2023 CRE Overview
The commercial real estate landscape faced considerable challenges in 2023, marked by declining asset valuations that originated in the latter half of 2022 and spread to a broader array of markets by year-end 2023. Transaction volume plummeted as buyers and sellers engaged in pricing standoffs, hindering dealmaking.
The debt market has been subdued due to the rapid increase in capital costs and the uncertainty surrounding where and when these costs will stabilize, giving rise to price discrepancies and a large gap in bid-ask spreads. A significant concern has emerged surrounding refinancing maturing debt coming due, and investors are wary of the tangible challenges that lie ahead.
Investors are optimistic for a more favorable 2024 as pricing stabilizes, restoring the market to more typical levels of activity. However, the timing and method of this recovery remains uncertain and dependent on Fed decisions to revitalize the economy. Despite the uncertainty, the abrupt market shifts witnessed over the past 12 to 18 months have altered dynamics significantly. Investors are reevaluating their real estate allocations and strategies to manage substantial risks and capitalize on opportunities arising from the market’s disarray.
The combination of structural and cyclical trends influencing the market has created a diverse investment landscape, characterized by varying levels of risk exposure and anticipated returns. This article outlines what to expect in 2024 as investors navigate the complex market.
What to Expect in 2024
Transaction Volume Will Rise
Based on year-over-year trends, the market is heading into a period where transaction volume will begin to rise. As seen in the graph below, transaction volume typically does not stay in a decline for more than one to two quarters (aside from 2008’s Great Financial Crisis). However, the current market has experienced five consecutive quarters of transaction volume declines, indicating that volume will soon rise. The Fed has indicated that it is holding steady as inflation eases but forecasts three rate cuts in 2024.
Lower Interest Rates
With financing rates being the main reason for the transaction slowdown experienced in 2023, the Fed has indicated that it is holding steady as inflation eases, but forecasts three rate cuts in 2024. When interest rates were hiked at the pace they were, the market doesn’t move as quickly as the stock or bond market and buyers cannot justify paying the prices that sellers still think their asset is worth. The CME Fed watch tool below shows the probability of the Fed lowering interest rates at each individual meeting. The squares highlighted in blue indicate the highest chance of the rates dropping in each meeting.
Closing the Gap on Bid-Ask Spreads
In 2023, the gap in bid-ask transactions was wide, where buyers and sellers are separated by a space between their respective valuations of a deal. Fortunately, the price gap is expected to narrow in 2024 as deal transactions return and the market accepts new interest rates, which fall back to the levels seen before the low interest rate environment of 2021 and 2022. While evidence suggests that price adjustments have settled into cap rates, which have risen, real estate fundamentals still remain strong in terms of vacancy declines and rent growth. 2024 will be marked by a period of growth as investors accept the new reality of the market.
