The wailing and gnashing of teeth over inflation and recession and uncertainty is coming to an end. Inflation has become stubbornly persistent, but it seems to have turned the corner and is lower than last year. The potential for recession — at least a severe one — has faded. And uncertainty has simply become a fact of life. As such, 2024 is shaping up to be a year of transition from impatience (waiting for the economy to turn around) to grudging acceptance (that low interest rates are a thing of the past, consumer and worker shifts are here to stay).
Waiting for the perfect time to invest means you won’t be investing at all.
YEAR OF MAKING DUE
At this time in 2022, you would have been hard pressed to find an economist who wasn’t seeing a recession on the horizon as the Fed continued to raise rates. The only questions anyone was asking focused on the severity of the expected recession and where interest rates would peak. Today, practitioners of the dismal science are sounding relatively optimistic on the U.S. economy going into 2024. Positively giddy would be stretching it, but they are certainly seeing more positive than negative signals as we approach a new year.
Most of the economists who participated in The Wall Street Journal’s fall survey believe there is less than a 50 percent chance of the United States falling into a 2024 recession.
BMO economists Doug Porter and Scott Anderson are quoted in the survey report as noting, “The probability of recession continues to recede in the U.S. as the banking turmoil subsides, and strong labor market resilience and rising real incomes support consumer demand.”
In addition, respondents believe the Fed will be done raising rates by the end of 2023. Roughly half expect the Fed to cut rates in the second quarter of 2024, assuming economic growth cools, and the historically low unemployment rate — which was 3.8 percent in October — starts to creep up.
Despite a tight labor market, which could continue to exert pressure on wages and consumer demand, these economists expect inflation (as measured by the consumer price index, which was 3.7 percent in September), to drift down to 2.4 percent by the end of 2024 and 2.2 percent by the end of 2025.
Exactly where inflation lands will influence what investors can expect to achieve, so this is the area of the economy receiving the most scrutiny — and the most debate.
“Labor constraints have continued to challenge companies,” says Mina Pacheco Nazemi, Barings’ head of diversified alternative equity. “Retaining talent and attracting a skilled labor force are some of the pressures that have led to wage increases. While we are seeing some easing, workers are demanding higher wages to cover increased costs of housing, energy and food. If the labor supply issue continues, inflation will likely persist for much longer than many people expect. There will be several issues investors will face next year, not the least is persistent inflation [even at a lower rate] that eats away at their real rate of return.”
In addition to a tight labor market continuing to drive inflation, other factors could upend the economy. The current geopolitical clashes could widen and impact energy prices, disrupt global supply chains, result in shortages of rare earth metals used for electronics and agriculture, and increase the national debt. Domestically, severe weather could disrupt energy production, as well as increase energy demand, both of which could cause a spike in energy prices and inflation. In addition, insurance companies pulling out of markets hit by hurricanes could depress economies in the booming Southeast.
Finally, 81 percent of economists who responded to the WSJ survey also said the recent run up in bond yields is concerning. While the strength of other economic factors should continue to underpin growth, this type of upward trending bond rate has typically occurred before a downturn. The economy will likely hold its own, but the warning flags need to be acknowledged.
So, what does this all mean for real assets? It means investors need to be careful — that rising tide has long ago receded — but there are opportunities for those able to take advantage of a higher-rate economy and changing demographics. For the private investor, real estate — especially multifamily and debt — presents an interesting opportunity for 2024.
YEAR OF FACING REALITY
Commercial real estate roared back as we came out of the COVID days, but reality has set in and long-term demographic and workplace changes, as well as inflation, are having an impact. Rising interest rates are being felt in all areas, even the very popular industrial and multifamily sectors.
A recent Mortgage Bankers Association (MBA) report noted the delinquency rate for commercial real estate has increased four quarters in a row, as of third quarter 2023. The delinquency rate for loans backed by offices now exceeds rates for retail and hotel properties. Delinquency rates for multifamily and industrial property loans have also increased, though they remain below 1 percent.
“Commercial property markets are working through challenges stemming from uncertainty about some properties’ fundamentals, a lack of transparency into where current property values are, and higher and volatile interest rates,” says Jamie Woodwell, head of commercial real estate research for the MBA. “The result has been a slow and steady uptick in delinquency rates.”
These challenges are expected to continue well into 2024, though some sectors will fare better than others. Multifamily has been an attractive sector for years, and it is expected to continue to lead the pack, though investors will need to be more selective and cognizant of intended and unintended consequences. For example, while inflation is driving demand for multifamily units, it is also increasing property management costs.
“The economic landscape will heavily influence the commercial real estate market,” says Derek Graham, principal and founder at Odyssey Properties Group. “Although there is still uncertainty across the market as a whole, there is optimism in the multifamily sector for 2024. For example, as high mortgage rates continue to depress homeownership, demand for multifamily housing is starting to tick up again. Multifamily demand improved in 2023, and we can expect a continued uptick with new household formations driving further demand.”
Despite an increase in demand, multifamily will face its own headwinds. In addition to increased management and insurance costs, supply could become a factor. A record-breaking 554,000 multifamily units are projected to be completed in 2024, according to Apartments.com. While the demand for new apartments is still high, it’s not keeping up with supply. This influx of supply will apply downward pressure on rents, forcing property owners to prioritize efficient operations, tenant retention and lease renewals.
