The world is waiting for a commercial real estate crisis to hit, so what should financial advisors do as it looms?
Things are likely to get worse before they get better for commercial real estate, said Rich Byrne, president of real estate credit giant Benefit Street Partners, who sees demand for office space continuing to decline as workers who used to come into the office five days a week are now coming in four or even three days.
“There's an oversupply of office space,” he said. “Obviously, the better quality properties are doing well, Class A properties are doing better than the lower quality Class B and C properties, but as a rule, you need to rationalize all of your office space.”
As for what will happen next, Byrne believes weaker properties will close. Owners who don't have the capital to continually bring in new tenants will simply not be able to afford to keep them.
He said the good news is that for now, no new capital is being pumped into office construction, which should help solve the oversupply problem in the long term.
Meanwhile, Byrne sees an opportunity in housing, especially apartment complexes, as the housing supply remains undersupplied. Another factor driving up home prices is the recent rise in interest rates. Byrne said rents are so high that people are staying in their homes and their children are living with their parents.
“Nobody has been investing in real estate since interest rates started rising,” Byrne said, “so I think in the medium term that's going to start to be a real positive for multifamily.”
Matt Malone, president and chief investment officer at Opto Investments, also remains cautious on commercial real estate, citing the possibility of a “prolonged elevated” interest rate environment. He said he has seen transaction volume slow on his private markets investment platform since rates began to rise, limiting price discovery.
“Traditional property managers that rely on positive leverage to generate revenue are challenged in this environment,” Malone said. “We are open to opportunistic, capacity-constrained debt or equity strategies in this environment, particularly in new portfolios without legacy assets.”
When it comes to residential real estate, he expects transaction volume on the platform to decline as rising interest rates make it harder for buyers to meet price expectations.
“Longer mortgage terms should enable this market to weather a high interest rate environment without significant forced sales,” Malone said.
Meanwhile, David Gottlieb, a wealth manager at Savvy Advisors, has been touting the benefits of diversification to his clients, which includes real estate holdings, and he has a cautiously optimistic outlook for commercial real estate compared to his peers.
“Sources of uncertainty for CRE include the decline in demand for office space due to remote work solutions and retail struggles due to the dominance of internet retail and e-commerce,” Gottlieb says. “But other areas of CRE are interesting and promising, such as grocery stores, biomedical office buildings, storage facilities, and industrial real estate consisting of warehouses and distribution centers.”
Gottlieb is more bullish on residential real estate than CRE, but with similar “conditions.” In his view, it comes back to the traditional three rules of real estate investing: location, location, location.
“Location plays a lot into the quality of your investment,” he said. “States and municipalities that have been relatively more supportive of tenants than others have held landlords back when it comes to hurdles against evictions, rent collection, rent increases, environmental regulations, etc., while other parts of the country have more protective legal environments for residential property landlords.”
For Gottlieb, other location concerns include demographic trends, the health of infrastructure, microeconomic measurements and trends, crime rates and proximity to employers.
In his view, entry prices for both sectors are crucial for investors today, and the collapse of the commercial real estate market has undoubtedly made it a buyer's market.
“The interest rate environment is having a devastating effect on the ability of loans with expiring interest rate caps to be repaid,” Gottlieb said. “We are seeing distressed sales, particularly for developers and investors who locked in interest rate caps before the second quarter of 2022 that expire over several years. Now is a good time to explore those scenarios as a buyer in this environment.”
Given the challenges facing purchasing single-family homes, demand for multifamily housing appears poised to generate strong growth that supports attractive income and cash flow profiles, said Ted Brooks, founder of Nordwand Capital.
“Residential development is all about understanding the market trends, partners, terms of economic exposure and revenue drivers of the submarket you're involved in. In the right location, exposure to residential real estate has many benefits,” Brooks said.
