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This Q&A was published as part of PitchBook's H2 2023 Global Real Estate Report sponsored by Baker Tilly.

In what ways are members of the industry preparing for increased levels of activity?

The substantial decrease in activity since inflation and interest rate levels peaked has given many in commercial real estate (CRE) and related industries the opportunity to get their proverbial houses in order. This is in anticipation of improved opportunities and activity levels in 2024.

Almost unilaterally it has meant fine-tuning operational efficiency and cost effectiveness while enhancing the user experience. However, depending on your specific role in the CRE ecosystem, this could mean different things. Many property owners, for example, have focused on improving net operating income (NOI) or making property improvements ahead of the possibility of bringing assets to market.

Regardless of the role in CRE, most individuals have been working their contacts to cultivate new relationships, stay connected and expand buyer/seller networks.

What are some of the most important lessons the industry is learning/has learned since the Federal Reserve (Fed) started increasing interest rates to combat inflation?

The prolonged period of historically low interest rates induced some real estate owners and investors to take aggressive loan positions, which may have been costly. The steady upward movement in interest rates through much of 2023 has taught us that a good asset in 2019 is still likely a solid asset in 2024. However, some good assets are saddled with a bad debt structure.

Ultimately, the industry has come to the realization that for at least the near future, long-term interest rates will remain elevated compared to the last 20 years. It is unlikely that we will witness the low-cost debt for the foreseeable future.

Another lesson learned or reinforced is that relationships are critical, especially in terms of sourcing capital. Over the last couple of years, any opportunities for debt financing were mostly limited to long-term relationships with banks. Financing deals based on new lending relationships have been difficult given the reduced activity and the recent track record of investors for lenders to digest.

What is your prognosis for distress and what kind of opportunities will it create?

The “good” news is that the Fed’s decision to not further increase interest rates has helped alleviate considerable consternation about distressed real estate. But alleviating distress doesn’t eliminate it. There will be distress, but we expect it will be more isolated and it won’t have the contagion effect it would have with a weakening economy, rising interest rates and increasing unemployment coupled with a banking crisis of sorts.

However, there are other factors to consider. Over the last 15 years, considerable money has been pumped into CRE, which served to inflate asset values along with artificially low borrowing rates. Realistically, there could be a substantial pricing correction. Further, the increasing level of debt coming due will create challenging situations for highly leveraged owners and investors. Yet the difficulty or inability of some owners to refinance will create opportunities for investors with greater liquidity and available capital or access to capital.

Overall, there is reason for optimism for 2024—more specifically for the second half of the year. We believe we’ve reached the bottom of the cycle and the bid-ask gap has begun to close.

What is your greatest concern for commercial real estate in 2024?

Concerns about 2024 include those focused on a more global picture and those related specifically to commercial real estate sectors.

Chief among our concerns are outside events that would have a substantial ripple effect, like another bank failure or global/geopolitical events like the pandemic, the wars in Ukraine and Israel, and the failures of Silicon Valley, Signature and Republic Banks, among others.

Another significant concern is the state of U.S. office markets. Trophy assets are generally performing well because they are the most modern, state-of-the-art and amenity-field properties. Unfortunately, more assets are substantially underperforming. Countless lenders have taken significant write-downs on loans and this has a trickle-down effect for lenders’ ability to make other loans. Similarly, if a building sold for a significant loss or is taken back by a lender, there are consequences for investors.

If distress in the office market or other sectors occurs over 12 to 18 months, we could emerge relatively unscathed. If the period of distress occurs over a shorter time frame, it would become increasingly problematic for investors.

Distress can also present itself as an opportunity. For every owner who cannot refinance a loan and must sell an asset, there may be another owner or investor that can acquire an asset at an attractive price—,and the cycle continues.

What is your outlook for interest rate movement in 2024?

We are optimistic that relief in the form of a few rate declines is on the horizon. Yet as we’ve witnessed over the last several months, patience is necessary as Fed meetings occur and economic indicators such as inflation fluctuate. It’s important to realize we’re still processing the jolt of the pandemic and its aftermath. It takes time to normalize. Normalcy and clarity are necessary and help shift sentiment from uncertainty to certainty, which investors demand.

Each decline helps lenders to have greater capacity for making loans. A greater number of loans equates to greater levels of acquisitions and development/redevelopment projects, which strengthens the industry.

What type of impact, if any, could the 2024 presidential election year have on CRE?

Generally, it takes time for the effects of a presidential election to take hold and be impactful. With that in mind, we don’t expect to see any material changes or impact on commercial real estate until, at the earliest, the second half of 2025.

For more information on this topic, or learn how Baker Tilly specialists can help, contact our team.

Mike Kamienski
Brent W. Maier
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