Is the CRE Market Bottoming Out? Insights on Debt, Transactions, and Asset Trends

Author: Boots Dunlap, CEO & Co-Founder

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Is the CRE Market Bottoming Out?

According to RCA, declines in both values and transaction volume are the smallest they have been in over a year, which could mark a bottoming out of commercial real estate values. As market participants get more comfortable with how higher interest rates and inflation affect fundamentals, they are becoming more likely to buy and sell in this environment. These transactions create a virtuous cycle because they provide the market with increased comfort with asset values, which then leads to even more transactions and even price appreciation. But only time will tell if we are at a volume/value bottom. Real estate is cyclical, and you are never quite sure where you are in a cycle until it is far behind you.

*Source: RCA CCPI National All-Property Index. Volume YOY Change truncated at 150%.*

One thing that will very likely elevate transaction volume is the so-called wall of debt maturities that is upon us. According to Trepp estimates, roughly $1.7 trillion, or nearly 30% of outstanding CRE debt, is expected to mature from 2024 to 2026.¹ A sizable portion of this debt will not qualify for refinancing due to its high leverage or other issues. The primary way to pay off such debt is through a property sale. As such, transaction volume should increase over the next two years due to this alone. That said, lenders have a variety of ways to avoid troubled loans coming due at inopportune times. They might “extend and pretend” that the loan is performing as they wait and hope for a more favorable market. Whether transactions rise in a meaningful way or remain sluggish, RRA will continue to search out the idiosyncratic, non-correlated investment opportunities that have been our bread and butter for the last 10+ years.

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What We’re Watching

Secondary apartment markets are outperforming larger markets according to CoStar. Despite the top 50 multifamily markets accounting for 75% of inventory, the next 20 largest markets recorded 2.6% annual rent growth, compared to the national average of just 1%.²

‍Our View: With some markets even recording negative rent growth, annual rent increases can no longer be relied on, at least in the short term. Paying close attention to market conditions and comps has never been more important for apartment underwriting.

Apartment conversions rebounded in 2023 led by an increase in converted hotels. Conversions from offices remain well below the 6,600 delivered projects in 2020, while delivered hotel-to-multifamily conversions reached a 13-year high.³ Our view: In an era of inflation and rising construction costs, developers are eyeing floor plans that are easy to convert and minimize construction risks. Office conversions can work but are not a copy-paste solution to rising housing costs.

Office vacancies will continue to rise into 2026 even in the most optimistic scenario. In the conservative scenario, they estimate that 12% of US workers working from home would result in office vacancies peaking at 23%. If 25% of US workers worked from home, office vacancies would exceed 28%.⁴ Our view: While the return-to-office trend is real, many office leases signed pre-pandemic will be up for renewal in the next few years. Vacancies will rise as companies adjust leases to new needs. Office values and occupancy have yet to bottom.

Fortress closed a $493MM CMBS loan comprised of logistics and industrial outdoor storage assets (IOS). This is a first for the IOS asset class and brings institutional legitimacy to the product. According to Prologis, transportation accounts for 45-55% of supply chain costs compared to just 5% for warehouse/IOS rent.^5,6 Our view: As e-commerce continues to grow, firms will continue to lease IOS facilities to maximize slack in their supply chains. While this sector is not immune to exuberance, zoning restrictions on new supply act like a “moat” for this asset class.

CBRE is projecting a break in the historical relationship between real GDP growth and hotel demand. While CBRE upgraded its 2024 US GDP forecast to 2.3%, they simultaneously downgraded their forecast for hotel demand growth from 1.9% to 0.9%. The personal savings rate has fallen to 3.6%, leaving little room for additional consumption. International tourists are unlikely to provide an additional boost: inbound international travel has leveled off at approximately 86% of 2019 levels.⁷ Our View: With nightly leases, hotels are the canary in real estate. The luxury and economy hotel markets should be avoided, as well as full-service hotels, because of high sensitivity to recessions.

Staying Ahead of the Herd

‍The inherent value of real estate lies in its immunity to daily trading fluctuations, allowing investors to remain insulated from volatile news cycles and maintain a focus on long-term investments. At RRA, we emphasize a bottom-up approach to investing, prioritizing the intrinsic qualities of the property and its neighborhood over sensational headlines about property types and metropolitan statistical areas (MSAs).Our mandate at RRA is to generate higher idiosyncratic returns, which leads us to seek out unique opportunities often overlooked by others. This approach enables us to observe, rather than react to, the prevailing news cycles. As active market participants, we typically identify emerging real estate trends within our portfolio and originations pipeline long before they become mainstream news. If we were to rely on industry publications for new trends, it would signify a lapse in our proactive strategy.

RRA’s investment strategy goes beyond merely blocking out the noise; it’s about staying ahead of the noise in the WSJ and uncovering opportunities that diverge from common market theses. In the context of price arbitrage, we recognize that alpha is often found along a price spectrum influenced by the institutional investment community's varying perceptions of assets. Specifically, within reasonably marketed transactions, one may overpay for assets that the market adores, achieve fair value for those it ignores, and significantly underpay for those it despises. Assets that are highly favored require the most aggressive underwriting assumptions, increasing investment risks. This is why RRA is more inclined to finance Class A suburban office properties over Class A data centers. This strategic approach has consistently enabled RRA to navigate real estate bubbles.

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