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RealFacts Weekly Real Estate Report

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This Week’s Topics

The Best Opportunity in CRE is for Commercial Lenders

Richard Byrne, CEO of Benefit Street, recently shared his insights on CNBC regarding prevailing economic trends and the potential impact on lending practices.

In a conversation with CNBC, Richard Byrne began by shedding light on his long-held assumption about interest rates, expressing his belief that they would remain higher for a considerable duration. This anticipation, rooted in economic analysis and market trends, formed the backdrop against which he gauged the current financial landscape.

However, Byrne wasn't entirely pessimistic about the future trajectory of rates. Despite his overarching expectation of sustained elevation, he did foresee the likelihood of a single rate cut within the year. This nuanced perspective revealed his astute awareness of the dynamic interplay between economic indicators and monetary policy decisions.

Delving deeper into the implications for lenders, Byrne underscored the opportunity in commercial lending. On one hand, he acknowledged the prospect of heightened profitability within the lending sector, buoyed by prevailing rate dynamics. Yet, on the other hand, he acknowledged the commensurate escalation in risk accompanying this potential windfall. It was a delicate balancing act between opportunity and prudence, lenders need to be more thorough than ever in their underwriting process.

For Byrne, however, the prevailing rates represented more than just a balancing act—they epitomized a golden opportunity. As a lender attuned to the nuances of the market, he viewed the current rate environment as fertile ground for capitalizing on lucrative prospects. It was a moment to seize, characterized by the convergence of calculated risk and strategic positioning.

Yet, amidst the optimism, Byrne didn't shy away from addressing the looming specter of sectoral vulnerabilities. In particular, he sounded a cautionary note regarding the office space segment, identifying it as the proverbial Achilles' heel within the broader economic landscape. Those heavily exposed to office-centric assets were forewarned of impending turbulence, serving as a clarion call for proactive risk mitigation strategies.

Source: CNBC

CRE Distress Rate Up 26 Basis Points in March

In March, CRED iQ increased its distress rate for all property types to 7.61%, a 26 basis point increase from the month prior. This is the highest distress rate since they began tracking the metric. The most surprising part? Office wasn’t the biggest mover.

The biggest mover in March was retail which saw a 108 basis point increase mostly due to a $158 million loan that was backed by the Miami International Mall failing to pay off the balance at its February maturity. The hotel sector came in second in terms of highest MoM distress rate increase climbing to 7.7% from 6.9% in February. This was also mainly caused by a large loan moving into special servicing. Office also had a distress rate increase. Although it wasn’t as large as the hotel or retail sectors, office still holds the highest distress rate at 11.4%.

Overall distressed rates by property type graph

It’s still unknown if or when the Federal Reserve will cut interest rates this year. This cloudy picture may put an end to the “extend and pretend” game that is being played to avoid defaults and foreclosures. The remainder of 2024 still needs to play out, but it wouldn’t be surprising to see this index tick higher in the months to come.

Some Experts Float the Possibility That the Fed Could Raise Rates Again

Recent fluctuations in the financial markets have been prompted by speculation regarding the Federal Reserve's next move in response to higher-than-expected Consumer Price Index (CPI) numbers. Yesterday's CPI data revealed a trend of prices not declining as rapidly as previously anticipated, leading to concerns about the Fed's future policy actions.

Earlier in the year the FED announced that there would be two to three rate cuts during the year, but since that announcement, there has been no sign that that will be the case. Former Treasury Secretary Lawrence Summers, in an interview on Bloomberg Television, emphasized the need to consider this scenario seriously, estimating the likelihood of an upward rate move to be between 15% to 25%. Summers' remarks underscore the growing uncertainty surrounding the Fed's monetary policy trajectory.

Federal Reserve Governor Michelle Bowman echoed similar sentiments, suggesting the potential necessity of raising interest rates to control inflation. Despite acknowledging that it is not her baseline outlook, Bowman highlighted the risk of inflationary pressures necessitating future policy rate increases. Her remarks carry weight as a permanent voting member of the Federal Open Market Committee, adding to the complexity of market sentiment.

JPMorgan Chase CEO Jamie Dimon also contributed to the discussion, acknowledging the need for preparedness for a wide range of interest rates in the future, signaling concerns about potential market volatility and uncertainty.

