Strategies to score real estate wins in 2024

 

Property owners, investors adapt to ‘new ball game’ in commercial real estate

 

2023 was a record year for real estate transactions — unfortunately, not in the right direction.

 

“At the end of 2023, real estate transaction volume was down almost 60 percent from 2022 and about 70 percent from its peak in 2021, which is an incredible decline,” said Grant Thornton Advisory Services Managing Director Don Davidson, who specializes in real estate valuation. “The cost of borrowing increased dramatically, and higher commercial mortgage rates had a devastating impact on  the industry.”

 

Property values also saw a decline — almost 12 percent in 2023 and about 20 percent below their peak in early 2022 according to analyst estimates. Despite these trends, however, 2024 shows signs of steadying with opportunities for property owners and investors to find value — but they will likely need to try new tactics. Because, as Davidson said, “it’s a new ball game.”

 

 

 

Commercial real estate seeks to rebuild from the perfect storm

 

Throughout 2023, the real estate market experienced what Davidson describes as “the perfect storm” of factors affecting transactions and valuation: rising interest rates, inflation, tightening lending standards among banks and changes to tenant needs, particularly in the office sector.

 

“Transaction volume stalled when loan-to-value ratios fell sharply, and banks began requiring more capital to even consider deals. Furthermore, inflation is causing the cost of operations to increase way beyond what is typical for property managers,” Davidson said. “Combine that with mortgage rates going from 2.75 percent to over 7.5 percent, and suddenly, owners and investors are facing a completely new reality.”

 

Now, owners are struggling to afford to keep their properties or initiate new loans, and on top of that, they’re having to reevaluate the use of their spaces completely. As a result, there has been a huge spike in delinquencies. And generally, there has been a slowdown in city centers, putting many metro areas in a transactional slowdown.

 

Toward the end of 2023, interest rates declined from their peak, but they’re still much higher than what has been typical for the market in recent years. Most recently, the Federal Reserve signaled that it is finished raising interest rates but made it clear that it is not yet ready to start cutting rates. Current expectations are for rates to decline in the second quarter of 2024, which should lead to property value stabilization across all sectors.

 

 

 

Some sectors can expect value stabilization

 

Recently, Davidson said, property values clearly aren’t declining at the rate they were, but, he warns that they haven’t necessarily bottomed out yet.

 

Headshot of Don Davidson

“There is no guarantee that the declines in value are finished, but at some point, sales volume will find a new normal level and the contraction in activity will moderate. There are signs that capitalization rates and property values will stabilize by the end of 2024. Rents will remain flat or even increase, and commercial real estate activity could pick up.”

Don Davidson

Managing Director, Advisory Services

“There is no guarantee that the declines in value are finished, but at some point, sales volume will find a new normal level and the contraction in activity will moderate,” Davidson said. “There are signs that capitalization rates and property values will stabilize by the end of 2024. Rents will remain flat or even increase, and commercial real estate activity could pick up.”

 

Asset classes aren’t all faring equally, though. While almost all asset classes are seeing a decrease in transactions, the office sector is driving much of the decrease, with increasing vacancies, heightened tenant improvement costs and waning rent growth tempering investor interest.

 

The industrial sector remains solid, particularly due to growth in e-commerce.

 

“There continues to be a strong demand for distribution centers and warehouse space, although growth may be at a slower pace than in 2023,” Davidson said. Also growing is the demand for specialty last-mile logistics space and data center space, which is being fueled by the artificial intelligence boom.

 

Retail remains strong as well. While the expectation was that the height of retail ended a long time ago, higher-end facilities have been performing surprisingly well.

 

Multifamily is in high demand in many markets, Davidson said, “Multifamily was the most preferred real estate sector over the past year. A lot of apartment projects started in 2022, and it usually takes 18 to 24 months to get these projects going, so there’s a huge amount of new supply coming online soon."

 

Despite a tough year, REIT performance had an impressive late-year surge, giving some degree of optimism. 

 

 

 

Diversifying portfolios, making upgrades to add value in 2024

 

In 2024, those seeking to buy will need to alter their approach to stay afloat, particularly when it comes to office space. Many companies have needed to reevaluate their space needs, so there’s a demand for flexible office spaces. Buyers will likely be able to find opportunities to rehab older buildings or convert them for an alternate use.

 

Many investors, Davidson added, are diversifying their property targets — for example, going after “last-mile logistics facilities” — the buildings at the end of the distribution cycle that allow us to get our Amazon packages within a matter of hours. Non-traditional real estate, such as gaming properties and cell tower portfolios, is also gaining traction.

 

For current owners, investing in upgrades and enhanced amenities will also boost their property value. One growing trend is sustainability, which is prioritized by investors and tenants alike.

 

“Sustainable operations command higher rents,” Davidson said. “If a building can be upgraded to get energy-efficient certifications, it’s in their best interest to do so because they trade at a higher value.”

 

Technology advancements, like the use of virtual reality in site visits, will continue to impact the industry. Additionally, with the increased cost of operations as a result of inflation, smart-tech buildings are on the rise, increasing operational efficiencies, improving security and enhancing the overall tenant experience.

 

Even with uncertain market conditions, Davidson said there are reasons to be optimistic.

 

“Chaos creates opportunity. With disciplined and strategic planning and research, well-funded investors will find opportunities to attain low-cost, high-quality assets in major metro areas,” he advised.

 
 

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