How Recent Rate Moves Are Reviving Stalled Debt and Equity Markets in 2024

Commercial real estate capital markets seem to have reached a pivotal moment at the close of 2023. Here’s a look at where debt and equity markets are going in 2024 due to recent rate moves.

What happened: December 13, 2023, marked a pivotal moment in the world of CRE capital markets. Federal Reserve Chairman Jerome Powell announced the federal funds rate would stay at 5.25 to 5.5 percent, with potential rate cuts in 2024. This led to the 10-year Treasury rate falling below 4 percent for the first time in six months, indicating a turning point for commercial real estate capital markets with an optimistic outlook for the new year.

Signs of life: Access to capital is everything for the CRE debt and equity landscape, and deals can go boom or bust on the smallest price changes. The recent changes in interest rates are sparking a renewed sense of activity after nearly two years of turmoil. But, deploying the funds has been more or less of a mystery. Market activity has significantly dropped over the past year, with a 54% annual decline in transaction volumes through Q3 2023, as per CBRE. This slowdown is attributed to higher equity financing costs and tighter debt markets.

The case for debt: The recent financial climate has presented lucrative opportunities for debt investors. Higher interest rates since early 2022 have led to increased profits for lenders. The retreat of regional banks from lending has opened the door for private credit funds and mortgage REITs to set higher loan rates, shifting the competitive landscape. This change has allowed debt investors to capitalize on higher yields, a trend not seen in over 15 years.

The case for equity: The equity side of the market has been more challenging. Institutional equity investors, after a period of cautious observation, are gradually re-entering the market. There's a growing interest in opportunistic equity, focusing on high-return projects, especially in distressed situations. Yet, the equity market faces challenges, particularly in the office sector, where the uncertain demand in a changing work environment complicates investment decisions.

➥ THE TAKEAWAY

Zoom out: With interest rates stabilizing and capital structures undergoing significant changes, both debt and equity markets are expected to see increased activity. While debt investment seems to offer more security and higher yields, the equity market holds potential for significant returns, especially in development projects. The choice between debt and equity will depend on evolving market conditions, investor risk profiles, and the transformed dynamics of the CRE market.

Nontraded REITs Ran Off the Rails in 2023: Can They Get Back on Track in the New Year?

From 2019 to 2022, nontraded REITs boomed in the commercial property market. In 2023, however, they faltered with reduced fundraising and higher withdrawals. The question remains: Can they recover in 2024?

What happened: In 2023, these funds faced a steep decline. Fundraising by sponsors like Blackstone and Starwood Capital Group plummeted due to growing concerns in the commercial property sector. This led to a surge in shareholder redemptions, with many seeking to cash out their investments.

Fundraising decline: Nontraded REITs, unlike publicly traded ones, are primarily invested in by individuals through financial advisors. Last year, they raised only $9.8 billion compared to $33.2 billion in 2022, and redemptions reached about $17.4 billion. This imbalance created a symbol of one of the worst downturns in the commercial property industry since World War II.

Valuation disputes: The crisis sparked a debate over whether nontraded REITs were accurately valuing their properties. Despite falling values, nontraded REIT shares dropped less than those of many public REITs, leading to investor skepticism. This imbalance between inflows and redemptions pushed the net asset value of all nontraded REITs down to $96 billion from $110 billion a year earlier, pressuring sponsors to sell assets to meet redemption requests.

Market pressure: The commercial-property downturn, exacerbated by high interest rates, negatively impacted both public and private REITs. These high rates diminished the attractiveness of nontraded REITs, which were previously favored for their high dividends. Additionally, the relatively stable share prices of nontraded REITs compared to public REITs reduced their appeal, as investors saw less potential for discounted investments.

➥ THE TAKEAWAY

Big picture: While the imbalance between inflows and outflows has recently decreased, continued challenges could force more asset sales. The future of nontraded REITs remains uncertain, with factors like interest rates, sector-specific pressures, and investor confidence playing crucial roles in determining whether these funds can recover and regain their position on Wall Street.