Historically, commercial real estate has been far less volatile than other investment markets. Whereas our instant news landscape makes the world seem good or bad with a few clicks, the information lag and long-hold nature of property investing, which is less reactive, provides a more reliable glass with which to scry the future.
As we head into 2024, the commercial real estate industry is poised for a year of change and opportunity. With interest rates stabilizing and potentially being cut in 2024, underwriting requirements reverting closer to the mean, and a push toward affordable housing, investors and industry experts predict some gradual shifts in the coming months.
Additionally, the impact of AI on the industry is becoming increasingly apparent, with both new tools and technologies emerging to enhance productivity and streamline operations coupled with the societal change those changes may bring. Based on our conversations with industry experts over the last year, we'll explore some of the top discussed predictions for commercial real estate in 2024 and what they mean for investors, developers, and industry professionals.
1. Interest Rate Hikes Winding Down
The Fed’s November decision to keep interest rates steady (at 5.5%) represents a second consecutive pause in interest rate hikes, following 14 such increases since March 2022. These signs - plus generally good news overall from the economy in terms of slowing inflation, an unchanged CPI in October, and cooling job and wage growth – herald a hopeful end to rate hikes in 2024. The stock market is currently pricing in a ~75bps cut next year.
This is by no means set in stone, as we’ll need November and December’s numbers to set us up for 2024 more decisively. But several positive economic indicators and an industry outcry in response to the non-stop rate hikes suggest we may narrowly avoid a recession and that the Fed is probably finished with its corrective action.
CME Group estimates a potential rate cut in May 2024, but inflation is still above the Fed’s 2% target – which may be slightly unrealistic in today’s fast-moving world. We must observe the spillover impact these rates have on deal flow, but signs are optimistic. As many participants in the market today are pausing activity on all but the best value-add acquisitions, such rate cuts will allow transaction velocity to increase again, though likely not nearly at the same volume as the 2021 peak.
2. Underwriting Requirements Will Slightly Loosen
As uncertainty fades and positive ROI looks more likely while capital becomes less expensive, lenders may open the door to more opportunities and loosen requirements. Banks will likely remain eager to mitigate risk and still be choosy overall with whom they conduct business, with caution stretching well into 2024. Because lenders created so much cushion for themselves in their abundance of caution in 2023, wiggle room to more proactively finance deals may emerge next year.
To get ahead and set themselves up for capital access when the perfect deal emerges, investors should continue doubling down on solidifying relationships with their lenders and other financial partners or capital providers. We observed many such proactive conversations occurring in 2023 to solve problems deal-by-deal. This clear communication flow between parties may make all the difference in being ready to strike whenever a solid opportunity appears.
3. A Push into Affordable Housing
Affordable housing is a hot topic in the commercial real estate space. The federal government and state and local administrations are prioritizing affordable housing in the years ahead, with major markets such as Seattle earmarking nearly $250 million to build out the sector. Creative conversion options such as transforming offices into mixed-use and hospitality into multifamily faces are gaining traction. Though they face their own challenges, well-planned asset conversions may cost less than starting development from scratch in some markets.
While home prices are predicted to fall in 2024, younger demographics are still expected to prefer renting rather than buying, which will continue the surging demand for multifamily units. However, multifamily – particularly Class B and C assets – may face upcoming storm clouds in the months ahead.
Many investors who purchased in the 2020-2022 peak were able to justify low cap rates by assuming hyper rent growth in fast-developing markets. As many tenants who would otherwise choose these Class B and C properties (compared to the luxuries of Class A) can no longer afford to remain and moved elsewhere, some markets that had assumed high rent growth have stagnated or even declined year-over-year amid rising operational and renovation costs.
As such, savvy investors may want to turn their eyes to markets with little rent growth but better cap rates and solid fundamentals. Striking a balance between healthy demand, stable rent, and taking advantage of affordable housing incentives may be a goal worth pursuing in 2024. In our “Best Markets of 2024” series, some high-potential markets we identified included:
Jersey City, NJ
Madison, WI
Columbus, OH
Knoxville, TN
Pittsburgh, PA
4. Construction Deliveries Will Slow Demand
Construction finally picked up steam again in 2023, following slowed progress in a post-pandemic shortage of labor, supplies, and affordable materials. While the strict underwriting requirements in 2022-2023 will have placed holds on many prospective projects, construction was well underway this year, with estimates predicting a 5.8% multifamily delivery increase YoY in 2024. However, these new assets are primarily Class A, which may experience reduced demand in 2024 as outsized rents limit tenant’s ability to capture unit space.
