Values Decline as Lending Slows, Yields Rise

Good morning,

Values decline as lending slows, yields rise; developers hit pause on multifamily construction; survive till ‘25?; and cities incentivize office conversions. Let’s delve into today’s topics.

📈 Market Update

😓 Values Decline as Lending Slows, Yields Rise

Lending Grinds to a Halt:
After robust loan growth in recent years, CRE lending at both large and regional banks is decelerating - with loan balances even contracting at some large banks in September. This pullback comes as banks face $1.9T in upcoming CRE loan maturities and ongoing struggles in the office sector. Tighter credit conditions dampen transaction volumes and weigh on property values, forcing sales, capital calls to refinance, or handing back the keys.

Yields on the Rise:
US commercial property prices fell again in August as Treasury yields climbed, reducing demand amid rising interest rates. The value-weighted composite index slid 1.4% for the month, while the equal-weighted index dipped 0.3%, as property sales closed at higher yields compared to July. At the same time, new commercial space deliveries are outpacing weak tenant demand, pushing net absorption negative in Q3 for the first time since the pandemic's onset. The supply-demand imbalance adds further downward pressure on prices.

🏗️ Developers Hit Pause on Multifamily Construction

The number of new apartment starts has fallen dramatically this year, down 41% in August compared to last year. This slowdown comes as developers face challenges securing financing due to higher interest rates and banks tightening lending standards. The cost of construction loans has risen significantly, making new projects difficult to pencil out. Investors are also hesitant to provide equity for new construction amid flat rents in some markets and uncertainty around future property values. Major metro areas that saw a surge of apartment building like Denver, Dallas, and Phoenix will likely see far fewer new projects break ground over the next couple years.

🔍️ All Comes Down to Rates:
While construction and hiring in the sector have declined, the still hot for-sale housing market will continue to drive demand for rentals. If interest rates stabilize, developers will regain confidence to restart stalled plans. But expect subdued apartment construction until financing challenges ease.

Rental Market Cooling to Pre-Pandemic Levels:
Renewal rate growth has stalled while concessions rise, move-ins and move-outs are balancing, and lease terms are shifting strategies to align expirations with next summer's anticipated higher prices. After spiking, the market appears to be settling back to norms last seen in 2019.

⛈️ Survive till ‘25?

According to a recent Bloomberg survey, nearly 70% of respondents believe the US office market will rebound only after a severe crash, and over 80% think CRE prices won't bottom out until at least the second half of 2024. With $1.5T in CRE debt due by end of 2025, the office sector in particular faces refinancing struggles. Regional banks, which hold 30% of office debt, have less lending capacity amid deposit shrinkage. With long lease terms delaying impact, the office revenue reckoning will play out over years. Though CRE woes won't likely threaten overall markets, significant loan losses are expected.

🏢 Cities Incentivize Office Conversions

As the office sector struggles with high vacancies, conversions to other uses like residential and life sciences are accelerating - with 100 projects set for completion this year, more than double the annual average since 2016. Incentives from state and local governments are driving much of the boom in conversions, which now total 60M sf across 40 markets. While adaptive reuse helps breathe new life into underutilized offices, CBRE notes conversions alone won't resolve all the challenges facing the market. Strategic public-private partnerships will be key to transforming obsolete office districts into vibrant mixed-use neighborhoods.

✍️ Further Reading

• Americans Are Still Spending Like There’s No Tomorrow (WSJ)

• Why a US Recession Is Still Likely — and Coming Soon (BBG)

• Value Losses Attributed to WeWork Could Reach $7 Billion Under Worst-Case Scenario (CS)

• China Comes Under Growing Pressure to Fix the Country’s Housing Market (WSJ)

• What’s at Stake in Trump’s $250 Million Business Fraud Trial (BBG)

• CRE Debt Finance's Current Complexity (GS)

📊 Chart of The Day