Menu
By Partner Valuation Advisors Eric Enloe
December 19, 2024
Q: It has been an action-packed fall, and the Fed just cut rates again yesterday. In your view, how might the new Presidential administration shape short- and long-term trends across the commercial real estate sector from an investor, owner, or a developer's perspective?
A: Overall, a new Presidential administration is being viewed in the markets as a positive. Clearly, President Trump has experience in the commercial real estate business. He understands the dynamics of the business. So, I do think overall, the net effect of his policies will promote demand for real estate in this country. There's certainly a little bit of concern about what impact the tariffs could have when you get into the industrial space and what that could do to retailers and what that could do from a commerce perspective. I think that will also have the potential impact of encouraging additional industrial development in the U.S. That said, all companies would rather have their manufacturing in the US, but it is a function of production cost and having more cost effective options abroad. It will be very interesting to see how this plays out. Overall, I think the Presidential election is viewed as a net positive for the commercial real estate industry.
Commercial real estate investors I talk to don’t generally have strong feelings about either political party or that one that would be better or worse for them. The biggest sentiment I heard was investors simply wanted to know who the President was going to be so they could make their own investment decisions. On the margin, investors may have believed President Trump would be slightly better for business, but it was more about quickly putting the uncertainty of who was going to be running the country behind us. Investors were prepared for either candidate to win, and since candidates don’t typically move the needle tremendously on commercial real estate values, it was more about knowing which party was in power so big institutional investors could create their business plan and execute their investment thesis.
Q: Where will the opportunities be ahead in terms of property types or markets for investors?
A: The question of where the best opportunities will be takes investors back to the fundamental supply and demand equation to determine what’s next. I'm a little bit of a contrarian. Office would be probably the greatest example where there's a lot of B and C class office that does not have a great future, but there is a lot of Class A and B plus office that is well located but needs a little bit of love. Return to office is improving and we are starting to see some positive leasing traction pertaining to Class A office. The levels of tenant improvement allowances and rent abatement are substantial, but at the right basis we are seeing some incredible buying opportunities.
Industrial will continue to be in demand, especially around the ports, around transportation, around major airports, and rail will continue to be important. There is also a significant amount of non-functional industrial space in this country that has 20-foot clear ceiling heights, which is obsolete compared to a modern industrial building that features 30-foot plus clear height. That functional obsolescence will likely produce a host of redevelopment opportunities from an infill perspective on industrial, as well as new bulk distribution development on larger land sites. I think there's a real opportunity there.
Retail has really been somewhat of the darling in the last year of the core four property types. Much of that is the capitalization rates in 2021 and 2022 didn’t dip down to the same levels as multifamily and industrial. So as a result, there was less of a value adjustment to make when borrowing rates skyrocketed. The exception would be malls that are considered dead malls, which are a whole other category. But the community centers, and grocery anchored centers are the darlings in retail that have held up. The pandemic placed a momentary halt to shopping in a physical retail center. After the pandemic there was a big question if people would go out and want to shop again, after they had gotten used to online retail out of necessity. But we are seeing retail centers performing well with strong retail sales volumes. A recent valuation assignment we completed involved a 300,000-square-foot luxury center that was exceeding $2,500-per-square-foot in sales, which is staggering and makes it one of the top centers in the country. National retailers overall are strong, though there’s certainly some concern about the longevity of big department stores. We’ve seen some close and the demise of the traditional anchor store is opening up opportunities for different types of anchor retail.
Texas continues to be an interesting market from an industrial and multifamily perspective with new product being delivered in both of those product types. I expect we will continue to see companies relocate to Texas, whether that's Dallas, Houston or Austin, or even San Antonio. Those are different cities that offer distinct opportunities for investors in four markets that have demand generators that bode well for Texas in the future.
Q: What strategies might investors' owners, or developers consider to navigate the future landscape the best way? What advice are you now giving clients compared to before the Presidential election and interest rate cuts this fall?
A: There are a few factors investors must consider when developing their strategies. They are weighing the positives like the interest rate cuts and a positive business environment coming out of the election, as well as a little negative such as the Treasury shift. At the end of the day, it always gets back to the fundamentals and finding out what supply and demand in a market looks like. It doesn't matter if we are in a high inflationary market, a high interest rate market, or a low interest rate market. Certainly in a low interest rate market, there’s more wiggle room and a little more room for error, whereas that doesn’t exist in a high interest rate market.
Once an investor knows what supply and demand looks like they can determine what a market’s prospects are. For instance, you can’t paint all office as a bad investment, despite the challenges that sector faces, there are some fantastic opportunities. Switching over to multifamily, there are a few markets that are oversupplied. Austin and Nashville are good examples of markets that are oversupplied from a multifamily perspective. But that doesn’t necessarily mean investors should lose any sleep about Austin or Nashville. I think those are going to be two of the best performing multifamily markets in the country over a five year or 10 year time horizon, but they're in a rough patch due to the fundamentals. There is a lot of noise out there that values are down x in this market, and values are down y in this market, or this product type is so challenged. That may be true, but you can't paint everything with a broad brush. There are some interesting opportunities as a result of some dislocation in markets that has created some smart buying opportunities in growth markets where an investor can get in at a basis that they look back in 3 to 5 years with a big smile because they captured a really strong opportunistic buying opportunity and with patient money were able to generate outsized returns.
Q: What's your advice to your clients on some of those specific impacts as you drill down into the details?
