By Jerrold L. Bregman
Jerrold L. Bregman
Looking back at 2023 and looking ahead to 2024, it's clear that Denver's commercial real estate market, like the rest of the country, has not been immune to broader economic challenges. A combination of factors, including the highest interest rates in decades, a pandemic that forced workers and businesses to reexamine their real estate requirements, rising corporate contract and payment defaults and bankruptcies, bank failures, and a lack of housing supply squeezing homebuyers, have made this a challenging year for various sectors of the commercial real estate market. Denver is no stranger to these challenges. MileHighCRE recently reported that while Denver saw notable growth in some areas in the third quarter of 2023, commercial property leasing volume was down 9.9%.
Similar issues are occurring across the country, with CRE delinquencies on the rise. Banking institutions are well aware of the problem and are feeling it firsthand. Reuters reported that Morgan Stanley is setting aside $134 million for credit losses incurred in the third quarter. The bank said this was due to “deteriorating conditions in the commercial real estate sector.” These losses are occurring across the banking industry, so it remains to be seen whether this will or will become a full-blown “crisis.”
These experienced and expected losses have slowed lending significantly. CRE debt held by banks is at its lowest level in nearly a decade, according to Federal Reserve data. Some attribute the decline in lending to a decline in CRE purchases. GlobeSt.com reports that CRE sales in the first half of 2023 will be $137 billion, down 55.2% from the $306 billion in CRE sales in the first half of 2022. However, this decline in sales is more likely due to a significant increase in interest rates and a decline in demand for many CRE developments, especially commercial offices, due to changing business and consumer needs. While we expect the Federal Reserve to eventually lower interest rates, it is unclear whether this will begin in 2024 as recent statements suggest, or how quickly they will do so. It would be reasonable to assume that when interest rates do fall, it will be at a gradual pace, with enough time between each cut to allow for a clear market reaction. There's been no word on where the Fed wants to keep interest rates in the long term, but many believe we won't see rates return to their previous near-zero levels anytime soon, or ever.
There are bright spots in the CRE market in the national multifamily and industrial markets. According to Moody's Analytics, payment rates in September 2023 were the lowest so far this year at 71.7%. The company attributes this to two separate events that have developed over time: Millenia Companies' failure to repay loans on an affordable senior housing project that was eligible for low-income housing tax credits, and its failure to repay the outstanding loan on a student housing project in Gainesville, Florida. Moody's report emphasizes that it is “less concerned” about the overall multifamily market, where payment rates remained above 90% for most of the year. Due to the necessity nature of housing combined with expectations of high demand over the long term, multifamily CRE is expected to remain strong for the next few years, despite the recent decline in payment rates.
During this challenging time for CRE overall, industrial CRE is experiencing significant growth. There has been a significant increase in large-scale real estate development of artificial intelligence and data centers housing “bitcoin mining” computer farms. As the pandemic has prompted many companies to ramp up their e-commerce and delivery models, accelerating the race for faster delivery, industrial CRE for warehousing and logistics continues to benefit. Many banks with CRE holdings are seeing the silver lining in the sector and have begun increasing their exposure, according to S&P Global Market Intelligence.
This is also true for industrial real estate in Denver. According to Mile High CRE, development activity in the second quarter of 2023 was down 18%, but total lease volume increased 73.1% quarter-over-quarter. Some expect the next three to four quarters to be less exemplary as long as robust consumer spending stagnates and/or companies postpone capital projects. However, many see this as a short-term issue and expect consumer spending to remain robust and capital projects to recover, especially as interest rates decline through 2024, if recent indications that the Fed will cut rates in the new year hold.
Looking ahead to 2024, it is not easy to predict what monetary policy actions the Federal Reserve will take if the current outlook for lower inflation and an easing labor market continues as currently expected. We know that they will eventually want to lower interest rates to relieve pressures on businesses and consumers, but even though we expect that a rate cut will come in 2024, the timeline is not yet clear. There is also an unresolved question of whether there will be further rate hikes before any rate cuts. Given this, it is best to assume that many of these pressures will remain in some capacity for much of 2024. Bank problems are expected to continue in some form, and funding will still be more expensive than in recent years.
If you’re looking for CRE financing in 2024, working with an attorney who specializes in financing can be extremely helpful. An experienced attorney can help you negotiate interest rates and terms with lenders. They can also help you secure financing through credit bureaus and private lenders, who have different risk tolerances and terms than some banks.
The views expressed in this article are for informational and promotional purposes only and are not intended to be, and should not be considered, legal advice.
Jerrold L. Bregman is a business attorney and partner at BG Law LLP, where he represents major parties in high value real estate transactions, financial restructurings, commercial financings, private debt and equity transactions, and related litigation in multiple jurisdictions. Jerry is licensed to practice law in California, New York, and Colorado and holds a law degree from UCLA Law School and an MBA from the Anderson School of Management.