While some foresee multiple rate cuts starting in July and September, others anticipate a more cautious approach, with only one reduction expected in September. Kathy Bostjancic, chief economist at Nationwide, expressed skepticism about the Fed's ability to execute its promised rate cuts amidst persistent inflationary pressures.

One concerning indicator contributing to uncertainty is the super core inflation reading, which excludes volatile components such as food and energy prices, as well as shelter and rent costs. The recent acceleration of super core inflation to a 4.8% pace year-over-year has raised alarms among market participants, indicating sustained inflationary pressures beyond the Fed's target.

Despite these concerns, the Fed remains committed to its pledge of rate cuts, albeit amidst growing uncertainty and speculation. The potential ramifications of a rate hike would present significant challenges for the institution, potentially tarnishing its credibility and undermining market confidence.

Source: Bloomberg

The Real Estate Nightmare Unfolding in Downtown St. Louis

Many cities around the nation are trying to avoid the dreaded doom loop that can be caused by office vacancy. A doom loop is when office districts experience vacancy which makes the area seem less desirable. As fewer workers occupy the office buildings, nearby restaurants and shops close which causes less foot traffic through the area and the downward spiral continues. This is an issue that San Francisco and Chicago are trying to avoid, but one that St. Louis is trapped in. The city's central business district experienced the steepest decline in foot traffic out of 66 major American cities between the start of the pandemic and last summer according to the University of Toronto’s School of Cities.

This is a stark reminder to the rest of the U.S. that if downtowns aren’t able to reinvent themselves and conform to new preferences, they too can find themselves in a doom loop. Although many cities have rebounded since the pandemic, others further from the coast seem to be struggling, with 6 out of the 10 cities with the largest decrease in foot traffic being in the Midwest, according to the University of Toronto. “It’s a classic chicken and egg kind of deal,” commented Glenn MacDonald, professor of economics at Washington University in St. Louis’s Olin Business School. “People don’t go there because there’s nothing to do. There’s nothing to do because people don’t go there.”

The city is trying to revive foot traffic and activity in multiple ways. Improving landscaping and adding bike lanes has been one strategy. Greater St. Louis Inc. has paid buskers to play music on street corners to make areas seem more lively and friendly. That organization along with the St. Louis Development Corporation has even begun a program this month that pays retailers who move downtown $50,000 for construction expenses. Reversing the dreaded doom loop isn’t easy, but the city has high hopes that it can revive its downtown with continued effort and incentive programs.

Source: Wall Street Journal

China’s commercial property segment is seeing some bright spots amid a slump in the wider realty sector

China has been in a real estate slump since the beginning of the pandemic and hasn’t recovered as well as most other countries. However, that might be changing. JLL recently reported that rents for prime retail locations in Beijing rose at their fastest pace since 2019 climbing 1.3% in the first three months of this year compared to Q4 of last year. According to JLL, the increase can be attributed to growing demand for new food and beverage brands, unique foreign fashion items, and electric vehicles, all of which have driven foot traffic to shopping malls. The firm expects rents, which remain well below pre-pandemic highs, to continue growing through the remainder of the year.

According to Wind Information, sales of commercial real estate by floor area in China rose 15% and 17% YoY in January and February respectively. While this marks buyers and sellers beginning to find equilibrium, the same can’t be said for the residential scene which continues to struggle. During that same period sales by floorspace in residential tumbled 25%.

Jo Kwan, managing partner at Raffles Family Office located in Singapore, is optimistic about upcoming buying opportunities. In an interview last week Kwan said, “We do have an internal timeline or projection of how far valuation has to fall before it makes it attractive for us.” Adding, “I think the opportunity is about to open up for us right now.” He believes that there is still a longer fall to the bottom, but investors who position themselves to buy these discounted assets will be winners if they hold on for the mid-term.

Source: CNBC

Blackstone Making $10 Billion Multifamily Purchase, Going on the Real Estate Offensive

In a strategic maneuver signaling confidence in the rebound of the real estate sector, Blackstone, one of the world's premier real estate investors, has announced its agreement to acquire Apartment Income REIT (AIR Communities) for approximately $10 billion. This acquisition, the largest in Blackstone's multifamily market history, underscores the firm's bullish stance on rental housing and its belief in the resilience of commercial real estate despite recent


Apartment income REIT share price graph

AIR Communities boasts ownership of 76 upscale rental housing communities, primarily located in coveted coastal markets such as Miami, Los Angeles, and Boston. Blackstone's commitment to inject an additional $400 million into improving these properties underscores its dedication to enhancing value and maintaining competitive advantage in these sought-after markets.