A: I step back and look at the big picture here, it is easy to see there are a myriad aspects to consider. One, we've had a 50 basis point cut that occurred, that was followed up by two 25 basis point cuts, the latest occurring in mid-December bringing the federal funds rate to a range of 4.25% to 4.50%. Those are positive developments, and capital is impacted in a good way. It shows that there is Fed movement, which should be a positive for real estate values and for development in this country. The negative that we have seen is that the anticipation of future cuts has been tempered based on the Fed’s feedback about the future. Additionally, the 10-year treasury has spiked from around 4.20% to nearly 4.60%. That is all about the market saying that maybe we had gotten ahead of ourselves on the future rate cuts.
The other component of that is there was a Presidential election that we view as a net positive for real estate investors. That's the feedback I've been receiving from clients, and I've heard numerous times from the tenant side that plans are changing because companies expect a more pro-business environment ahead. Tenants that were considering taking 300,000 square feet of industrial space are looking at leasing 500,000 square feet of space now that the election has taken place. That is a good thing!
The 10-Year Treasury movement has been a little bit of a negative, per se. It was hovering in a 3.6 to 3.7 range, and as late November, it is sitting at a 4.3 to 4.4 range. So that impacts the cost of capital. That's taken a little bit of the wind out of the sails of those interest rate cuts. But overall, what's changed to the positive is the sentiment and it started with the 50 basis point cut – that was followed up with two subsequent quarter-point rate cuts – because there were a lot of investors on the sidelines. They were needing to get assets out in the market to sell. They want to get their capital back, whether it's to return to investors or invest in new projects, and they've been on the sidelines. When the 50 basis cut hit, they then felt there’s positive momentum and a sentiment to get these projects out in the market because it will lead to more transactions. The Presidential election did nothing but further that somewhat, and then the only other holdback is the 10-Year Treasury’s move. That’s taken a little bit of the wind out of the sails, but still a net positive on where investors are at.
Q: Did the Fed achieve its purpose in increasing rates, and can the cuts now being made create a softer landing or at least not cause a major disruption?
A: It almost makes my head swoon in some ways because if we have low unemployment, then that typically would lead to wanting to raise rates. If we have higher unemployment, then you look to cut rates. But the reality is there's a healthy balance that made sense. Clearly, it's a good thing for people to have jobs. That's a positive, that promotes spending on the consumer level. But on the business level as well, the reality is when rates get cut, companies need to make capital investments, and their borrowing costs are lower. So, there's numerous factors to consider and much of it is tied back to inflation. If you're running hot, there's huge risks that come with that. So, I don’t envy what the Fed does. Finding a balance and equilibrium of where the economy's growing but we're not running high inflation is hard to accomplish and that is where we find ourselves today.
Q: What are some of the infrastructure, or regulatory or tax issues to keep an eye on now?
A: Risks facing this country are infrastructure like bridges and transportation, as well as power, which could really be a limiting factor in the future from a manufacturing and development perspective. One of the key issues we're keeping an eye on is power because the country is underpowered and there's a significant infrastructure spend that needs to occur to keep up with all of the needs that we have.
Another issue to watch is the municipalities that properties are located in because from a real estate tax perspective the impact is significant. Municipalities are becoming more and more sophisticated about how they're looking at real estate taxes, which doesn't bode well for property ownership since in many cases they are increasing assessments to help cover underfunded budget needs, whether that be pension liabilities, city services expenses or inflation costs that have not gone down. Those are considerations investors must really look at closely. We're seeing investors really hone in on this area and it's driving purchase decisions in some areas where some markets are not in favor due to tax environments that are highly challenging. But also on the flip side, there are areas where the tax environment is accommodating and that is an investor consideration.
Q: What momentum or positivity can investors take from the policies of the new administration or recent interest rate cuts?
A: The expected policies of the new Presidential administration are clearly more accommodating for business, though there is no guarantee that the Fed will continue making rate cuts. The 50 basis point cut that the Fed initially made was viewed favorably because it instilled positive feelings that the future will be better than it is today as it pertains to real estate values. And from a lending perspective, what's held up lending in many ways is uncertainty on where values stand, and it's held up the entire market. It's kept investors from listing properties for sale. Even when they do place an asset up for sale, buyers and sellers are not able to meet at an acceptable price to each party, which means there's not sufficient clarification on where pricing is. We are seeing that gap narrow, which is the most positive shift because what we need for healthy markets is a steady flow of transactions – properties clearing the market. It gives comfort for lenders. It gives comfort to buyers. It establishes a price point for sellers. It helps valuation experts like us determine values. It really helps brokers because they can be even more detailed in their analysis because they can point to actual transactions. Healthy markets have a regular flow of transactions and this sense of optimism that came from the interest rate cuts leads everyone to believe there will be more transactions. Sellers are wanting to get properties out there and expose them more, and the market always speaks. In a good market, bad market, the market will speak on what an asset is worth. The market has been speaking in the last year and a half and either people didn’t like or agree with what the market was speaking but now there's going to be a meeting in the middle and we’re going to see trades, and that’s healthy for the market.
I would expect activity in the first quarter to really heat up. If the 10-year Treasury didn't make that move from 3.6/3.7 to 4.3/4.4, I'd probably have a little bit different tune. That shift has taken a little bit of the wind out of the sail of that momentum. There is still positivity in the air, but it's just taking a little wind out of the sail. I do think things will really heat up in first quarter of 2025. I am encouraged by the increased activity that I'm already seeing. By every metric I've seen, there’s increased sales volume that's occurring now. It's occurred last month; it occurred in November and again in December. That trend itself is a positive trajectory.
Eric Enloe, MAI, CRE, FRICS, Senior Managing Director, Partner Valuation Advisors, directs valuation and consulting engagements related to a wide variety of property types for national institutional assets and portfolios. His broad range of experience in valuation and analysis includes retail, office, industrial, multi-family, development land, manufactured housing, regional malls, hotels, self-storage, and educational facilities.
