ADVERTISEMENT COST OF CAPITAL IS MAJOR IMPEDIMENT TO INVESTMENT SALES In 2022, the majority of money center and regional banks raised interest rates to combat soaring in ation, ending decades of low interest rates. While massive in-terest rate hikes have been ham-mering the commercial real estate market, the recent Federal Re-serve decision to hold rates un-changed should give the market a Pat Sullivan break. This increase in short-term NAI Hiffman | interest rates led to a virtual mar-Hiffman National ket-wide shutdown and a repric-ing of commercial real estate. This has led to a repricing of real estate assets in both the public and private sector. With low interest rate loans maturing at much higher rates, real estate investors face the challenge of transacting, with market participants dealing with negative leverage. There is a gap in pricing — sellers are slow to lower their pricing expectations, and buyers are struggling to place capital at favor-able yields. Add to this that lenders have a differ-ent perspective on values, which dictates how much they will lend. Banks are still basically out of the market, and CMBS and debt funds are an expensive option, so favorable debt capital is in short supply. Small and mid-sized banks who historically provided most commercial real estate loans have implemented tighter lending standards, making nancing and re-nancing challenging. The substantial number of maturities in the debt market has added to the slowdown in the transac-tion market. Lenders have kicked the can down the road, and they will need to deal with those maturi-ties in 2024. That dynamic will have an effect on the industrial market, causing some forced sales, be-cause favorable re nance options will not be avail-able for all borrowers. Investors usually have two options when a loan matures — re nance and replace the existing loan and possibly get more proceeds, or sell. Both of those options don’t really exist in today’s market, unless an investor is willing to do an equity pay down of an existing loan. In the commercial real estate world, the of ce sec-tor seems to be getting all the press and creating the illusion that the whole commercial real estate sec-tor is in trouble. The of ce sector is only one part of commercial real estate, albeit a large part, but the other sectors are in unusually good shape. Industrial is truly an essential asset class and will continue to perform well in the foreseeable future. The sector remains robust with strong rent growth, even with demand slipping closer to the pre-pan-demic level. Boosted by growing e-commerce de-mand, a constantly evolving supply chain and reshoring initiatives along with domestic manufac-turing, demand for industrial space has led to un-paralleled competition for available space. The pandemic completely changed the warehous-ing and manufacturing space to historically high rental rates/values. The vacancy rates for distribu-tion and warehouse space are at record lows, and have progressively declined each quarter since the end of 2020. While the sector is still very healthy, it is showing signs of softening. The investment transaction market is muted, but as interest rates stabilize, we believe transaction ac-tivity will pick up with the narrowing of the bid-ask spreads. The current capital-constrained market has reduced new construction, with 15 percent fewer deliveries expected in 2024 and 2025, according to Green Street estimates. The market remains under-supplied, though additional supply is coming to market at the end of 2023 and 2024. With tough lending criteria, fewer lenders and higher borrowing costs, commercial real estate in-vestors will struggle deploying capital at favorable yields in 2024. Industrial investment sales volumes have dropped well over 50 percent so far through 2023 in the Chicago market. We expect investors to remain cautious in 2024, though eager to transact. High interest rates, an uncertain economy and tighter credit requirements are the primary obsta-cles to increased deal ow. Cap rates have contin-ued to rise throughout 2023, though we expect them to stabilize in early 2024. The expectation is for the market to stabilize in early 2024 with an increase in transaction activity as the year progresses. Pat Sullivan is executive vice president with NAI Hiffman | Hiffman National. 22 • December 2023 • Heartland Real Estate Business
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