Jonathan Gray, President of Blackstone, has articulated the firm's conviction in the timing of this acquisition, citing the emergence of key indicators signaling a real estate recovery. Gray emphasized Blackstone's proactive approach, asserting that the best investments are often made during times of uncertainty.

The commercial real estate market has weathered a tumultuous period, marked by record office-building vacancies and pressure on apartment rents due to increased supply and higher interest rates. Despite these challenges, Blackstone's move suggests a turning point, with the firm positioning itself to capitalize on the evolving landscape.

While some investors remain cautious, anticipating potential fluctuations in pricing amidst uncertain economic conditions, Blackstone's bold acquisition signals confidence in the long-term viability of the multifamily sector. The firm's willingness to pay a 25% premium for AIR Communities reflects its conviction in the underlying value of the assets, which it perceives to be undervalued in the public market.

Blackstone's acquisition of AIR Communities is emblematic of its broader investment strategy, which includes recent ventures into distressed real estate assets and strategic partnerships targeting high-growth sectors such as data centers. These initiatives underscore Blackstone's agility and willingness to adapt to shifting market dynamics.

Source: Wall Street Journal

AI’s Rising Tide Has Potential to Transform Commercial Real Estate

The rise of artificial intelligence will fundamentally change how most firms and industries operate including the commercial real estate sector. Commercial Observer suggests that “AI-powered tools can analyze space usage patterns, predict future space needs, and optimize collaboration layouts, potentially leading to significant cost savings and increased efficiency for businesses.”

As office space continues to evolve and hybrid work becomes more prominent, investors would be wise to implement AI to stay competitive and ahead of the curve. “AI can assess occupancy patterns and space usage data, surfacing underutilized areas ripe for transformation and breathing new life into them as dynamic collaborative spaces,” according to Commercial Observer.

One such platform by Raise Commercial Real Estate called WorkplaceOS is able to “leverage real-time data for strategic decision-making,” according to the article. Although we are still in the early stages of the AI boom, over half of U.S. firms are actively pursuing or integrating artificial intelligence in some form according to the CompTIA AI Industry Outlook. Early adopters and innovators can use this technology to get ahead of the competition and improve their profit margin as this new business landscape emerges.

Source: Commercial Observer

These Are the Riskiest Multifamily Securitization Markets

In recent years, the multifamily real estate market has faced growing challenges, marked by rising vacancy rates and a surge in unit construction. To assess the risk landscape of multifamily securitizations across major metropolitan areas (MSAs), KBRA conducted a comprehensive evaluation of 25 of the largest MSAs in the United States.

The study, which examined multifamily supply and demand dynamics, aimed to develop a risk score for multifamily securitizations within each MSA. The analysis encompassed a wide array of factors, including vacancy rates, construction activity, employment and population growth projections, and affordability metrics.

The findings revealed a spectrum of risk levels across the evaluated MSAs. At the weaker end of the spectrum were cities such as Detroit, Chicago, Denver, Washington D.C., Atlanta, and Philadelphia. These areas exhibited higher vulnerability in their multifamily securitizations, with factors like low employment growth, negative population trends, and elevated vacancy rates contributing to their risk scores.

Conversely, cities like Las Vegas, San Diego, Houston, San Francisco, Portland, and Riverside emerged as the stronger performers, boasting more robust multifamily securitization profiles. Factors such as strong employment and population growth projections, favorable vacancy rates, and positive affordability indices bolstered their resilience in the face of market pressures.

The analysis delved into the specific drivers influencing risk profiles in each MSA. For instance, Detroit and Chicago grappled with low employment growth and negative population trends, while Denver faced challenges stemming from higher-than-average vacancy rates and ongoing construction activity.

On the other hand, cities like Las Vegas, Houston, and San Diego showcased strong economic fundamentals, with robust employment and population growth forecasts contributing to their favorable risk scores. Additionally, factors such as vacancy rates and the percentage of units under construction played pivotal roles in shaping the risk landscape of each MSA.

