The fourth quarter of 2022 saw a decrease in commercial lending activity, largely due to rising interest rates and an effort by the Federal Reserve to slow inflation. Data shows that the volume of new loans dropped substantially compared to the same time period in 2021, with debt funds and mortgage REITs experiencing particularly pronounced declines as a percentage of total loan closings.
Unfortunately, this loan slowdown was accompanied by another troubling trend: a sharp rise in delinquencies among commercial lenders. This increase has caused concern for regulators, who are questioning lenders’ concentration of loans secured by commercial property—particularly in new developments.
While this data showed a troubling fourth quarter, it’s unclear how likely either trend is to continue amid a continued high-interest-rate environment and the Fed’s consideration of further rate hikes to combat ongoing inflation. Though it’s still too early to draw conclusions, this data could signal coming distress in the commercial real estate market, as well as potential difficulties for investors seeking loans.
Multifamily residential properties and developments are continuing to see positive trends nationwide despite the growing potential for a coming economic downturn. In the South and Midwest regions, rents continue to grow, and recent data from states like Arkansas have revealed a decrease in apartment stock. Markets like western Michigan remain similarly strong due to strong market fundamentals, including a noticeable lack of distressed assets on the market and an area-wide housing shortage.
Simultaneously, conversions of non-residential commercial properties into multifamily units are showing few signs of slowing down. In fact, some areas have even seen an acceleration in these projects. The numbers appear to support these opportunities, as landlords have so far been able to avoid vacancies due to the high demand for residential properties.
Overall, the continued boom in multifamily conversions is a testament to the strength of the market and increased investor confidence despite some regional challenges. In spite of fluctuations in certain markets, the profitability of these conversions has been a strong signal to investors that markets remain hungry for these types of redevelopments. This is good news for both tenants and owners as they can look forward to more housing options for local populations and less volatility in local rent.
All told, it is clear that multifamily continues to prove its strength as an investment within the broader American real estate market.
The return of the U.S. Prime Rate to pre-2008 levels—though off-putting for those seeking to refinance or secure new loans—is an encouraging sign for commercial real estate investors. This is because the return has occurred without the loose underwriting standards that were rampant before the crash and ultimately contributed to the wave of defaults.
Although the recent rise in rates could cause some pricing adjustments (particularly for investors using CapEx valuation models), it is far from a death knell for the sector, as rents and asset prices have so far continued their steady upward march, continuing to support record-breaking real estate prices nationwide.
For informed investors with patience and understanding of today’s market conditions, these trends provide significant opportunities, and fears of rising rates distressing the national market should be discounted.
The recent extension by the IRS of its deadline for completing 1031 exchanges in response to unprecedented storms in California demonstrates a crucial insight: that the agency is paying attention to the disruptions caused by natural disasters and their effects on taxpayers—especially those involved in real estate investing. This is especially significant considering California’s importance as one of the country’s most active real estate markets.
Further, this flexibility by the IRS may signal more consideration for investors and taxpayers struggling with climate-generated crises from storms or their lasting effects. It may also be indicative of a shifting attitude towards capital gains taxes, which have been hotly debated in recent years, with talk of repeal having been floated in Congress as recently as this month. Only time will tell if such flexibility leads to additional policy changes, but this extension remains a strong sign that hard times can still lead to some leniency from Uncle Sam.
The jobs market in the U.S. remains remarkably strong. Data released last month by the Department of Labor reports that new unemployment claims continue to hover around 200,000, which is well below long-term historical averages. This is indicative of an economy with strong and consistent demand for labor and is proving highly advantageous for real estate investors.
Strength in the U.S. labor market shows that many businesses in the retail and service sectors are still struggling to find additional employees to serve the steady stream of customers they are receiving. For investors, this implies a healthy and plentiful supply of buyers and tenants, providing them with great opportunities to pursue commercial deals in most major markets.
What’s more, as there is no shortage of potential renters or buyers, employers struggling to fill open positions should translate into continued confidence among workers to buy or rent new housing as it becomes available.