With the inflation rate remaining above 6%, this week’s quarter-point interest rate hike by the Federal Reserve, and the recent collapse of two large regional banks, commercial real estate practitioners may find it a bit more difficult to borrow money for new investment and development, National Association of REALTORS® Chief Economist Lawrence Yun said Wednesday at NAR’s Real Estate Forecast Summit: Commercial Update. Yun also predicted a softening in overall commercial transactions, but he said there’s plenty of reason for optimism, noting that the multifamily, retail and industrial sectors continue to see strong demand.
Regional banks are a critical source of funding for commercial borrowers because national banks such as Wells Fargo and Bank of America are less likely to provide funds to the average commercial practitioner. But with the recent failures of regional lenders Silicon Valley Bank and Signature Bank, smaller lenders may consider commercial projects be too risky. These banks may even mark down the value of some commercial loans. Yun predicted that commercial lending will see a “slight contraction” over the next year.
Yun also predicted that the transaction volume nationwide for commercial properties valued at $2.5 million and higher will decline to $450 billion this year from $600 billion last year, due to higher interest rates and regional bank woes. Commercial appraisal value in January 2023 was down 16% from its peak a year ago, Yun noted. This means property values are decreasing, creating challenges for owners who want to sell or refinance. “So as [property owners] are refinancing, they will recognize that their property value may be a little lower, the interest rate they have to take on could be higher, and the regional banks are saying, ‘Sorry, we don’t have the money to help you on the refinance,’” Yun said. “It’s quite a difficult environment related to the capital market.”
Despite the uncertainty, there are bright spots in the economy and in the commercial sector, Yun noted.
- Job growth is solid, which means businesses are expanding their footprint.
- Apartment and retail rents continue to grow, albeit at a lower rate than in 2022.
- Retail vacancy rates are declining while industrial vacancy rates remain at historically low levels.
- Multifamily construction is booming and reached a 40-year high in January.
Caitlin Sugrue Walter, vice president of research at the National Multifamily Housing Council, took a deeper dive into the apartment sector during NAR’s summit. While demand for investment-grade buildings with five or more units remains strong, most of the growth has been on the luxury end—leaving affordable housing largely out of the equation, Sugrue Walter said. She estimated that 600,000 units are needed at a variety of price points to ease the current housing crunch. That number needs to increase to 4.3 million by 2035 to keep pace with housing demand, she warned.
But despite the recent surge in multifamily construction, the output won’t be enough to meet demand, particularly for those in greatest need of housing, Sugrue Walter said. “Those units are not being built everywhere, and they are Class A units. It takes a long time for apartments to filter down to the next class level.” One of the major barriers to new development is NIMBYism, she added. NMHC research has found that neighborhood opposition creates a 5.6% increase in development costs and a 7.4-month delay in starting a multifamily construction project.
Regulations such as rent control can also be a hindrance to new construction, Sugrue Walter said. Rent regulations can prevent development from occurring at all. According to NMHC research, 88% of developers say they avoid building in jurisdictions with rent control laws. “This is what folks need to be paying attention to,” Sugrue Walter said. “Rent control just ends up making it so that you can’t fix the affordability problem. There are a lot of better solutions.”