We expect similar deliveries for industrial properties, though the impact here may cause vacancy rates to grow. Still, tenant demand is mostly stable in many markets. In the office sector, while the pandemic radically changed how we relate to offices, a halt in construction will mean no supply in 2024, which will likely produce an increase in demand as the economy continues to perform strongly.
5. AI Will Change Productivity and Workflows
Undoubtedly, AI will change - and is already changing - how we live, work, and play. AI's recent advancements are already ushering in a new era of tools to enhance CRE's relationship-driven business. Such tools can heighten productivity, lessen operational spending, and strengthen industry players' abilities to uncover, analyze, and close deals.
In 2024, outside of some potential regulatory limitations, AI shows no sign of slowing down. While CRE is traditionally slower than other sectors to adopt new tools, those who can effectively learn to use such technology will enjoy an enviable advantage over teams who choose not to.
6. The Reign of Retail Concepts
Retail is transforming, outstripping the dusty pall of the “retail apocalypse” we expected in a post-e-commerce and post-pandemic world. While buying online has changed things, the retail experience has become much more meaningful, with many operators experimenting with creative concepts to attract and retain visitors.
Pursuing retail concepts such as flagship brand stores, experiential shopping, and even microunits makes retail hubs more valuable to corporations who want to build long-lasting relationships with their customers. Direct-to-consumer brands are also getting into the brick and mortar retail game, with flagship stores in major cities allowing consumers to try before they buy. Who would have thought Barnes and Noble retail locations would begin sprouting en masse.
Indeed, the rising penalties involved with returning an online purchase (restocking fees, etc.) have driven 40% of survey respondents in PwC’s 2023 Global Consumer Insights Survey to express their intention to shop more in-store. Harnessing a multi-channel approach, in which the in-store experience is critical, will be of increasing importance to brands and shoppers in 2024 and beyond.
7. Rising Insurance Costs
Increased insurance costs, especially in coastal markets, concern both potential investors and current owners. An increase in the frequency and severity of disasters nationwide have exposed weaknesses in current infrastructure, and, in turn, are heightening insurance companies’ perception of risk.
As such, up-and-coming developments need to be future-proof, which makes construction costs more expensive. And once these buildings are completed, insurance providers are offering much higher rates than before; Moody’s reported that rising costs are up 7% in 2023 compared to 2017.
Insurance costs are expected to continue to rise in several markets, with some high-profile companies even withdrawing from places like California and Florida. In 2024, it will be necessary to factor weather-proofing and insurance premiums as operational costs before committing to a property purchase. Investing in renovations to make a building more climate-resilient may actually reduce total insurance costs and even help owners secure coverage in the first place.
8. Auctions Will Become Important Tools
Auctions will increasingly be a tool to effectively and quickly dispose of property. As technology speeds up the overall process and opens the bidding pool to a national audience, what was once a hush-hush affair has become a viable and date-certain way to sell a non-performing or healthy asset.
Online auctions offer bidders greater control and transparency while providing sellers with more effective marketing tactics, broader reach, and certainty of close. In an economy where the most flexible and fast have the most to gain, online auctions indicate how transparency, data, and technology will forever change how CRE trades hands.
We anticipate continued, expanded use of such deal-flow facilitators in 2024, especially as banks reshuffle their loan portfolios and seek to dispose of potentially risky line items. The result: an effective pathway to liquidity and plenty of untapped potential for those with cash to find a great deal on the virtual auction calendar.
The Bottom Line
While 2023 was an uncertain year with shifting ups and downs, 2024 looks to offer a glimpse of stability as post-pandemic trends normalize and we turn a cyclical corner. None of these trends are outright predictions, but we hope this forecast will provide the best possible information to tackle the year ahead.