Notably, cities like Austin, Phoenix, and Charlotte stood out among the top performers despite facing double-digit vacancy rates and significant construction activity. Their resilience stemmed from healthy demand drivers and favorable market conditions, which offset the challenges posed by elevated vacancy rates.

Source: Globalest

Supreme Court Rules that Legislation Does Not Protect Improper Impact Fees

In a landmark ruling, the U.S. Supreme Court has delivered a resounding victory for California homeowners, builders, and developers by asserting their right to challenge improper local impact fees for housing development, even when these fees are authorized by legislation.

At the heart of the case, Sheetz v. El Dorado County was a pivotal question of proportionality and constitutional rights. George Sheetz, a California resident, found himself embroiled in a legal battle after facing a hefty $23,420 "traffic mitigation fee" imposed by the county upon his application to build a 1,800-square-foot manufactured home on his residential-zoned lot.

Sheetz's challenge rested on the assertion that the fee was not commensurate with the actual impact his new residence would have on local infrastructure, a contention supported by the precedent outlined in prior Supreme Court cases. The county, however, argued that the fee, authorized by legislative decree, was exempt from scrutiny under the Takings Clause of the Fifth Amendment.

In a unanimous decision authored by Justice Amy Coney Barrett, the Supreme Court categorically rejected this argument, affirming that property rights must be safeguarded irrespective of whether the imposition stems from legislative or administrative channels. The ruling dismantled any notion of a "loophole" that could exempt fees authorized by legislation from constitutional scrutiny.

While the immediate repercussion of the ruling remains confined to Sheetz's specific case, its implications reverberate far beyond the courtroom. By affirming the principle that improper takings are impermissible regardless of legislative sanction, the Supreme Court has empowered homeowners, builders, and developers across California to challenge unjust impact fees.

The commercial real estate sector, in particular, stands to benefit from this decision. With developers granted greater leverage to contest exorbitant fees, the landscape for property development becomes more conducive to investment and growth. The ruling injects a much-needed dose of accountability into the calculus of impact fee assessment, ensuring that fees are proportionate to the actual impact of development on infrastructure.

Source: NAHB

Rising Insurance Is Killing More and More Deals

A new adversary has emerged: soaring insurance costs. According to the Spring 2024 Investor Sentiment Survey by RCN Capital, these escalating expenses are reshaping the landscape for investors across the board.

Brennen Degner, Managing Partner of DB Capital Management, vividly illustrates the tangible impact of this phenomenon. With insurance costs tripling for assets in Denver, what was once a lucrative proposition has now dwindled to a breakeven scenario. This narrative of missed opportunities and dwindling profitability is echoed by over 68% of surveyed investors, who cite rising insurance costs as a decisive factor in their buying and selling decisions.

Eric Brody, Managing Partner at ANAX Real Estate Partners, elaborates on the challenges his firm faces in simply obtaining coverage, especially in states like Florida and California, where extreme weather events exacerbate insurance complexities. Sean Kent, Senior Vice President at FS Insurance Brokers, further underscores the multifaceted repercussions, particularly in hurricane-prone regions like Florida and windstorm-afflicted areas like California.

Yet, it's not just real estate investors feeling the squeeze. Developers, too, are grappling with the fallout of skyrocketing insurance expenses. Michael L. Webb, Counsel at Farrell Fritz, highlights the strain these costs impose on project proformas, particularly in the multi-family rental sector. Alan R. Hammer, Esq., of Brach Eichler, acknowledges the impact of rising insurance costs on deal flow, compounding existing challenges in the housing market.

Looking ahead, optimism remains tempered by apprehension. While fewer investors believe conditions have improved compared to previous years, there's cautious optimism regarding future market conditions. However, Rick Sharga, CEO of CJ Patrick Company, sounds a cautionary note, suggesting that the insurance issues plaguing California and Florida could herald similar challenges in other states prone to extreme weather events.

