The commercial real estate market – or parts of it – were beaten up in the past two years as the US Federal Reserve tightened monetary policy. What sectors are in play and what sort of investments make most sense? The author attempts to answer these questions.

The following commentary on the commercial real estate market in the US comes from Patrick Kennedy, co-founder of AllSource Investment Management, a business located in New England. Kennedy works with high net worth investors. The editors are pleased to share these views; the usual editorial disclaimers apply. To respond, email tom.burroughes@wealthbriefing.com

Commercial real estate was nothing short of a bloodbath in 2022 and 2023. For most sectors within the asset class, the worst correction since 2008 unfolded due to the US Federal Reserve aggressively raising interest rates to fight 40-year highs in inflation. This led to a liquidity crunch and ultimately a regional banking crisis.

Heavily reliant on the cost of debt and the ability to loan from regional banks, commercial real estate (CRE) valuations went through what many are referring to as “the great reset.” Since valuations were discounted across the board and the US has avoided recession so far, institutional managers are looking for a recovery in 2024. 

What is that recovery based on? It is the expectation that the Fed will cut rates, liquidity conditions will ease, consumer sentiment will continue to rise and the US will avoid recession due to a resilient job market. 

What are the core risks of this view? One risk is sticky inflation. Consumer price inflation came in hotter than expected in January. When the Fed fought aggressive inflation in the 1970s, inflation continued to come back as soon as liquidity conditions eased hence the term, “the bull whip effect.” Another potential risk is consumer debt.

With household credit card debt growing 16 per cent on a year ago (as of 9/30/2023) and delinquency rates rising, one has to wonder how long the US consumer can hold up with the cost of consumer debt skyrocketing.  

Lastly, while the job market holding up is a core component of the CRE recovery theses, there are signs of cooling as we enter 2024 with wage growth decreasing and job growth slowing.

Where the opportunities are within the recovery…
Logistics: There are secular tailwinds with robust demand. E-commerce growth has exploded since the pandemic, which has created massive demand for logistic centers to handle the supply chain needs for the modern business. One- and two-day shipping is now the norm rather than a competitive edge. “Last mile” logistic centers that make this possible are becoming more and more critical. Global trade alignment and supply chain onshoring should also increase demand for these assets. With valuations correcting across the board and some asset owners seeking liquidity, compelling opportunities should continue to surface throughout 2024. 

Net lease back strategies: These strategies buy a building from a company and lease that building back to the company effectively turning the company into their tenant. This allows the manager to not only strategically target best-in-class properties but best-in-class tenants as well.  

Our managers are able to lock in long-term leases with some of the largest companies in the US. The reason why these companies agree to sell the property to the fund and rent from the manager is quite simple; having the ability to access the equity within the property without losing the functionality of the property or taking out an equity loan against it. There are also tax advantages associated with rental expenses.

Private credit: After the Fed hiked rates aggressively and the regional banking crisis ensued, lending standards tightened, to say the least. Banks are under pressure from regulators and increased default risk in the highest rate environment in a decade. With public debt markets still largely “frozen,” private lenders have the opportunity to fill the gap and finance the recovery while setting attractive terms.