One of the best markets for commercial mortgage bankers in modern history lasted for more than a decade and was followed by one of the most disruptive periods between Q3 2022 and Q4 2023. Right now, 2024 is looking like the beginning of a positive correction into a higher-rate environment and shifting fundamentals from those long months.
For the generations that came of age and entered the workforce in the 2010s forward, they have now experienced their version of the Great Financial Crisis. Or the Tech Wreck. Or the Savings & Loan Crisis. For those of us who have survived all four, it’s important to share perspective on the road ahead. Yes, cycles do shift and not always how you want them to or for the better. Let’s start there.
Now there is a growing sense that we are on the other side of rate hikes and volatility. In turn, there is a vibe of euphoria diffusing throughout the markets—what I might call over exuberance considering the work still ahead to correct a disrupted commercial real estate market. If experience has taught us anything, we will still need to be vigilant in our market assessments and conscious of the disruptions that could shape the years to come. For your consideration, the following is a window into both a realistic yet optimistic perspective on the marketplace
Rate volatility
It seems like we have met the peak trajectory for rate increases, and that Fed Rate stasis alone will positively impact lending programs and commercial mortgage rates. However, any euphoria should be couched in a more realistic assessment. This second wind needs to be tempered by “higher for longer” expectations as rates most likely will drift lower, not drop, and not to 2020 levels for any foreseeable future based on where the financial markets and political landscape stand today.
I expect to see fixed-rate debt range from the high 4s to the high 5s. This ongoing higher cost of capital will require, for many, a correction to values, impact cash out refinance strategies, and manifest a new equilibrium for sales in the year ahead. Unfortunately, this is where the pain will be felt as riskier short-term debt resets and long-term debt placed years ago meets debt yield/DSCR requirements in the current rate climate.
Price discovery
I expect the 2024 sales market to pick up because the equity investors for existing deals are putting pressure on sponsors. They want redemptions. Maturities will also continue to force a re-pricing of assets to the new cost of capital and break the log jam of the current cycle as sellers come to terms. We are already seeing activity pick up at the start of the year with funding for strong business plans priced to perform. There is liquidity for acquisitions that can meet DSCR criteria. For performing assets there are permanent and fixed rate loan programs that will meet refinancing needs at current operative cash flows. For some assets closing out a bridge or in a distressed phase, mezzanine debt or preferred equity can offset the capital demands of decreasing values. Variable rate debt may also become more appealing in the current 2- to 5-year mindset if Fed action begins to lower base rates and spreads come in as volatility dissipates.
Banks
The shifting macro-economic climate in 2023 essentially removed banks from their dominant role in commercial real estate finance originations, and their absence is profound. For banks to return to their role as a primary lending source, it may ultimately require congressional intervention to shore up how banks are regulated. It will be interesting to see how this plays out, particularly for the regional and local banks that committed to long-term investments when overnight money was cheap. Unfortunately, in some cases, they are now facing illiquidity from these depreciating assets and fickle depositors enjoying higher yields or migrating their deposits for security and return elsewhere. Expect banks to only be available to their best clients and largest depositors in 2024.
Bank alternatives
There is not enough capital in the broader markets to fully replace banking as a primary source for commercial mortgage debt. That’s going to be a handicap in 2024 no doubt. Here are the key players that will be active in gap.
Insurance companies will continue to be a ready resource but will cherry pick who they work with and favor proven borrowers. Most of these lenders will seek to invest in collateral positioned right down the fairway and so those assets could face significant competition from their peers. Money good transactions that are picture-perfect will offer them higher yields. They will be in demand for 3- to 5-year loans, a fairly new space for them. They will compete amongst themselves for projects that meet their underwriting criteria, which will be good for qualifying borrowers.
Debt funds will continue to be active. There are plenty of debt funds available as well as relevant sources like family offices and private REITs. Their money will often be more expensive, but their allocations to any one loan will be more flexible. Many will have issues accessing the customers they will need to deploy their capital. They will be looking for vetted sponsors to determine if they can be counted on to pay it back. These lenders mostly work in a silo and will favor specific property types so funding sources will vary widely by asset type, region, and ultimately sponsorship experience.
CMBS has the potential of making a strong comeback in 2024. My instinct is CMBS will have a reasonably good year because of the many variable rate loans where caps have expired will have no choice but to lock up debt at the highest leverage feasible.
Distress remediation
Expect a post-COVID prolonged period of “lend, now extend” to start winding down in 2024, forcing the hands of asset owners and commercial mortgage providers to either embrace loss with a distressed sale or move forward with foreclosures, respectively. In most cases, these will be mutual negotiated decisions. Before such dire outcomes are required, we are seeing solutions like participation loans from our capital sources for some projects requiring more equity, mezzanine and preferred equity relief options are also readily accessible for the same purpose, and a continued aversion from capital sources to take distressed assets on to their balance sheets remains. Significant capital resources are currently waiting for opportunities to acquire distressed assets, which will encourage resolutions.
Politics
This is a presidential election year. Will it be a disruption or just distraction? Let’s talk about that in six months. Thankfully, Congress seems to have reached consensus on funding government for the year ahead, but real divides continue to limit progress and foster uncertainty. I expect partisan conflicts will make 2024 a difficult year for meaningful, collaborative progress.
Global conflict
Diplomacy. Deterrence. Conflict. Aftermath. These are also wild cards in 2024. An expansion of the conflict in the Middle East leading to U.S. involvement? Escalation or broadening of the conflict in Ukraine? Tensions boiling over between China and Taiwan? Trade wars? Major conflict is brewing that could have far reaching economic impacts. As commercial real estate professionals, much of this is out of our control, but we must be prepared as we pray for peace.
Workstyle
Mentorship is the primary casualty of the post COVID work-from-home trend. As someone who considers long-term outcomes from short-term impacts, I am a firm believer we will begin to see gaps in talent development. Personally, I believe remote work is not the way to build a brand or a career.
At Gantry, we ask our people to be in the office five days a week. I am the son of Greek immigrants, and commercial real estate finance is not something I grew up in. As I look back at my own development, I started as an analyst in the late 1980s working in an office five to six days a week surrounded by mentors and peers that helped me develop insights and identify solutions. These professional relationships were invaluable.
Today, my peers at Gantry have elected me as our corporate President and I am a partner on our Board of Directors in the largest privately-held, independent, commercial mortgage banking firm in the U.S. with billions in transactions under our collective belts. I would think that in finance, law, medicine, and many other fields where mentorship is also critical, it will ultimately lead to less productivity. Many do not see it this way and will continue developing their remote workstyles. Maybe we are on the road less traveled, and I am ok with that. The jury is still out.
That’s a lot of ground to cover in this essay, and we haven’t addressed the specific challenges and market dynamics affecting office, multifamily and all the property types as they respond to higher debt costs, new fundamentals, and nuances within their geographic regions. Construction lending is picking back up as materials and labor costs stabilize and accurate LTCs emerge. Those topics could be the subject of their own deep-dive analysis.
However, this is a good primer for where my attention will be at a macro level as we move forward into 2024. We are already seeing a major uptick in new assignments to begin the year, and that is heartening after a cycle that put a market in standstill mode. For my younger peers in the early days of their careers, be of good cheer. The bonus of surviving a shift is that you are still here.