Source: Globalest

Seattle's Office Market Struggles Amidst Transformation

The economic report from Capital Economics paints a grim picture for commercial office space in certain markets, particularly on the West Coast. Specifically, San Francisco and Seattle are expected to see further declines in office values, with a projected plunge of at least 25% from end-2023 levels. Kiran Raichura, chief property economist at Capital Economics, highlights the high sublease availability in these markets, which is anticipated to lead to negative absorption in the coming years. This trend is exacerbated by soaring vacancy rates, with Seattle expected to lead the nation in this regard due to decreasing occupancy and increasing inventory. Raichura notes that while rents have shown surprising resilience in most metros, all office markets still appear overvalued, indicating more challenges ahead as the market seeks equilibrium between supply and demand.

In parallel to these challenges, Seattle's office landscape is undergoing a profound transformation, with a significant portion of office properties now considered suitable for multifamily conversion. The city has implemented initiatives to streamline approval processes and incentivize developers, paving the way for a wave of conversion projects. While luxury condominiums may offer attractive returns, there's a growing recognition of the importance of mixed-income rental apartments with affordable housing allocations to ensure inclusivity and address diverse community needs. Federal funding programs, such as the Low-Income Housing Tax Credit, are crucial in supporting these efforts, although it's acknowledged that such projects represent just one facet of addressing Seattle's housing crisis.

Seattle office vacancy and apartment effective rent graph

Source: Moody’s Analytics

Fed Ponders If SFR Investors Help or Hurt Communities

In response to rising home prices and limited inventory, the Federal Reserve Bank of Minneapolis conducted a study examining the effects of large investors in the single-family rental (SFR) market. The study focused on the Minneapolis metropolitan area, and revealed a doubling of investor-owned SFR homes from 2006 to 2015, accounting for 3.4% of detached SFR properties.

While SFR rentals offer housing alternatives in areas lacking multifamily options, concerns arise regarding investor practices. Investors often target properties needing repairs, potentially improving housing quality. However, instances of neglect and exploitation have been observed, prompting calls for transparency and accountability in property ownership data.

Challenges faced by individual homebuyers, such as financial constraints and limited access to credit, contrast with investors' advantage in distressed-property acquisitions. Proposed interventions include down payment assistance programs and non-profit initiatives to promote affordable homeownership.

At the legislative level, policymakers are considering measures to restrict corporate conversion of single-family homes and curb large-scale investor influence. Senator Jeff Merkley's proposed legislation aims to mitigate investor dominance in the housing market.

As debates unfold, stakeholders aim to balance housing affordability with sustainable community development, guided by insights from the Federal Reserve study.

Source: Globalest

ULI Spring Conference: Trickle of Office Deals, Creating Destination Workplaces, Next-Generation Downtowns

The Urban Land Institute's annual Spring Conference, held at the New York Hilton Midtown, has become a focal point for discussions surrounding the evolving landscape of commercial real estate in the wake of the pandemic. This year's event, marked as the largest in the organization's history, showcased insights into adapting to market shifts and revitalizing downtown areas affected by the global health crisis.

A key theme emerged regarding the office market, with sentiments suggesting a gradual transition rather than an immediate resurgence in deal activity. Harry Klaff, president of Avison Young's U.S. operations, highlighted the slow pace of price discovery due to owners' reluctance to sell at steep discounts. Despite a modest increase in transactions, the market is witnessing a more measured adjustment process, characterized by extensions and selective sales, rather than widespread resets.

The focus on workplace design reflects a growing emphasis on creating destination workplaces rather than obligatory office spaces. Diane Hoskins, Co-Chair of Gensler, emphasized the importance of investing in high-quality environments that attract employees back to the office. Companies are now prioritizing premier buildings equipped with amenities and flexible layouts to accommodate post-pandemic work trends, fostering collaboration and productivity.

Moreover, downtown revitalization emerged as a critical topic, addressing the challenges posed by empty office towers and reduced foot traffic. Megumi Brod, Senior Managing Director for the Rockefeller Group, emphasized the need for reimagining central business districts as vibrant, inclusive hubs. Strategies include repurposing obsolete properties for housing and fostering public-private partnerships to drive economic viability and create diverse, thriving communities.

The overarching goal is to cultivate around-the-clock environments that integrate live, work, and play elements, ensuring accessibility and affordability for all residents. Brod underscored the importance of socioeconomic diversity in enriching neighborhood dynamics and fostering inclusive urban ecosystems.

Source: CoStar

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