CRE Values Stabilize in 3Q 2024 As Investor Sentiment Improves

Following two years adjusting to sharply higher interest rates, the commercial real estate (CRE) market appears to be stabilizing, with market participants seeing relief on the horizon as interest rates have started to decline. That is according to the CRE Debt and Valuation Trends analysis, which leverages the boots-on-the-ground perspective of SitusAMC professionals across the organization, offering investors real-time market insights ahead of many traditional CRE data sources.  

Real Estate Valuation Trends 

Valuations appear to be stabilizing, with aggregate values remaining flat and the gap between price and value narrowing amid improving investor sentiment. Transaction activity is showing signs of improvement, with robust bidder pools suggesting a renewed interest in property types excluding office. The overall transaction market has stabilized, with early third-quarter data showing a 100+ basis point improvement over second quarter. 

Industrial and apartment values have remained flat to slightly positive. However, industrial properties with long-weighted average lease terms (WALT) are under scrutiny as rents lag market expectations, highlighting a disconnect in price discovery for these assets. 

For apartments, amid rising delinquencies and oversupply, negative lease trade-outs have been a significant worry. However, these lease trade-outs have narrowed recently, with some even turning positive, easing concerns for this sector. Seasonal effects may have influenced these positive signs, but the general sentiment is cautiously optimistic, with multifamily valuations projected to see slight positive growth in third quarter 2024. 

In the retail sector, valuations are either holding steady or increasing, primarily driven by strong net operating income (NOI) growth. Office valuations remain in decline, albeit at a slower pace than observed at the end of 2023 and the beginning of 2024. While the NCREIF NPI-ODCE index has office cap rates averaging 5.8%, many well-performing office properties are being appraised at cap rates of 6.75% to 7.25%, showing that even premium office assets are not immune to the prevailing valuation challenges. 

Looking ahead, total return expectations for the quarter remain uncertain, with predictions suggesting a performance similar to last year’s figures. 

Debt Valuation Trends 

CRE debt markets are also starting to stabilize. Excluding the embattled office segment, performing product bond and loan spreads have been flat to slightly tighter over the last few months. SitusAMC is also seeing an increase in transitional products. 

The debt market is bifurcated between rate distressed and credit distressed. Borrowers that are rate distressed may be performing well, with strong credits, but were facing high refinance rates. Declining interest rates will be beneficial for these borrowers as they can refinance into lower rates. Lower rates should also alleviate stress as we approach maturity walls. However, rate declines will have less of an impact on credit-distressed borrowers – those that have strayed from their business plans and are unable to meet financial obligations. SitusAMC is seeing more resolutions as the CRE debt market has come to accept that there will be more foreclosures for these borrowers.  

Asset Management Trends 

Lenders have been lenient, resulting in modifications and extensions, keeping asset managers busy. Nevertheless, many are wondering if market prices have bottomed out, which is catalyzing the growth of new funds and loans that aim at transitional real estate. Whether high-ticket or middle-market, investors believe now is the time to refurbish these discounted properties and sell when prices rebound. Although not replacing old loans, these prospective funds are revitalizing transaction volume. 

Additionally, AUM was flat from fourth quarter 2023 through the first half of this year, but originations are ticking up significantly. Lenders are feeling more confident in the market with expectations of rate cuts and better valuations. Much of this volume, unsurprisingly, takes place in the multifamily and industrial sectors. However, asset managers must be aware of shifting dynamics that pose risk to their properties: the return to office and a need for more affordable living are reducing interest in two-bedroom apartment that people were looking for when work was remote and they needed in-home office space. This shift is challenging the assumptions under which some of these Class A, amenity-rich properties were planned. 

Special Servicing Trends 

Although fluctuating, office pricing has been trending downward for the past two years amid the sector’s post-pandemic woes. Pricing varies by market, but bondholders as well as the owners are finally starting to realize that they will have to endure losses; losses that they will accept over foreclosure. The potential for an economic downturn in the aftermath of Fed tightening raised concerns about a wave of distress. Although it still possible, it appears less likely that office, as well as the other property segments, will have to endure distress to the level once thought. Nevertheless, prices have fallen, and as the bid-ask spread narrows, the question becomes when firms and investors with a stock of dry powder will take advantage of these reduced office prices.  

Advisory Trends 

Following industry-wide investigations into fraud, including instances in which client financials were allegedly falsified, underwriters are now required by GSEs to perform more rigorous analyses, including reconciling rent rolls with actual leases and validating rent increases resulting from property upgrades. This extra layer of due diligence is being driven by pressure from B-piece buyers, particularly in light of rising delinquency rates in the multifamily sector. 

Despite the increased scrutiny, there has been a significant increase in multifamily underwriting volume and a robust pipeline of deals. This is partly due to the GSEs’ reduced lending activity, which has created opportunities for banks and non-bank lenders to fill the gap. However, values for some of these deals are coming in lower than initially projected. 

There is also the prevailing sentiment that timelines have become compressed as underwriters feel increased pressure to satisfy B-buyers in the securitization process. This can be challenging for credit professionals who would prefer to conduct thorough due diligence before committing to a transaction. 

Securitization Trends 

A flurry of deals in the fourth quarter of 2024 is expected as Freddie Mac and Fannie Mae strive to meet their caps for the year. While neither GSE is likely to reach its cap, there is an expectation of a surge in Q-deals, with new players entering the market and deals that had previously considered going public now aiming to close before the end of the year. 

There has been an uptick in CLO activity, with more expected in the first quarter of 2025, depending on how much interest rates drop. This shift is expected to lead to an increase in fixed-rate single asset deals, a change from the preponderance of floating rates in recent years. 

The conduit space continues to move forward at a rapid, healthy pace. However, there has been a shift in B-buyer focus, with increased attention on the multifamily sector from a pool composition and property-type standpoint when deals are about to go to market. 

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