Investment Strategies for Today’s Volatile CRE Market
Emily Butler and Wesley Prato share insights on risks and opportunities.
The commercial real estate landscape is experiencing a period of unprecedented flux, with office vacancies reaching record highs nationwide. Yet, this narrative is not uniform across the board.
While major Texan and Californian cities are grappling with soaring vacancy rates, areas such as Palm Beach and Fort Lauderdale, Fla., are witnessing some of the lowest vacancy rates in the country, pointing to a nuanced picture of both challenges and opportunities. As companies continue to reassess their spatial needs, the manner in which developers and investors navigate these market dynamics will be crucial in 2024.
CPE interviewed CohnReznick Partners Emily Butler and Wesley Prato about the ramifications of a weakened office market and prevailing capital challenges. In the interview below, they outline strategies for success in emerging markets, pinpoint key opportunities in 2024 and offer guidance on maintaining a competitive edge in a market that’s becoming increasingly congested.
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Given the record-high office vacancies in the U.S., can you elaborate on the specific capital challenges affecting the macro commercial real estate market in 2024?
Prato: To start, we are currently looking at roughly a trillion dollars of commercial real estate debt that will come due by the end of 2024. This presents issues involving debt currently owed and assets commercial real estate investors are trying to acquire. Overall, investors are hesitant right now because of the leverage issues.
Butler: With current interest rates, the cost of capital is much higher. Coupled with high office vacancies in most markets and lower appraisal values, investors are nervous about the commercial real estate asset class in general. There are alternative funding options, but many come with additional costs. All of this, plus the fact that the pandemic accelerated so much change in terms of work and life preferences, has greatly impacted the need for and use of office space.
South Florida appears to be a growth market amid the remote work trend. What strategies do developers employ to capitalize on this growth?
Butler: Florida experienced a very different reality from other parts of the country amid evolving market conditions and challenges. The Sunshine State had its share of the bright side due to various factors. Even before the pandemic, there was a migration of business down to Florida as Boomers retired, keeping one toe in the business world and the other in the sand, and creating a demand for commercial property development—both residential and office—that never slowed down.
Much of Florida never really closed its doors during the pandemic like other markets across the country. So, the workforces of many companies within the state never left the office in any meaningful way.
Favorable operating and tax incentives continue to compel industries like financial services and tech to migrate south, adding to the pipeline of development opportunity. The shift to prioritizing amenities and experiences remains paramount. Developers are approaching projects holistically, looking to construct micro-communities and not just offer space. As people continue to work from home, the “‘Sandwich Generation” houses both kids and parents—all with different requirements—and what everyone needs from their space is the ability to do it all and have it all, without needing to go far.
Conversely, for markets with a surplus of vacancies such as Texas, what considerations and strategies should developers adopt to address this challenge effectively?
Prato: Like South Florida, Texas has many people and companies migrating into the market. This makes it surprising that cities like Austin and Dallas currently have high office vacancy rates. Developers must consider that Texas markets are sprawling, and there is no public transportation infrastructure like in other large cities. As there is so much land, they need to find ways to make their office location a destination that will stand out. Developers can consider capitalizing on federal spending to help build out the infrastructures needed in these booming Texas cities.
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In light of these market dynamics, what are the strongest opportunities you see for commercial real estate developers in 2024?
Butler: Given current interest rates and the overall market environment, developers will have to be creative in their target investments. This may involve converting their properties to a different asset type. We may also see funds holding on to investments longer than they may have in prior years, providing the opportunity to repurpose or add value to an existing asset. Finally, we are seeing more diversification in portfolios and continued interest in exploring new asset classes.
Are there specific sectors or types of developments that stand out as particularly promising in the current landscape?
Prato expects to see a more active market beginning in the second half of 2024. Image courtesy of CohnReznick
Prato: With increased use of artificial intelligence, along with continued use and adoption of cloud-based apps, data storage and risk mitigation/disaster recovery efforts to house data offsite, data centers are a promising type of development to watch. I also anticipate that medical offices will be a stand-out this year. While interest in multifamily housing has declined, specific subsets like single-family rental, build-to-rent and student housing will be worth watching this year.
As the commercial real estate market becomes increasingly competitive, what best practices do you recommend for developers to stay ahead of the curve?
Butler: It depends on the specific sector. But overall, considering the end-user and their specific wants and needs will go a long way in staying ahead of the curve. Developers and construction companies always operate knowing that the building they are currently designing will be out of date with current technology by the time it is completed. That is the nature of the beast: Time to build will always be a roadblock for being truly state-of-the-art as the speed of change charges forward.
Looking to develop projects with adaptability in mind is more important than ever. What’s needed is a holistic, human-centric strategy that carefully integrates digital services and building facilities. The way these are delivered is through technology and, fortunately, proptech has embraced apps to plug and play into what is current and easy add-ons that can elevate the overall amenities of a space.
How do you foresee the demand for office spaces evolving in the coming years?
Prato: This is an interesting question as it applies not just to commercial real estate but to societal behavior at large. Commercial real estate serves as a “squeaky wheel” to indicate where we may be headed. I think location will be a key factor in success for office buildings. Offices that are directly off the highway or public transit will have lower vacancy rates. Demand will be driven by the need for convenience by employees needing to get to the office.
Given your experience with real estate funds, how are investors responding to current market conditions?
Butler: Investors are working to diversify their portfolios across several asset classes rather than focusing on just offices. They are also seeking increased transparency in what they are investing in and what the fund is doing to get the best returns possible.
Prato: Additionally, the focus on ESG will likely shift to a more specific focus on climate and environmentally focused investing. Markets like Texas and Florida are facing climate, water and natural resource issues. This may drive more concentrated investing elsewhere, such as the Midwest, for those with a longer-term view. Investment strategies should ultimately instill longer-term value by helping to curtail risk, attract and retain both investors and talent, and make buildings run better.
Any final thoughts?
Butler: The rise in interest rates has had an enormous impact on the market. I anticipate that later this year and into 2025—assuming interest rates begin to decline—there will be appetite for more activity and deals will pick up.
Prato: It’s not all doom and gloom. The outlook for the commercial real estate industry is positive. I completely agree that we will see a more active market beginning in the second half of 2024.
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