There are currently some headwinds that may affect commercial real estate heading into 2024. For buyers, higher interest rates have the greatest impact as they increase the cost of borrowing, thereby reducing the capacity to borrow.
For property owners, higher borrowing cost affects the return and, consequently, property values.
Higher interest rates can deter buyers from purchasing a property when the cost of borrowing exceeds the investment return, resulting in what is referred to as negative leverage. For example, buying a property with a 5% return when the borrowing costs are 6% wouldn’t make sense unless there are other compensating factors.
The fall of some regional banks has also had a negative impact on commercial real estate, as these banks account for about 69% of outstanding commercial real estate loans. The ongoing troubles in the regional banks made them tighten their lending practices.
A report from Goldman Sachs estimates that $1.07 trillion worth of mortgage loans will mature before the end of 2024. The investment bank believes this could put more pressure on net operating income and potentially increase vacancies and delinquencies, mainly in the office sector.
Property owners with maturing loans or adjustable-rate mortgages may need to sell to avoid higher rates, creating opportunities for investors. Sellers are beginning to improve pricing and offer more attractive returns to compensate for higher interests.
The reality is that rates are currently high as the Fed tries to tame inflation, which has been at a 40-year high. However, if the right opportunity presents itself, it’s important to remember that you can always refinance when rates come down.
The other factor that could impact commercial real estate is a potential recession. That could have a damaging effect on businesses, causing companies to delay or cut expansion plans. During an economic downturn, there would be decreased demand for space, and this put pressure on rents. This will affect the cash flow of properties, resulting in lower returns for investors.
However, sectors such as healthcare facilities and essential retail, including groceries and fast-food companies, are more resilient and can potentially mitigate the impact of an economic downturn.
So, where are the opportunities?
It is expected that new opportunities will emerge in the market as loans mature and adjustable-rate mortgages reset. This will create perhaps the greatest opportunities for buyers in recent years.
In an economic downturn, investors should also consider distressed properties or those with potential appreciation through repositioning or renovation. To be able to acquire properties, investors should maintain a sufficient cash reserve. It is crucial to identify areas with strong economic fundamentals.
No matter which direction the US economy takes, Florida is expected to perform better than other states due to its business-friendly environment, migration, lack of income tax, a robust service economy and tourism. Consumer spending should all contribute to Florida’s success and allow businesses to better withstand any economic downturn.
Fernando Echeverri, is a broker specializing in commercial investments properties, and works with Great Properties International on Key Biscayne.