Commercial Real Estate Making Waves as Investors Look for Calmer Waters

The commercial real estate market has begun to show some signs of wavering due to the current economic landscape. While some commercial sectors like healthcare and industrial properties are still performing well, some investors in retail and office spaces are beginning to show some evidence of skittishness by attempting to reduce their exposure to commercial properties.

Rising Interest Rates Lead to A Domino Effect

With the US economy suffering under rising inflation, the US Federal Reserve has been hiking interest rates steadily for several months in an effort to reduce the impact of that inflation. Yet increasing interest rates has had a negative impact on real estate developers looking for a good return on their investments; as the cost of lending for the purchase of property increases due to rising interest rates, investors naturally begin to back off on the market except in instances where their returns are high enough to counteract their increased costs. 

Unfortunately, the acts of some real estate investors have triggered concern with a number of real estate investment trusts. REITs such as Blackstone Inc are announcing redemption tightenings. Meanwhile, Starwood Property Trust’s subsidiary Starwood Capital Group also placed new restrictions on any investors looking to divest themselves from its own funds as well. 

Both of these nontraded REITs have paid out billions in withdrawals in the third quarter of 2022 even after capping investor redemptions, yet if these trends continue these trusts may have no choice but to sell other assets to continue to pay these redemptions.

A Long Time Coming

The writing on the wall for this trend began in the spring and summer of 2022 as international investors began to respond to the decline in property markets triggered by raising interest rates. For Blackstone, that saw more than 2 percent of the net assets of the trust being withdrawn by investors in July alone. C-level executives for Blackstone, including the CEO and the President and COO of the trust, sought to balance out the discrepancy by personally investing $100 million in their own funds to slow the descent.

Making matters worse is that the legacy of the coronavirus pandemic is still interfering with the recovery of many aspects of the commercial real estate market. The office space sector is particularly feeling the pressure as employees have been recalcitrant to return to the office after several months or even years of enjoying the flexibility of remote working. As a result, the push by workers to continue to enjoy these benefits has severely limited the sector’s growth, further complicating the issue for commercial real estate investors.

Investments Shifting Away from Commercial Real Estate

With interest rates ballooning and demand for certain types of commercial space remaining low, investors are indeed gearing up for a mass exodus away from the specific sectors of the commercial real estate market that are being affected. Instead, more low-risk investments are showing some growth, with bonds being an early frontrunner thanks to their better liquidity and higher rates of return. This trend is likely to continue as the Fed continues to report plans to increase interest rates consistently over the next few months as they chase an end to inflation.

For the average real estate professional, this means that beginning to pivot away from the affected types of commercial real estate properties is likely to be a good strategic move. The retail and office space markets may bounce back eventually, but the likelihood of that happening anytime soon seems to be low unless economic conditions change drastically - something that isn’t going to happen anytime soon. In such a landscape, it’s possibly better to pivot to institutional and healthcare real estate sectors for the immediate future if you do work within the commercial real estate sector.

What About Residential Real Estate?

While there are some important differences in what drives the residential real estate market when compared to commercial real estate investment, the two markets do tend to react in similar ways. Increased interest rates across the board mean that the price of a residential mortgage is also higher than it was before, and there is some evidence showing that such mortgage rate hikes are exerting downward pressure on the ability of prospective buyers to secure larger home loans. Over time, this is likely to lead to a drop in house prices as well, as fewer sellers will be able to find buyers who can afford current house prices.

For some, this may indicate an incoming “buyer’s market” for residential real estate. However, it’s crucial to bear in mind that as inflation stays high, a buyer’s purchasing power remains diminished overall. Additional expenses, such as the cost of food, fuel, clothing, and other utilities place additional pressure on prospective home buyers, possibly pricing them out of the residential market completely until conditions improve. In such an economic environment, fewer home buyers likely translate to more activity in the rental sector; savvy real estate professionals can follow these trends for better success in the coming new year.