Reflecting and Projecting 2023 – 2024

As humans, it is natural for us to take things for granted.  Our children will stay young forever.  A business will continue on its current growth trajectory.  2023’s rapidly changing interest rate environment served as a reminder that things can change quickly.  On March 17, 2022, the federal government set out to slow down an economy that was growing at an unsustainable rate.  The federal funds rate rose from 0.25% to 0.50% in March 2022 to 5.25 to 5.50% on July 26, 2023 which represents the last rate hike (https://www.forbes.com/advisor/investing/fed-funds-rate-history/).  That’s 500 basis points in 16 months!  Rapidly increasing the federal funds rate achieved the government’s goal of slowing inflation.  The speed of change was rapid, being the fastest in multiple decades, and sent shock waves throughout the commercial real estate world. Some of Black Diamond Realty’s observations are captured in the bullet points below.

• Buyers were forced to adjust their internal underwriting to account for higher borrowing costs, due to higher interest rates, which ultimately led to rising cap rates.
• Sellers are also forced to adjust value expectations when evaluating their assets and pricing to meet required DSC for Buyers of their assets (making it a bankable deal). Sellers are slow to adjust to a changing economy.  Human nature protects our psyche resulting in most sellers reluctancy to accept the fact that asset valuations from mid-2022 are no longer an accurate representation of today’s market value.
• The buyer-seller gap was wide at the beginning of early 2023 but slowly shrunk. Like many things in life, time heals wounds or, in this case, narrows the buyer-seller value expectation gap.
• Banks are quick to adjust pricing and risk tolerance guidance and adjust required DSC levels and reprice assets.
• Banks struggle with nonperforming assets and collections.
• Metro markets often rise faster than tertiary markets and, therefore, tend to fall faster when economic conditions adjust. The markets Black Diamond Realty services experienced a slowdown in activity but it was much less profound than many metro markets consuming national media.
• Greater increase in creative deal structures including seller financing.
• Higher interest rates make leasing a more attractive option for some businesses. In comparison to sale volume, leasing activity has experienced increased transactions across most sectors of commercial real estate.
• High borrowing costs, combined with increased labor and material costs, have resulted in a significant slowdown in new construction starts. This is a national trend in most markets.
• Land sales have slowed. Higher interest rates and increased construction costs make it more difficult to “pencil” returns that meet developer hurdle (internal return) rates.
• Less individuals can afford to buy their “dream home” because of rising home prices and rapidly changing interest rates which has resulted in many potential buyers sitting on the sidelines and renting longer. Market rents have continued to tick up in most markets helping to create greater demand in CRE’s multifamily sector . Market inventory continues to be the key struggle leading to lower transaction volume this sector.
  • Buying single family homes has become an attractive investment for large players. The federal government has a bill called The End Hedge Fund Control of American Homes Act which is aimed at preventing hedge funds from “mass buying” single family homes.  (https://truthout.org/articles/new-bill-targets-hedge-fund-stranglehold-on-housing-market/)

2023’s theme was rapid change.  What will 2024 look and feel like?  Predicting the future is impossible, but national trends and experience allow us to make educated guesses.  Please bear in mind you should always complete your own due diligence before making an investment decision.  Black Diamond Realty’s 2024 predictions are as follows:

• The Federal government is anticipated to lower interest rates three to six times throughout the year. BDR anticipates four lowering events with a final result between 100 to 150 basis points.
• Election years usually create uncertainty and fear which causes many investors and businesses to adopt a holding pattern. Declining interest rates should create a market buzz but uncertain political outcomes will soften 2024’s activity.  In comparison to 2023, greater CRE deal volume is anticipated.
• Combined with high bank CD and money market rates, 2023’s slowdown in CRE activity has led to pent up demand with a lot of “powder” sitting on the sidelines. Cash is, once again, king/queen.  “One person’s demise is another’s potential treasure.”  Many adjustable and/or maturing loans will present buying opportunities over the next 12-24 months.
• Banks will be quick to move nonperforming/uncollectable assets off their books. This will create opportunities for buyers to pick up properties at a discount…timing and connections will be key to buying up these assets.
• Office assets, overleveraged real estate and properties financed with short-term debt all face headwinds in 2024. Distress, leading to buying opportunities, is anticipated across these categories.
• User demand for industrial/logistics, retail and residential is anticipated to remain strong.
• Cash buyers and international investors are anticipated to be more prevalent.
• Banks will continue to tighten their lending belts and stress properties at higher interest rates (8-9%). Debt service coverage ratio (DSCR) levels will continue to be higher than pre-COVID levels.  Most banks will require a 1.25 DSCR

We often joke Black Diamond Realty is not a group of magicians.  We are skilled CRE professionals whose job is to maximize exposure, navigate complicated processes and provide sound consultative investment and decision-making guidance based upon experience.  We are in the commercial real estate trenches every day.  We do not sell homes.

Diversifying investments, pursuit of passive income, filling a void in your portfolio’s performance (leasing) and liquidating an asset to meet long-term goals are all reasons to contact our Black Diamond Realty team.  Call our team of experts today to set up a consultation.  We look forward to serving you in 2024 and beyond.

Article by:
David Lorenze, CCIM Principal, and team.