Interest Rate Hikes, Office Sector Noise, and Proptech Promises

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Welcome to the CRE News Digest from First American Title NCS, where we explore the biggest stories in commercial real estate. As a legacy brand working in CRE for more than 120 years, First American keenly knows the market and the forces that are impacting our clients’ businesses.

Big Picture: 2023 Rate Report 

Much of the commercial real estate conversation this year revolved around the implications of the Federal Reserve’s campaign to raise interest rates. According to Bisnow, while banks significantly increased direct lending to landlords during a period of “historically low” interest rates from roughly 2015 through 2021, the honeymoon period has long since ended. Increasing interest rates through 2022 and 2023 have contributed to instability in CRE lending. High borrowing costs have posed challenges for property owners looking to refinance ahead of looming CRE debt maturities. Recent data from S&P Global highlights that the delinquency rate for bank-backed CRE loans increased to 1.03% in Q3, marking the steepest quarterly jump “in at least five years” and surpassing the delinquency rates of the early pandemic era.

 Long-term high interest rates are also impacting transaction volume more broadly. In a recent analysis, First American Senior CRE Economist Xander Snyder highlighted that “higher rates typically lead to higher CRE mortgage rates, which make CRE deals less profitable… [incentivizing] buyers to wait on the sidelines until prices fall further.” However, the Federal Reserve’s November 1 decision to hold interest rates offers some hope as the industry looks to 2024.

 State of the Sector: Office

Across all commercial asset classes, the office sector garnered the most attention in 2023. The heightened focus was largely due to the sector’s struggle to recover from the COVID-19 pandemic. The rapid shift to remote work hit office properties particularly hard; national vacancy rates in October stood at 17.8%, a 150-basis-point increase over this time last year. Office loans also account for a significant share of the nearly $4.5 trillion dollars of outstanding CRE debt, of which nearly $1.5 trillion is expected to mature by the end of 2025. The sector’s troubles have gained renewed focus in recent weeks as former coworking giant WeWork filed for Chapter 11 bankruptcy. The move is likely to further drive up vacancy rates in key markets.

The current dynamic in the sector between vacancy rates, maturing debt, and the lingering effects of the pandemic has been nicknamed the “doom loop,” but CRE experts have cautioned that this term may be overblown. There are several bright spots moving into the new year, including an uptick in office-to-residential conversions, a decline in new construction, and a gradual shift back to in-office work policies.

Innovation: Proptech Year in Review

While proptech got off a slow start in 2023, investor confidence as well as total investment picked up in Q2 and were buoyed by a handful of key trends.

The rapid rise of AI was one of the most heavily discussed developments across the proptech industry and the tech sector more broadly. Key industry stakeholders ranging from top developers to startups to landlords have begun to incorporate AI into their business streams. While Commercial Observer cautions that the AI hype “remains for now more smoke than fire,” other experts over the course of the year have expressed their optimism for the technology’s future within the industry.

As climate change dominates the news cycle, proptech aimed at improving sustainability has also been on the rise. Propmodo recently hosted their sixth annual PropTech Challenge, in which firms competed to showcase their solutions to reduce carbon emissions from buildings. Contenders “[ranged] from purpose-built data models and emissions monitoring platforms to closed-loop geothermal wells, living walls, and carbon capture systems.” 

Proptech’s upswing in the second half of 2023 coupled with the CRE industry’s ongoing demand for innovation paint a promising picture for the new year ahead.

 

 



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