By Jerrold L. Bregman
As we reflect on 2023 and look ahead to 2024, it is evident that the Denver commercial real estate market, like the rest of the country, has not been immune to the broader economic challenges. Factors such as the highest interest rates in decades, a pandemic causing workers and companies to reassess their real estate requirements, an increase in corporate covenant and payment defaults and bankruptcies, bank failures, and a limited housing supply stressing home purchasers, have collectively made this a challenging year for various sectors of the commercial real estate market. Denver is no stranger to these challenges; MileHighCRE recently reported that in Q3 of 2023, while Denver saw notable growth in some areas, it saw a 9.9% decrease in commercial real estate leasing volume.
The greater national market has been experiencing similar challenges, causing an increase in CRE delinquencies. Banking institutions are well aware of and feel the challenges firsthand. Reuters reported that Morgan Stanley is setting aside $134 million for credit losses incurred in Q3 with the bank noting this was due to “deteriorating conditions in the commercial real estate sector.” Given that these losses are being incurred across the banking industry, it is unclear yet if this presents, or will become a full-blown “crisis.”
These experienced and expected losses have caused lending to slow down significantly. Federal Reserve data shows that the CRE debt held by banks is at its lowest level in nearly a decade. Some attribute the reduced lending to the reduction of CRE purchases. GlobeSt.com reported that CRE sales in the first half of 2023 were $137 billion, a 55.2% drop from the $306 billion CRE sales in the first half of 2022. However, this drop in sales can likely be attributed to the significantly higher interest rates and the reduction in demand for many CRE developments, particularly commercial offices, due to shifting business and consumer needs. While we expect the Federal Reserve to ultimately lower interest rates, we don’t know if they will start in 2024, as recent statements indicate, or how quickly they will be reduced. It is safe to assume that when interest rates drop, it will be at a gradual pace, and with enough time in between each cut to allow for clear market reactions. There isn’t any news of where the Federal Reserve wants to park rates in the long term, but many believe they won’t return to their previous near zero anytime soon, if ever.
We have seen brighter spots for the CRE market within the national multifamily and industrial markets. According to Moody’s Analytics, September 2023 had the lowest payout rates of the year thus far at 71.7%. They attributed this to two separate events that have been developing over time, namely, The Millennia Companies’ failure to pay off loans for affordable senior housing projects that were recipients of low-income housing tax credits and a loan balance that failed to pay off, which involved a student housing project in Gainesville, Florida. The Moody’s report highlighted that they are “less worried” for the greater multifamily market which maintained payout rates of over 90% for much of the year. With the nature of housing being a necessity combined with long-term, high-demand expectations, multifamily CRE is expected to be well-positioned for years to come, despite the recent downtick in payout rates.
Industrial CRE has seen significant growth during this rough time for CRE overall. We are seeing substantial growth in large real estate developments for data centers to house artificial intelligence and “bitcoin mining” computer farms. As the pandemic pushed many companies to strengthen their e-commerce and delivery models, the race for faster shipping shifted up a gear, and industrial CRE for warehousing and logistics continues to benefit. Many banks with CRE holdings have noticed this bright spot in the sector and have begun increasing their exposure, according to S&P Global Market Intelligence.
This remains true for Denver Industrial CRE. While development activity was down 18% in Q2 of 2023 according to Mile High CRE, total leasing volume transacted was up 73.1% quarter-over-quarter. Some anticipate the next three to four quarters will be less exemplary to the extent strong consumer spending falters or businesses defer capital projects. However, many view this as a short-term issue and expect consumer spending to remain resilient and capital projects to pick up particularly as interest rates fall into 2024 if the Fed’s recent indications for rate cuts in the new year continue to hold.
As we look out to 2024, we cannot easily predict what monetary policy actions the Federal Reserve will take if the current outlook of lowering inflation and a moderated labor market continues as presently anticipated. We know the desire is to ultimately reduce rates to take the pressure off of businesses and consumers, but the timeline is not yet clear despite the rate cuts some are anticipating will occur in 2024, nor is the question resolved as to whether any more rate hikes will come before the reductions. With this understanding, it is best to assume that many of these pressures will remain to some extent for much of 2024. We can expect to see banking troubles continue in some form, and financing will still be more expensive than it has been in recent years.
If you find yourself looking for CRE financing in 2024, working with an attorney who specializes in financing can be an invaluable resource. An experienced attorney can assist in negotiating rates and agreement terms with lenders. They can also work to secure financing through credit agencies and private lenders who may have different risk tolerances and agreement terms than some banks have.
The views expressed in this article are for informational and promotional purposes only and are not intended, and shall not be considered, to be legal advice.
Jerrold L. Bregman is a business lawyer and partner at BG Law LLP, who represents principal parties in high-stakes real estate transactions, financial restructurings, commercial lending, private debt and equity trades, and related litigation in numerous jurisdictions. Jerry is licensed to practice law in California, New York, and Colorado, and received his law degree, and his MBA from UCLA School of Law and the Anderson Graduate School of Management, respectively.