, risk premiums – “spreads” – on fixed income securities have fallen sharply. This has also helped reduce borrowing costs).

January Headlines Stoke Fears

While the economic data was music to the ears of CRE types, the news headlines remained quite negative in January. (Did someone once say “fear sells?”).

Each day seemed to bring another half dozen headlines about borrowers defaulting on multifamily loans, office tenants downsizing, and properties selling at prices well below their pre-pandemic values.

Even though the economic numbers are pointing green, we can’t ignore the negative sentiment.  The doom and gloom will continue to come in waves of H1 2024.  This will cause lenders to remain cautious for now and for those with dry powder to tip toe, not race, back into the market.

(One such headline was that a portfolio of San Francisco apartments had sold for a deep discount. That led to The Real Deal pointing to a “massive loss” for lenders on that portfolio. Story here).

Survive until July

We would urge CRE pros to focus on the data and not the headlines. The term “survive until 25” has been used enough to now be considered a cliché. But a better spin might be survive until July.

Conditions are such – as our experts predicted – that the second half of the year could see the start on a nice rebound for the CRE markets (with the exception of office which will take much longer to heal).

Here are a few reasons for why sales activity could pick up later this year and that the levels of distress might not be as high as some are predicting:

Lower Lending Rates: Between lower Treasury yields and tighter risk spreads, fixed rate, 10-year loans are now about 100 basis points lower than at their peak. Three months ago, a significant percentage of borrowers with loans maturing were facing “cash in” situations.  That percentage got noticeably smaller thanks to lower yields and risk premiums.

Not to be overlooked is the sharp decline in the yield on the one-year Treasury, which is down 75 basis points over the last few months.  Many borrowers in from 2020 to early 2022 utilized floating rate debt – attracted by lower rates but also the appeal of being able to pay off the loans without penalty.  This was particularly attractive (but later regrettable) for developers looking at value add properties.

The problem for these borrowers is that most of the loans were structured with maturity extension options. However, extending the loan – which many borrowers needed to do – involved buying extremely expensive rate caps. The falling yields at the short end of the curve have made those cap purchases less expensive over the last few months. If the Fed cuts rates several times in 2024, those costs would go down even more while giving a bump to loan NOI as borrowing costs dip.

On the distress side of things, this may lead to fewer borrowers throwing in the towel. Think of it this way: we are now 20 months since peak inflation and Fed cuts could come as soon as the spring.  If you weathered nearly two years of abject misery, why would you not throw in the towel if relief may be just a few months away.

Lenders and Buyers Don’t Want to Miss Out

While 2009 and 2010 were disasters for most CRE types, those that put capital to work were rewarded handsomely.  Some distressed bond buyers loaded up on bonds at 30 cents on dollar and watched those assets climb back to par over the next few years making for extraordinary returns.

Property buyers that bought early rejoiced as most property values were back above pre-GFC levels by 2014 or earlier.  (Yes, much of that was due to ZIRP and we won’t be seeing zero interest rates any time soon. But falling rates will lead to a bump in most property-type segments from their mid 2023 lows).

Since 2010, the market has seen several mini-crises. The oil bust of 2015, the beginning of COVID, and the outbreak of the war in the Ukraine, which all saw significant spread widening and value declines for fixed income investments and CRE.  But those dips were extremely short-lived and shallow.  Investors lamented their missed opportunity.

No one in the current market wants to be the person that didn’t deploy capital as Consumer Price Index (CPI) went from 9% to 3% and cap rates fell 200 basis points.  As investors continue to see Treasury yields fall, property values restored, and liquidity come back into the market, there will be increased pressure to pull the trigger.  We believe this will lead to a substantial uptick in transaction activity.

For sellers, the bump in values will also trigger a race to take the money and run.  After watching their values plummet in recent years, there will be some relief at being able to take some money off the table.

Office – Yes, Office – May Even Surprise to the Upside

The bold print headline may shock you, but we should caveat this with the fact that we are measuring this on a huge curve.  (Consider this like the “ne’er do well” friend in college that always scored Ds on his exams. That periodic “C” was always met with back slaps and high fives).

So, in the office segment, the pain will be immense.  That being said, we are already seeing bottoms form in places like Baltimore, Chicago, and San Francisco. Yes, those sales prices are for discounts of 50% or more to sales from five or 10 years ago. However, the formation of a bottom is evidence that buyers and sellers are coalescing around a price for these assets. Once a market agrees on fair value for distressed assets and transparency emerges, there is opportunity for other distressed assets to be resolved.

Let’s not forget either, that legendary NYC sales broker Bob Knakal noted in the LightBox Predictions that it takes 12-18 months for sellers to capitulate.  We are now 18 months or more into the office depression which may mean that more markets are poised to “open.”

Liquidity Should Continue to Improve

Outside of office, liquidity in the lending markets should start to improve.  A near-death experience for the banking industry took place from March 2023 to May 2023 with the failures of Silicon Valley Bank (SVB), Signature Bank, and First Republic. 

Those failures were the result of and triggered more deposit runs for US banks. Those banks spent most of 2023 slow-walking lending to maximize available cash.

As the SVB nightmare gets further into the rear view mirror and as the US gets further away from peak interest rates, banks should start loosening the reins a little bit as the year progresses.

The Last Word for Now

At the risk of being repetitive, no one will be calling 2024 the start of the “Roaring ‘20s” for the CRE market.  That being said, transaction volume, price appreciation, and a lower-than-expected default rate could be pleasant surprises in 2024.

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