After the COVID-19 pandemic, commercial real estate (CRE) investors were thrown into the limelight and multinational companies (MNCs) focused on gradually opening work to manage their global work environments.
Moreover, it is clear that companies, environments, and people need to bring in changes that help better the scenario in the foreseeable future.
As the CRE industry is trying to adjust to the new normal, let us assess how industry leaders are focusing on bettering their teams and the future work environment.
Rise in Interest Rates In 2023
The new normal for US commercial real estate investors means an environment with a higher interest rate and a radical reorganization of the order of lenders and financial institutions. Another significant change is the usage of lesser leverage in future deals meaning it is important for CRE investors to adjust and transform their agenda.
According to Jerome Powell, the chair of the Federal Reserve, after the June meeting of the US Central Bank, interest rates are expected to stay higher for longer.
However, the Federal Reserve has chosen to let the rates remain the same at the meeting. Investors can expect two more increases before the end of 2023 as per the plan outlined by Powell.
This also means that The Federal Reserve is looking at establishing stringent rules and regulations and capital controls for banks/established financial institutions. As a result, CRE investors can expect higher debt costs for borrowers and reduced lending capacities for banks.
One can expect companies to be looking for better financing alternatives and the growth of non-traditional financial institutions.
Noteworthy Market Developments In 2023
Before we take a look at how CRE investors are adjusting to these changes, let us look at the noteworthy developments in the industry in 2023 Q1:-
Shifts in Buyer Profiles
Although more and more commercial real estate owners are putting up their properties for sale, the universe for buyers has still not expanded and is small. It is also highly constrained with more preference given to cash-only buyers and those with private capital or investors with family funds.
This has led to shutting off traditional investors from purchasing these listed properties and creating a wider portfolio. Moreover, high capital costs are also shutting some buyers off financing meaning transactions are down and price resets need to be determined. This is why there are fewer buyers for commercial real estate investors available in today’s CRE market.
Smaller Buyer Pool
Due to the increasing capital costs, a lot of buyers were shut out from investing in commercial real estate properties. Moreover, the added uncertainty caused a lot of investors to pull out of deals and stay on the sidelines to wait it out.
This caused a decrease in confidentiality agreements, which is a clear indicator of the decreasing size of the buyer pool. Although confidentiality agreements can significantly vary by asset class, it is an important metric that CRE investors must look out for.
It is a clear market indicator, but how? Well, if market uncertainty decreases, the number of confidentiality agreements increases which means that buyers are moving out of their shells and bringing their capital to the table for better investments.
Environmental Due Diligence Along With Decline in Appraisal Volumes
Since the transactions market is at an all-time low, it is not out of the blue that the demand for environmental due diligence and appraisals is at low levels. Yet more obvious is the fact that they have hit the lowest levels ever, while the demand for near-term appraisal demand will stay muted.
This is all the more justified as investors and lenders need to adjust and adapt to the upcoming hikes in interest rates before the end of 2023. Moreover, the expected loan maturity waves and aftermath of recent bank failures will bring in several changes you must look out for.
Rise in Multifamily Vacancy Rates
Although strict credit conditions and policies indicated a decrease in deal volumes, other fundamentals of the CRE industry are also weakening.
Moreover, office vacancy rates are at an all-time high, and with the uncertainty of the workforce returning to normal, it is expected to keep on rising. This has caused an increase in the multifamily vacancy rates, slowing down of industrial leasing activity, and high demand for industrial space.
So, retail vacancy rates are low, but the limited new supply is acting as a benefit for retail property market investors.
Slowing Down Of Rent Growth
Since vacancy rates have climbed, rent growth across different asset classes is at a moderate level. However, this has not slowed down the growth in the rent for industrial assets and properties. At the beginning of 2023, multifamily rent growth has significantly decelerated and is slowing down.
Moreover, with the increasing popularity of remote work, market demand is supposed to reduce and lead to a lowering of industrial office space rents. However, retail rent growth depends on consumer spending and can be predicted to grow (subject to location and other market terms).
Risk Factors CRE Investors Must Look Out For In 2023
As discussed, the CRE market has witnessed a lot of changes till now, but we’re still not out of danger. Some risk factors investors must look out for to develop plans that help them better adapt to changing times are:-
Market Sentiment
Although it might not seem obvious, experienced CRE investors know that the current commercial real estate investment is closely related to changes in the market sentiment. We recommend keeping an eye out for regular CRE analysis reports to get valuable insights into how the market is changing and the expectations of investors, private commercial lenders, and borrowers for 2023.
CRE Lending Forecast
Previously, lenders decided to back out of their planned changes to loan originations and had to adopt a risky stance in their underwriting. Moreover, the failure incurred by banks also sent huge shockwaves across the global finance industry.
This resulted in several banks and financial institutions setting up stricter policies, rules, and regulations. So, as of now, we can expect interesting changes to take place and change the complete scenario of the banking and finance industry.
Shift in Flow Parameters in Deals
In the current market scenario where the price is constantly on the decrease, everything is about value and you should be more concerned about it. Otherwise, it would be impossible to make sense of the values and numbers we are looking at.
Before you invest in commercial real estate, ask questions like – “Will the parking lot or mall space be worth more after 5 years? “As discussed in a previous section, the interest rate hikes in commercial real estate are at an all-time high as of now.
This is demotivating buyers from investing in commercial real estate and causing a significant decrease in the pool of potential buyers. So, sellers might need to start thinking about offering concessions to bring in more customers and potential buyers.
In uncertain markets and environments similar to that of 2023, CRE investors must conduct due diligence and assess ground-truth assumptions before making decisions to avoid errors and miscalculations.
Transaction Volume Trajectory
As the interest rates and property valuations try to establish a new equilibrium, CRE investors can expect transaction volume to significantly slow down. Over the past year, the shortage of sales comps has already caused investors to think about valuations and predict future trends.
However, as actual sales data and reports are coming in, they are replacing these educated estimates. This means that valuations across different boards might witness a significant decrease in certain areas and asset classes.
Shift in Property Valuations
If you have been a part of the CRE investment market since the beginning of 2023, you might know that a property valuation reset is on the way. The aim is to bridge the gap on the bid-ask spread that has stalled quite a few deals.
An important point to keep in mind is that appraisers play a significant role in this upcoming reset. Moreover, the market is struggling to adapt to the rapidly changing interest rates.
This ensures that the upcoming quarters will be difficult for sellers as they will need to come to terms with the new interest rates. A reminder that these conditions could worsen before showing any signs of improvement, making it necessary for you to thoughtfully plan your next moves.
Conclusion
It is clear that the CRE industry is still as dynamic as it was, if not more. Hence, it is important for investors to pause, thoroughly assess market conditions, make new plans, and regroup their strategies.
We hope the above article helped you understand the different factors working together and the parameters you must look out for. This will help you better analyze your strategy and modify it to better suit the current trends in commercial real estate.
Confused about how you can adapt to these changes and come back stronger? Get in touch with the industry’s top financial experts who stay updated on the market trends and dynamics.
We analyze your current strategies and make the changes necessary to help you make profits even in unstable market conditions. Our experts also have years of experience and have helped several businesses get a hold of the CRE market in no time!
