What Lies Ahead: Forecasting the CRE Finance Market in 2024 – By John Darrow
As we prepare to close the books on another year and get ready to ring in 2024, l will be making time to relax and reflect on the year that was. From my perspective, I know this year was a little shorter than usual in the victory column and more generous with its share of challenges than normal, but not all success is measured in terms of dollars in the bank. Besides, the most successful are equally as good at monetizing their intel and time. With that in mind, I have put together some intel I have gathered and things I am watching for in 2024:
It would be hard to write this article and not at least mention interest rates. Most people reading this article know what happened this year with rates, so I will not go into much detail summarizing. Still, I will mention that the market has started pricing in better than a 50% chance of rate cuts as soon as March of 2024—much sooner than the Fed seems to think. I firmly believe, “Be careful what you wish for.” Question: what bad thing would need to happen for the FED, which just raised rates at the fastest clip in history, to turn around and start cutting this quickly? I subscribe to the belief that the stock market drives the economy in this modern financial age, not the other way around, and to that point, the stock market, on average, doesn’t bottom until almost a year after the FED starts cutting rates. That means the S&P 500 has over 1000 points of downside potential in store (going back to the October 2022 lows). Try raising money with that playing out in the background.
Fragmented Multifamily Market
This is where most of the eyeballs will be in 2024, and for good reason. 2023 saw some of the hottest markets for multifamily start to cool off – Phoenix, Vegas, Texas, Carolinas, Georgia, and Florida, namely – and I believe we will see much more of that in 2024. I spoke with one client this week based in Texas who had to lower rents by $200/unit in Houston on a very well-located infill class B property. He said it just had to be done, and it worked to fill the property up. Are you wondering which lenders or investors are running models right now where rents are being lowered? I spoke with another senior executive in Dallas who manages over 30,000 units across Class A and B properties. When I pressed him on expenses going down next year, he said, “The only thing going down next year is rent.”
On the other hand, I received an investor letter on a class C deal being marketed for sale in a strong neighborhood of Dallas, and the sponsor said 60 parties requested information on the deal, and they received 9 LOIs. Offers were all in a tight range of 7.5% cap rate on a true T3. All but two units are classic, with occupancy at roughly 98%. In my book, this is the definition of value-add, and they likely could have traded on a 5 cap with a bridge loan 18 months ago. There are two takeaways from this example; the first is whether you like it or not, that is the definition of making a market, and the value of the property is a 7.5% cap rate today. Two, when this investor hits the bid and takes the offer at a 7.5% cap rate, every other property in the neighborhood will now have a yardstick to be measured against, regardless of what they think their property should appraise at. Values on both sales and refinances will be reset next year.
I believe we have seen the peak in property tax assessments for some time, and I am willing to wager that 2024 will see some meaningful downward revisions, especially for sectors like office. Where I live in Texas, you have finally caught a break in the fever that saw most property taxes double over the last five years. Texas passed a $18B property tax relief bill this year, and I imagine other states will follow based on their respective budget surpluses, which is good news to those looking to invest.
I will make a bold call here, but I believe sentiment hits the absolute low for office in 2024, and if you are a genuine value buyer, this is the single best sector to look at for generational buys in 2024. Do you remember the death of big box retail in 2017-2018? A few years later, that would be deemed essential during a pandemic and become a darling asset class to lenders. What about hotels in 2020? Lenders didn’t even want to think about foreclosing on hotels during the pandemic, fearing the borrower would throw them the keys happily. That was only two years ago, and look where we are now. My point is you can look at all different metrics to inform your decision-making regarding a good buy versus a bad one, some more objective than others, but the single best metric that is the least susceptible to manipulation is market sentiment. It is hard to argue that office sentiment isn’t getting close to a generational low. I have been thinking about this for some time and telling people this is where the best deals will be had in this cycle. The response is the same—some level of delusion, crazy, or “don’t waste your time.” We may be close to peak contrarian indicators flashing buy.
While I am in the seasonal spirit of making bold calls here, I think we have seen the peak in the non-bank private lending space and will likely start seeing credit deterioration take down lenders next year. If interest rates are falling, it is likely due to rising unemployment or some other exogenous shock to the financial plumbing. This is not idiosyncratic to private bridge lenders; I wouldn’t be surprised to see a few publicly traded mortgage REITs falter.
Under the current framework, as proposed to take effect in 2024, banks would need to set aside more capital the higher the loan-to-value ratios are. Banks must also set aside capital for loans sold to the GSEs (Fannie and Freddie). Numerous other provisions exist, but they sum up to banks being more conservative with lending next year unless the framework is changed. I expect to see more insurance companies step up to fill the void these banks are leaving in their wake.
Nevertheless, I wish all our clients and readers a happy and healthy holiday season and a prosperous 2024.