It looks like the commercial real estate market has finally bottomed out — and experts say it's time to invest
- Commercial real estate transactions are gradually recovering, Moody's said.
- The firm cited continued weakness in the office sector, where vacancy rates remain at record highs.
The embattled commercial real estate market may finally have a few things going its way, according to recent data.
A Moody's analysis cited that declining transactions have bottomed, with year-on-year sale volumes now positive for the first time in two years. In the second quarter, the four core real-estate sectors notched $64 billion in transactions — marking 9% upside turnaround.
That's not to say all is bright. The credit rating agency noted persistent weakness in the office space, as last quarter's vacancy rates hit another record high of 20.1%. However, national office utilization has increased enough to stabilize the market.
Post-COVID norms have been the chief culprit behind office sector strain, as remote work became an entrenched part of US corporate culture. With fewer employees using the office, buildings lost tenants. That left owners with harder-to-pay debt, made worse by high interest rates and tighter bank lending. Defaults have not been uncommon.
And yet, lending volumes are slightly improving, Moody's said.
Second-quarter mortgage origination volumes are up 3% year-to-year, an improvement that was led by commercial mortgage backed securities. In the same quarter, they've jumped 155% on an annual basis.
Moody's expects that banks lending could turn positive by the end of 2024. That may be welcome news for Wall Street, as fear has mounted of a distress wave looming over smaller dealers. As these lenders are most exposed to commercial real estate, some analysts have warned that hundreds of banks risk failing in the next few years.
Now, some see opportunity in the real estate market.
Analysts at KKR agree that sector conditions have bottomed, but predict that banks will become limited participants in the market moving forward. If these dealers reduce lending to 30% of the market, that would create a $300 billion gap, the firm said.
"We think this will be an attractive vintage for real estate credit," analysts Matt Salem and Dakota Sagnelli wrote, later adding: "A growing number of commercial real estate transactions should increase the number of opportunities to lend, while the dearth of bank capital should keep yields attractive and spreads relative to corporate credit elevated."
For instance, KKR noted that spreads on B-level CMBS assets have widened 400 basis points since 2022.
If investors are concerned about risk, the analysts pointed out that valuations have reset. Meanwhile, the market owes 30% less money than it did in 2022's first quarter when prices were near a peak.
"For lenders, this means a larger equity cushion and a smaller overall debt burden. We are often lending at some 50% of peak valuations," the note said.