Time to Change Course? – November 20, 2023
In 2024, commercial real estate will rally, with the likely exception of office space, said Lawrence Yun, chief economist at the National Association of Realtors (NAR), during last week’s 2023 NAR.NXT Conference in Anaheim, CA. For this revitalization to occur, though, the Federal Reserve will have to change course.
“Data that came out yesterday shows much calmer inflation,” Yun said. “The Federal Reserve should consider cutting interest rates as we go into early next year. Then the ongoing weakness will stop, and we will begin to see some revival.”
As it stands, commercial property owners are hamstrung by Fed policy. “There’s tremendous difficulty in the commercial real estate market with higher interest rates,” said Yun. “Given roughly $3 trillion in commercial real estate loans, roughly $600 billion will come due for refinancing each year and at higher interest rates.”
Along with hindering borrowing and making refinancing costly, the Fed’s rate hikes have hurt small-sized banks. “The small-sized banks – community and local banks – have much larger exposure to commercial real estate,” said Yun. “So, if commercial real estate is wobbly, it’s not going to hurt the big banks as much as the community banks.” He suggested that community banks will be recapitalized somewhat better with interest rate cuts.
Yun cited changes in commercial loan lending standards, which have made an already tight lending situation even tighter. He suggested the federal government’s large budget deficit is also pressuring the rate increases.
“Commercial real estate transactions activity has been cut in half in two years,” he said. “The condition for real estate deals is difficult. They simply don’t want to sell at a lower price, so commercial deals are not happening, because sellers don’t want to lower the price, and buyers aren’t jumping in due to higher lending costs.”
Yun added that commercial property prices are falling below pre-COVID levels and are set to decline further. “The 10-year Treasury yield is currently at 4.5%,” he said. “Most buildings now are still overpriced in commercial real estate. Property owners have to readjust. Maybe it’s better to get the deal done today rather than waiting until the future, when property values may be even lower.”
The chief economist also took a macroeconomic view. “By an objective measure, the economy is strong,” said Yun. “GDP growth is at 4.9%, but there are some worrying signs for the economy. First, businesses are not borrowing, because they’re cutting back on spending. Second, good inventory – or products produced – is increasing, but goods are not being purchased. Thus, there’s concern for future GDP.”
He said unemployment rates are the highest in nearly two years and wage growth is the weakest it has been in two and a half years. With that in mind, Yun asked, “The Federal Reserve is raising interest rates to tame inflation, but are they going to break the economy?”