Key Takeaways
- The CRE correction that began in mid-2022 appears to be in its later stages.
- Property values are close to troughing, as fundamentals have held up, despite higher rates.
- Fundraising has slowed drastically as LPs wait for market liquidity to return.
The U.S. commercial real estate market remains in a correction that began more than two years ago, when it became apparent the Fed would drastically raise rates to combat inflation. The rapid increase in financing costs drove a wedge between buyers and sellers, forcing the market to find a new valuation equilibrium. More recently, we’ve seen signs of life in the market, including stabilization of property values and a recovery in CMBS issuance, but a discernible rebound in transaction activity has been elusive.
Real estate fundraising has waned significantly as institutional investors grapple with a dearth of distributions and an uncertain market backdrop. Global capital raised totaled $151 billion in 2023, the lowest since 2016, and the first half of 2024 suggests this year could be even scanter for new commitments. Lower-risk core and core-plus strategies have borne the brunt of the fundraising slowdown, while opportunistic strategies have been the most resilient.
Debt financing remains expensive but available despite banks facing myriad challenges. Alternative lenders, including debt funds and mortgage REITs, have been the most active lender group in 2024, taking share from banks and insurance companies. The CMBS market saw issuance grow nearly 200% over the first eight months of 2024 compared to last year, a sign of improving market confidence as spreads have tightened materially. Alternative lenders will likely continue to play a critical role in refinancing maturing loans and financing rising transaction volumes.
Broadly speaking, we see the CRE market heading in the right direction, but any recovery will be uneven. Two of the key challenges for the market—elevated rates and a surge of new supply—are improving, while the third—fundamentals in the office sector—remains a thorn in the market’s side. Risk premia in CRE have remained tight relative to rates throughout this correction, restricting upside for property values in the short- to medium-term. We see a gradual improvement in market activity while returns are generated primarily via income.
