Commercial real estate companies have had a tough time over the past couple of years. Since the Federal Reserve began aggressively hiking interest rates, the industry has grappled with high refinancing costs that have sent shock waves across the economy.
Since last year, experts have predicted that a rebound in commercial real estate is just around the corner. Earlier this year, CBRE Group (NYSE: CBRE), the world's largest commercial real estate company, said it expected a rebound in the industry by the end of 2023. Those predictions continue to evolve, getting pushed further out into the future.
If you have investments in commercial real estate through the various real estate investment trusts (REITs) out there, here's when you could expect a rebound.
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Higher interest rates have weighed on commercial real estate
Commercial real estate properties include those used for offices, multifamily housing, warehouses, retail, and medical facilities. Companies that own and lease these properties can provide a steady source of dividend income, but rising interest rates have pressured the industry because of the leverage these companies use.
Commercial real estate loans aren't like residential loans. While many mortgages last 15 years to 30 years, commercial real estate loans have a much shorter term, generally between five and 10 years, with a large balloon payment at the end. Property owners don't make that big lump-sum payment and instead refinance their properties.
Borrowing costs have risen due to the Fed's rate hikes, which it implemented at one of the fastest paces in history.
So as commercial real estate loans come due, property owners have a decision: refinance at today's high borrowing costs, wait it out and see if interest rates stabilize before the due date, or walk away from the property entirely.
Image source: Statista.
CBRE's earnings show just how much the industry has slowed
CBRE Group is a huge player in the world of commercial real estate, with more than $144 billion in assets under management (AUM). The company provides services including leasing, property sales, property management, and development, and it knows the industry inside and out.
At the beginning of this year, it believed that a rebound in commercial real estate would happen in the second half of 2023. However, the banking crisis -- which saw the failure of Silicon Valley Bank (a subsidiary of SVB Financial), Signature Bank, and First Republic Bank -- put increased pressure on the industry.
Regional banks are the largest lenders for commercial real estate, holding about 67% of the total loans outstanding. However, banks are focused on cleaning up their balance sheets and are more selective about the loans they are willing to extend to the industry.
CBRE's most recent earnings report shows that the industry slowdown persists. Chief Executive Officer Bob Sulentic told investors that his company "experienced a sustained slowdown in property sales and debt financing activity," hurting its earnings per share (EPS), which declined 56% compared to last year. Global leasing revenue declined 16%, and sales revenue fell 38%, with "most debt capital sources remaining on the sidelines," Sulentic said.
Data source: YCharts.
Besides slowing growth, CBRE Group revised its core EPS outlook, expecting this key metric to decrease in the mid-30% range this year. It previously expected a 20% to 25% decline after its second-quarter earnings report. Buyers and sellers simply cannot agree on prices due to the volatility in interest rates and uncertainty about the future of those rates.
Here's when investors can expect a rebound
According to CBRE Group, the industry isn't expected to recover until late 2024, another setback for investors who had hoped for an earlier bounce back. Interest rates will remain high as long as economic activity stays robust.
Sulentic told investors, "We believe this process won't complete and transaction activity won't rebound materially until investors are confident that interest rates have peaked and credit becomes readily available."
Investors will want to watch these stocks when commercial real estate markets eventually recover
Commercial real estate property values will take time to recover, and stocks in the sector continue to take a beating. Longer-term interest rates keep rising, and financial conditions keep tightening, making it difficult for participants to complete deals.
Until interest rates stabilize and credit markets open up, commercial real estate companies will face an uphill battle. Investors will want to avoid companies specializing in higher-risk pockets of the market, including office properties that have faced pressure since the onset of the pandemic. SL Green Realty and Vornado Realty Trust are two office REITs I'd avoid.
Segments that should bounce back quicker include industrial real estate, such as Stag Industrial, which should continue to grow as the online shopping boom increases the need for warehouses and distribution centers. Data center operators, like Digital Realty, and multifamily housing providers, like Walker & Dunlop, are other areas where values could bounce back quickly during a recovery.
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SVB Financial provides credit and banking services to The Motley Fool. Courtney Carlsen has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Digital Realty Trust, Stag Industrial, and Walker & Dunlop. The Motley Fool has a disclosure policy.