Another important consideration is the surge in debt maturities approaching in 2024.
“Over the past few years, many investors acquired properties utilizing loans through debt funds with three-year loan maturities, of which a vast majority are due to mature next year,” says Graham. “If interest rates do not drop significantly over the next 12 to 18 months, property owners will face difficult decisions, as some properties will be undervalued, thereby making it challenging to refinance [without equity infusion] or sell without losing significant equity.”
This dearth of financing could open a door for investors with capital to spend, as they may be able to capitalize at significant discounts from property prices two to three years ago. The investment world is full of “when one door closes another opens” situations, such as this.
2024 will likely see some of the country’s hottest markets cooling. In 2022, investors could purchase nearly any property in booming cities, such as Austin or Phoenix, and expect a nice return. That is all changing as supply and demand fundamentals shift. However, all is not lost.
“Certain markets that have faced significant challenges may soon offer valuable opportunities,” says Max Sharkansky, managing partner at Trion Properties. “The current macroeconomic factors and interest rates, combined with a substantial oversupply of properties, has led to decreased rents and increased vacancy rates. Investors should closely monitor struggling markets like these in 2024. If, and when, rates decline — potentially within the next 12 to 18 months — there will be a short window of opportunity to purchase assets with great long-term potential at a deep discount.”
Fred Gortner, co-founder and head of U.S. strategy at Paladin Realty Partners, sums up this dilemma: “U.S. multifamily rents are declining at exactly the same time as a 40-year high of new supply comes online and tens of billions of dollars of floating-rate bridge loans are maturing. 2024 is going to be fun.”
One of the subsectors of multifamily that seems poised to outperform in 2024 is workforce housing.
“With uncertainty remaining a dominant theme in 2024, we believe workforce housing will continue to be one of the most attractive segments for real estate investors,” says Kunal Merchant, COO at Revitate. “The reason? Consistent renter demand. In periods of high inflation and high interest rates, middle-class Americans are often priced out of homeownership and class A rentals. As a result, access to attainably priced housing is at a premium, driving high occupancy and renewal rates in workforce housing communities.”
This is a product that should keep its value, in good times and bad, and well past the uncertainty still facing investors in 2024.
“In periods of less inflation and lower interest rates, many of these same households may leave workforce housing in favor of homeownership or class A rentals,” Merchant continues. “However, because demand for workforce housing so significantly outpaces supply, vacancies are quickly filled, with continued high occupancy and renewal rates. As such, workforce housing can be a compelling ‘double economy’ investment, offering stable cash flows and potential for long-term appreciation in all seasons of the economy.”
YEAR OF RESCUE CAPITAL
About $1.2 trillion of debt on U.S. commercial real estate is scheduled to mature in 2024 and 2025, according to the Newmark Group. Much of this is highly levered because rates were low three or four years ago, and putting as much debt as possible on a property seemed a no-brainer. Developers and owners expected rates to stay low and rents to rise, making refinancing a non-event. But now interest rates have risen, rents are falling, property values are declining, and securing bank refinancing is problematic.
“I think rescue capital will be a big theme for next year across all sectors,” says Bryan Kenny, president/principal of Bandon Capital Advisors. “The banks might kick the can down the road a bit like they did during the great recession, but in the end, the private market is going to have to step in with rescue capital.”
William James, principal at Bandon Capital Advisors, adds: “Once the Fed began its path to deflate the economy by raising interest rates, funds were being raised for the impending CRE decline. There are numerous funds now raised and ready to deploy rescue capital for distressed CRE. The returns that they’re going to be able to get are going to be better than equity could deliver on a new deal right now.”
Debt could be the one area seeing more activity than previous years. While acquisitions and transactions in general are expected to decline across the board, it is likely we’ll see an uptick in capital markets activity.
“In the next few years there will be over $1 trillion in commercial mortgages coming due,” notes Kenny. “These maturing loans will come to market in a much tighter lending market than when they were originated. Loans that were moderately leveraged at origination and had good rent growth can easily find debt. Those more leveraged loans with pro forma rents that didn’t materialize will have to seek rescue capital to get their deals refinanced. On the acquisition front, it’s just really hard to make anything pencil with the current gap between cap and interest rates. Until cap rates adjust to these higher rates, we’ll see muted acquisition activity.”
BEGINNING OF AN ERA, PERHAPS
Real estate isn’t the only investment concern cropping up in 2024. AI will likely see a surge as owners look to bring efficiency to property management and businesses look for ways to deal with a labor shortage. A scarcity of rare earth metals (most deposits are found in “challenging” countries, such as China and Afghanistan) will likely cause pain in the commodities market and impact data, electronics and agriculture. (Mining asteroids has been suggested as a solution — maybe the topic for 2025 predictions.) Enormous infrastructure funds are getting more enormous, but most of their track record is based on smaller raises. Will they be able to duplicate that success on a larger scale? Climate change, aging demographics, a shift in corporate power to the workers (will this be abiding or short term?), and another contentious national election will all feature prominently in how investors spend their capital next year.
It would surprise no one if investors decided to take another year off. But for those who can come out from under the covers and just accept that this is the world we live in now, 2024 could very well be the beginning of a new era in real estate. And they will be getting in on the ground floor.
Sheila Hopkins is a freelance writer in Auburn, Ala.