Here at the Financial Star, we follow today’s biggest trends.
Artificial intelligence, clean energy, infrastructure, electric vehicles…
We want you to stay informed about where the market is headed next.
And sometimes, you need to know what to avoid.
There are trends happening that you may want to stay away from.
And the decline of commercial real estate is one.
What’s Happening in Commercial Real Estate?
Prices of commercial real estate, and office buildings in particular, are falling.
In New York, commercial real estate companies are admitting that they are seeing prices fall to their 20-year lows.
The Covid pandemic forced millions of workers to stay at home. It was one of the biggest social experiments ever.
Turns out, quite a few of those workers don’t want to go back to the office. And with the labor market in the United States being tight, employees have a lot of leverage.
So office attendance has fallen. It may never recover to its 2019 levels.
Rising interest rates didn’t help commercial real estate, either. Traditionally, higher interest rates drive down the value of real estate. And interest rates are likely to stay high for a while.
Volatility in the banking industry earlier this year made liquidity somewhat scarce.
With fewer funds available, the real estate market slows down.
Some analysts estimate that at the end of 2022, the U.S. economy briefly entered a recessionary period. At the same time, even tech behemoths such as Alphabet and Facebook went through rounds of layoffs.
In other words, the commercial real estate found itself in the middle of a crisis.
What’s Next for Commercial Real Estate?
As the companies managing office buildings cannot fill them and earn enough to cover their loan expenses, they have started foreclosing and handing their properties back to the banks.
In the office industry, foreclosures have soared by almost 30% in the first quarter of 2023.
Some experts estimate that in New York, only the top 10% of all office buildings are in good financial shape. The vast majority of them aren’t.
On top of that, they are facing what experts call the “refinancing wall.”
The total amount of real estate debt that will come due before the end of 2025 is a staggering $1.5 trillion.
And debt maturities will continue climbing until they peak in 2027, at $550 billion, according to Bloomberg. Some properties will be sold at bargain prices.
What Can Investors Do?
Individual investors should be very cautious about commercial property ETFs. This group includes offices, apartments, retail outlets, hotels, and industrial properties.
They should make sure that the ETFs they prefer to hold are exposed to properties with steady or growing cash flows and no refinancing in the near term.
On the institutional side, there are more options. Investors who focus on distressed assets, both in real estate and in fixed income, will have plenty of opportunities to buy junk loans and “underwater” real estate.
This is a high-risk area, however, and it requires specialized expertise in valuation techniques and legal nuances of loan agreements.
In general, individual investors could do better by focusing on trends that have a clear and visible upside.
This year, real estate isn’t one of them.
Thank you for your loyal readership,
The Financial Star team