Last week, we had the pleasure of hosting two webinars as part of our 2024 Annual Market Outlook, aptly titled "Navigating the Curve: Accelerate through the Turn." These sessions not only offered a deep dive into where we see opportunities within the current alternatives landscape but also served as a platform for engaging discussions with our attendees. In this week’s note, we highlight three questions raised during the webinars, alongside a concise summary of the perspectives we shared on those topics.

With rates likely at a pivot point, what is our perspective on the use of debt in commercial real estate?

This is a timely question given recent volatility in the banking sector, and we should emphasize how lenders and borrowers have been proactive in their discussions throughout the rate hiking cycle. In our view, we anticipate a more favorable environment ahead for debt pricing and availability from both private and bank lenders. With a robust outlook for supply and demand dynamics in select sectors, we believe that it is likely one will find an environment where lenders are eager to deploy capital to strong performing assets.

A related question that we hear has to do with optionality regarding fixed and floating rate debt. In our view, a balanced mix of both acknowledges the complexity and risks of attempting to predict rate movements. Our perspective does not intend to outperform market predictions, and instead sees value in protecting potential gains from interest rate fluctuations. We believe that maintaining this balance is reinforced in an environment where rates are anticipated to decrease rates through a mix of fixed rates, hedges, and caps. Strategically, this approach is inherently defensive and designed to provide flexibility under varying market scenarios, while ensuring that we are positioned to capture value as opportunities evolve.

Which sectors do we see particular growth opportunities?

In our analysis, opportunities in the commercial real estate market are favorable where secular trends highlight the potential for long-term value. In particular, we believe these areas are concentrated at a macro-level on residential rentals, logistics, and fixed income. Supporting this, we view positive, long-term conditions in projected supply-demand dynamics, migration trends, and labor market activity. Markets and sectors that have experienced positive growth across these areas have weathered the storm well on a relative and absolute basis.

We're particularly optimistic about 2024 due to a reset in commercial real estate asset prices observed in late 2022 through 2023. In our view, this presents an attractive entry point, signaling a prime opportunity for those sectors and markets that we anticipate having strong, long-term tailwinds. In particular, we see diverse demand segments within the residential rental sector, from single-family to multifamily and workforce housing. We see similar conditions in industrial and logistics markets throughout the US with increased investment in advanced manufacturing and logistics infrastructure particularly promising. These investments are expected to generate significant job creation and associated demand for housing and other local economic activities. We anticipate both sectors are likely to experience declining supply pressures approaching year-end, which we believe will contribute to attractive supply-demand dynamics for the next few years, underpinning our bullish outlook.

Does the current environment change the attractiveness for strategies in equity versus credit, and are we thinking of either differently now?

In the current market environment, we find both equity and credit opportunities appealing, each offering distinct profiles in terms of current income versus growth and capital appreciation. On the equity side, the primary attraction is the resetting of values, which creates greater potential for capital appreciation—the trade-off is that current yield has become more challenging in this rate environment. Conversely, the credit landscape presents robust opportunities for yield, especially amid an anticipated shift in interest rate moves. We anticipate seeing common themes emerge among compelling opportunities: conservative capital structures and strong, resilient underlying collateral. Combined with the secular and market tailwinds that we see, these themes will likely define differentiated opportunities ahead.

This Week’s Developments in the US Economy

Banking Sector Update: Tight Credit Conditions Expected to Tighten Further, Particularly for Real Estate

Following the recent Fed meeting and subsequent commentary from Fed members, markets have trimmed expectations for early-2024 rate cuts. As a result, rates are likely to remain elevated, credit conditions remain tight from conventional bank lenders, reinforced this week by the Fed’s quarterly Senior Loan Officer Opinion Survey (“SLOOS”). The latest SLOOS data points to credit conditions remaining tight across most loan categories, with commercial real estate (“CRE”) anticipated to see tight conditions continue for the near future. While we anticipate that this may open avenues for non-bank lenders to increase their participation, we note that the outlook across CRE sectors varies, with some more likely to see an increase in capital market liquidity over the course of the year.

In this note, we look at what the SLOOS tells us from a high-level perspective on lending conditions, and then look at some of the major CRE sectors to gauge the potential appetite as well as perceived challenges to lending.

SLOOS
The SLOOS reveals a continued tight lending stance among banks, with CRE facing potential further tightening despite a slight decrease in the net percentage of banks reporting tighter conditions. At first glance, the data might appear as if conditions are loosening, but a closer read indicates that some banks tightened further in the fourth quarter of 2023, and some banks anticipate further tightening ahead for non-residential real estate loans.

While the net percentage of banks tightening credit conditions for CRE loans decreased between the third and fourth quarter last year, on balance banks remain in a restrictive stance. Further, the Fed included additional questions on forward expectations in the latest survey. Loan officers reported expectations for increased tightening for CRE specifically while noting expectations for increased demand but deteriorating loan quality across all categories (i.e., not just for CRE). We see this as an indication of hardening negative sentiment for CRE, but we also anticipate seeing sentiment vary based on each sector’s outlook—particularly with respect to supply-demand dynamics going forward.

Multifamily
Multifamily demand continued to improve towards year-end 2023, avoiding the usual end-of-year slowdown in leasing. The sector's average net absorption in 2023 was 58,000 units per quarter, which was close to the post-GFC average of 66,000 units and a significant recovery from the previous year's average of negative 31,000 units. However, demand did not keep up with the high supply of 110,000 new units per quarter throughout 2023, which was nearly double the post-GFC average.

Looking ahead, we expect supply-demand dynamics to improve in the coming quarters with supply constraints potentially reemerging by the end of 2024. This is due to a decline in multifamily permits and starts, moving towards historical averages amidst rising interest rates and tighter credit conditions from Q1 2023 onwards.

Industrial
The industrial sector experienced unprecedented supply levels in 2023, adding approximately 130 million square feet per quarter on average in 2023, which is more than five times the long-term average. Absorption in 2023 moderated after two years of exceptionally high demand, dropping to just below the historical quarterly average of 43 million square feet, after reaching 131 million and 105 million square feet in 2021 and 2022, respectively.

We see a strengthening of supply and demand dynamics in 2024 with projections anticipating demand and supply to come back into balance towards year-end. Seeing a similar story as the multifamily sector, the rate of new supply is declining as the rise in costs of construction has meaningfully constrained development activity.

Office
Conditions in the office sector remain largely unchanged, and negative views of the sector are becoming more entrenched. A modest number of new deliveries came to the market in 2023, but the sector has seen negative absorption on net for nearly two years. The sector faces a liquidity shortage, forcing sellers to accept significant markdowns. National market data, however, does not fully capture the office sector's complexities, as different submarkets and assets are at various stages of recovery or decline.

Retail
2023 marked the third consecutive year of positive 12-month net absorption in the retail sector, showing a recovery from the low demand seen early on during the pandemic. While the sector's average quarterly absorption of 14 million square feet last year fell below the post-GFC average of 22 million, demand was well in excess of supply, which averaged 10 million square feet per quarter. When looking at a more granular level, strip centers have seen favorable supply-demand dynamics over the past few years, but regional malls have seen both deliveries and absorption levels in negative territory since early 2021 and late 2018, respectively. While US consumer activity has been a strong contributor to the economy overall, brick-and-mortar retail outlets still face a longer road to recovery.