The Light at the End of the Tunnel: Commercial Real Estate’s Outlook in 2024 and Beyond

By: Jake Haldeman, Class of 2027

Background

            Approaching the final quarter of 2024, the beleaguered commercial real estate (CRE) market appears to be reflecting signs of cautious optimism. However, the preceding few years have been anything but consistent in market forecasts. In 2020, the economic fallout from the COVID-19 pandemic wreaked havoc on the industry: that year, CRE transactions for all property types fell by 68% compared with 2019, as CRE deals fell apart or were hastily reworked to adapt to the uncertain market conditions.[1] Lockdowns and the widespread adoption of remote work policies by CRE tenants led to disputes between market buyers and sellers on the valuations of their properties, particularly as tenants struggled to pay rent and delinquencies among borrowers rose.[2] Faced with $2.38 trillion in CRE loans on their books, banks took unusual steps to negotiate with borrowers to defer payments and waive late fees while some tenants outright refused to pay rent.[3] Consequently, observers at the time feared that a slump rivalling that of the aftermath of the Great Recession might follow.[4]

Brief Rebound

            The much-feared CRE collapse, however, never came to fruition. Instead, beginning in 2021, the CRE market experienced a remarkable rebound.[5] Investors purchased $144.7 billion of U.S. commercial property in Q2 2021, nearly triple the figure of second quarter of the prior year.[6] Bolstered by low-interest rates and post-COVID optimism, CRE transactions also returned to their pre-pandemic levels.[7] Nevertheless, the rebound did not herald a total return to pre-pandemic market conditions: compared to their pre-pandemic values, shopping malls were down 13%, hotels 4.2%. and office buildings 5.6%.[8] The pandemic fundamentally altered the landscape of the CRE market: warehouses, distribution centers, and multifamily housing properties rose in value in the wake of the pandemic as e-commerce exploded and more families became renters, respectively.[9]

Inflationary Pressures

            The upward trajectory of the CRE market proved to be short-lived. In 2023, the Federal Reserve raised interest rates to curb growing inflation, its most aggressive rate hikes since the 1980s.[10] For the CRE industry, dependent on lender financing to facilitate transactions, the hikes produced a calcifying effect on the market. Into 2024, CRE property valuations fell as the tightening credit market engendered uncertainty among buyers and sellers.[11] Transaction volume similarly fell to below $500 billion in 2023 in a considerable drop-off compared to 2022.[12] In contrast to the precipitous downturn caused by the COVID-19 pandemic, the market instead froze as investors and market players awaited more interest rate changes from the Federal Reserve.[13]

Looking Forward

            Finally, in September 2024, the Federal Reserve announced its first interest rate cuts since it began its quest to curb inflation in 2023.[14] Already, the CRE market has begun to show signs of increased activity in response to the rates as property prices are rising once again; likewise, transaction volumes are believed to have bottomed out and are increasing in response to the rate cuts.[15]

            Nevertheless, some uncertainties in the CRE market remain salient. Namely, persistent weakness in office spaces continues to plague the industry, a trend that began in earnest in 2020 and 2021 during the pandemic.[16] In the first half of 2024, the national office vacancy rate remained at a record low of 20.1%.[17] For major cities like New York and San Francisco, these office spaces anchored their commercial centers and provided important economic stimulus; such vacancies may have yet unforeseen impacts on the CRE market in the future.[18]

            As it stands today, investors, buyers and sellers, and practitioners do have some cause for optimism entering Q4 of 2024. Practitioners should expect their CRE business volume to steadily increase this year into 2025 as banks resume lending and investors’ interest similarly grows. However, not all business is good business: borrowers who financed their properties at peak values will be facing the prospect of significant losses as loans approach maturation.[19] Even more, transactions, both at origination and refinancing, may be driven by distress.[20] As such, in the coming months, practitioners should anticipate increased business volume but pay close attention to how the CRE market’s return to form will affect their clients in the near future. Still, with the pandemic in the rear-view and inflation seemingly constrained, 2025 holds promise for a strong return.

[1] John Gittelsohn & Noah Buhayar, Distress Mounts in U.S. Property Market Frozen by Pandemic, Bloomberg (July 22, 2020, 10:00 AM), https://www.bloomberg.com/news/articles/2020-07-22/distress-mounts-in-u-s-real-estate-market-frozen-by-pandemic?embedded-checkout=true.

[2] Id.

[3] Conor Dougherty & Peter Eavis, Tenants’ Troubles Put Stress on Commercial Real Estate, The New York Times (June 5, 2020), https://www.nytimes.com/2020/06/05/business/economy/coronavirus-commercial-real-estate.html.

[4] Id.

[5] Id.

[6] Id.

[7] Id.

[8] Peter Grant, Commercial Real-Estate Sales and Values Surge to Records, The Wall Street Journal (Oct. 26, 2021, 8:00 AM), https://www.nytimes.com/2020/06/05/business/economy/coronavirus-commercial-real-estate.html.

[9] Id.

[10] Scott Horsley, The Fed raises interest rates again in what could be its final attack on inflation, NPR (May 3, 2023, 2:03 PM), https://www.npr.org/2023/05/03/1173371788/the-fed-raises-interest-rates-again-in-what-could-be-its-final-attack-on-inflati.

[11] Natalie Wong & John Gittelsohn, The Commercial-Property Market Is Coming Back to Life, Bloomberg (Sept. 24, 2024, 6:00 AM), https://www.bloomberg.com/news/articles/2024-09-24/commercial-real-estate-activity-picks-up-with-buyers-lenders-returning?embedded-checkout=true.

[12] Id.

[13] Id.

[14] Catarina Saralva, Fed Cuts Rates by Half Point in Decisive Bid to Defend Economy, Bloomberg (Sept. 18, 2024, 2:00 PM), https://www.bloomberg.com/news/articles/2024-09-18/fed-cuts-rates-by-half-point-in-decisive-bid-to-defend-economy.

[15] Filip De Mott, It looks like the commercial real estate market has finally bottomed out – and experts say it’s time to invest, Business Insider (Sept. 13, 2024, 5:16 PM), https://www.businessinsider.com/commercial-real-estate-cre-debt-office-vacancy-bank-lending-moody-2024-9.

[16] Id.

[17] Carrie Taschman, The CRE outlook: new normal, the Fed, and the latest performance data, Moody’s CRE (Sept. 12, 2024), https://www.moodyscre.com/insights/market-insights/the-cre-outlook-new-normals-the-fed-and-the-latest-performance-data/.

[18] Jan Mischke et al., Empty spaces and hybrid places: The pandemic’s lasting impact on real estate, McKinsey Global Institute (July 13, 2024), https://www.mckinsey.com/mgi/our-research/empty-spaces-and-hybrid-places.

[19] Wong & Grittelsohn, supra note 11.

[20] Wong & Grittelsohn, supra note 11.