A commercial building for rent in Melville, New York, on April 17, 2023.
Howard Schnapp | Newsday | Getty Images
The tide may be turning in commercial real estate.
Fed meeting begins September’s rate cut cycle cut the federal funds rate by 50 basis points for the first time since 2020, while signaling that more rate cuts are on the way. This could bring long-awaited positive momentum to interest-rate sensitive industries such as commercial real estate.
Lower interest rates make debt cheaper, helping to accelerate deal flow in the sector, which has been stagnant until the second quarter of 2024. The pressure, ending a nearly 15-year bull market, faces rising borrowing costs, weak tenant demand and increasing property supply. As a result, property values and sales decline.
Wells Fargo analysts wrote in a September 3 research report that the Federal Reserve’s policy shift is the “most compelling green shoot” for the commercial real estate market. Analysts wrote in a follow-up note in late September that while lower interest rates were not a “magic bullet,” the Fed’s easing of monetary policy “lays the foundation for a recovery in commercial real estate.”
For stocks with higher dividend payments, such as real estate investment trusts, lower interest rates make these fixed-income investments more attractive to investors. But Alan Todd, head of commercial mortgage-backed securities strategy at Bank of America, said the main impact of the rate cut is psychological.
“Once the Fed starts cutting interest rates, they will continue on that path,” which will enhance a sense of stability, Todd said. As the market feels more comfortable, it will “incentivize borrowers to get off the sidelines and start trading.”
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Willy Walker, CEO of CRE financing company Walker & Dunlop, told CNBC in an interview at the end of September that refinancing and sales volumes have picked up as sentiment in the industry improves.
During the Fed’s tightening cycle, rising interest rates have led to a deadlock between buyers and sellers, who want lower prices while sellers hold on to lofty valuations. The impasse has frozen trading markets, prompting investors to adopt a wait-and-see mentality and leaving many wondering where the market will go next.
But analysts noted that overall transaction volume in the second quarter of 2024 recently posted the first quarterly growth since 2022, driven by sales in the multifamily sector.
According to real estate data intelligence company Altus Group, transactions exceeded US$40 billion in the second quarter, a quarterly increase of 13.9%, but a year-on-year decrease of 9.4%.
Wells Fargo analysts noted in research on Sept. 25 that the MSCI US REIT Index has risen steadily since spring through September as trading volumes increased and supply declined. , real estate valuations appear to be improving.
While these dynamics may set the stage for a broader recovery, the path forward may not be smooth as some major sub-sectors such as commercial retail real estate recover in tandem.
Headwinds in the office
Despite some signs of modest improvement in the second quarter, the office market in the commercial real estate market still faces a number of challenges.
Wells Fargo reported that net office absorption, an industry metric used to determine changes in occupied space, turned positive for the first time since 2022, with more than 2 million square feet absorbed in three months.
“While modest, this is the best result since the fourth quarter of 2021,” analysts said. However, this small victory was not enough to offset rising vacancy rates, with supply falling for the 10th consecutive quarter Exceeding demand has pushed the vacancy rate to a new high of 16.7%.
In major cities such as Manhattan, office tower visits averaged 77% of 2019 levels in June, the highest monthly visit total since the Real Estate Council of New York began tracking in February 2023.
Still, analysts at Wells Fargo noted that “the headwinds still far outweigh the tailwinds,” with slower growth in mixed work and office employment continuing to weigh on demand.
Analysts say prices remain below pre-pandemic levels, with CBD office building prices down 48.7% since 2019.
Chad Littell, national director of U.S. capital markets analysis at CoStar Group, said that in addition to temporary disruptions to remote work, “structural challenges” have exacerbated the industry’s difficulties since the pandemic, including sluggish demand, soaring job vacancies and flat rents.
Little said that for the commercial real estate office industry, “recovery still looks very far away.” “While other property types are finding their feet, offices may have a longer road ahead – perhaps a year or more before prices stabilize.”
Multifamily strength
On the other hand, demand for multifamily real estate assets rose, with second-quarter net absorption reaching the highest level in nearly three years, according to Wells Fargo research.
That’s the case even as multifamily construction booms, with completions expected to top a record 500,000 units this year, according to the data. Cafe for rent. By the end of 2024, developers will have completed more than 518,000 rental units.
With rental growth hitting double digits in 2021, the multifamily sector is a hot darling within CRE.
However, the increase in demand points to a shift in consumer behavior as “households are taking advantage of greater apartment supply, generous concessions and more manageable rent increases,” Wells Fargo said.
One of the factors driving renters toward multifamily housing is the lack of affordable entry-level single-family homes. The stark contrast between home ownership costs and rental expenses highlights the trend: Wells Fargo said the average monthly mortgage payment hit $2,248 in the second quarter, 31% higher than the average monthly apartment rent of $1,712.
Multifamily housing also benefits from stable vacancy rates. For the first time in more than two years, the vacancy rate did not rise in the second quarter and remained stable at 7.8%. This stability, coupled with rent increases averaging 1.1%, shows a healthier balance between supply and demand.
Looking ahead, the outlook for the multifamily segment remains positive.
Wells Fargo’s analysis suggests that “high home ownership costs should continue to support rental demand,” meaning current trends favoring multifamily housing are likely to continue in the near term.
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