Closing Statement
A combination of lower asset prices and the prospect of gradually cheaper debt appears to be setting the stage for a different market dynamic this year - one that could provide for initial tailwinds compared to the steady headwinds we experienced throughout 2023.
Below are some key themes investors may want to keep in mind for 2024:
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Reset Cost Bases
A defining theme for 2024, our review process will prioritize projects that offer significant discounts from their peak valuations and present compelling discounts to replacement costs. |
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2
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More Capital Calls and Recapitalizations
Many CRE assets will continue to struggle with unsustainably high debt service costs that are attached to cost bases that are above current market levels. Certain assets may be hopelessly trapped in negative leverage situations, and efforts to salvage them may prove to be too little too late as they succumb to the damage already incurred. For others, particularly those that continue to possess solid operating fundamentals, short-term financial distress may lead to creative opportunities to recapitalize and reposition them for potential success later this cycle. These scenarios may translate to contributing additional capital to existing investments or providing rescue capital to new ones. We see this trend accelerating in 2024. |
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3
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Paying attention to the 10-year treasury yield
One harbinger that may signal greater demand for real estate assets is the 10-year treasury. While it peaked at over 5% in October 2023, it has fallen over 100 basis points since then and currently hovers just under 4% (at the time of publishing, January 2024).55 I view this move as significant. The 10-year treasury rate has historically served as a benchmark above which cap rates for each CRE asset class tend to oscillate in ranges. While research conducted by economists such as Peter Linneman shows that the determinant of cap rates is capital flows, my experience also suggests that significant movements in the 10-year treasury rate can induce a change in capital flows.56 Essentially, if the 10-year treasury rate remains below 4% throughout the first half of 2024, I believe it may serve as a catalyst for greater capital inflows which, in turn, may provide an additional stabilizing factor for pricing and potentially help fuel the CRE recovery. |
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4
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Expect Some Interest Rate Relief
It is worth noting that a gradual reduction in the Fed Funds rate throughout 2024 may make for a markedly different capital markets environment than we experienced in 2023. While broadly anticipated, it’s still a key component of working through the market trough and towards a potential for market recovery. |
(Commercial Property Price Index)
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Source: MSCI Real Capital Analytics, December 2023.
Translating these themes into net positivity for the market this year relies on a series of assumptions that include, among other things, the avoidance of a recession and major exogenous geopolitical shocks and a presidential election that doesn’t culminate in chaos. These are not always a given. However, If we combine an environment of gradually decreasing interest rates with increased capital flows while continuing to see positive GDP growth, I think we may have a catalyst for the beginning of a real estate recovery.
(2002-2023 November)
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Source: MSCI Real Capital Analytics, December 2023.
My expectation is that fundamentals for certain asset classes may continue to remain tepid through the first half of 2024. Vacancy levels may rise in some markets, and rents for certain sectors, particularly multifamily, may remain flat for the next six months. But, to me, these are relatively short-term factors that I believe will help buyers to drive harder bargains. As a result, when evaluating deals this year, we will look for situations that have this short-term outlook baked into valuations. Overall, 2024 will be the year we will continue to find discounted assets or develop in-demand assets that offer the potential for expanded yields on cost, capitalize them prudently, and patiently operate them until we transition into the next growth cycle.
