You Stayed Alive Until ’25. Now What?
For most of 2024, we saw a more stable, improving rate environment with a return to a more consistent pace for new loan production. The MBA is forecasting that commercial real estate lending will be up 26 percent overall in 2024. Although this is a healthy improvement, we still we are not quite “there” yet for several reasons, including a recent pause for a rate reset. Most were thinking rates would come down dramatically as we moved toward the new year. The Federal Reserve lowered its benchmark rate twice with a full 75 basis-point cut since September and teased additional reductions, yet treasuries have since risen through November. This impacts CRE lending as treasuries are more closely aligned with our lending markets than the Fed rate.
Still, while we have seen some pressure return from upward treasury movement leading up to and since the election, overall rates are still lower year over year, if just. For the most part, the market has adapted its mindset to the current rate norm, higher for longer to some, but a range that is in the lower mid-tier of historic benchmarks. This reality will continue to weigh on maturing debt, but the relative consistency of rates is making transacting realities clearer for refinancing and new investment.
Now we are in the homestretch of 2024 and poised for the transition to a new year. For most if not all our lenders, we are already seeing a move in new origination focus to 2025 as they process their final crop of 2024 loans through the holiday season and towards year-end. For commercial real estate borrowers, this presents an opportunity to reflect and prepare for the opportunities to come, and the realities to expect.
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Rate climate
Rates—where are they heading and when? That’s the question everyone is asking as we plan into 2025. Earlier this year, one of my partners opined that we should expect the 10-year at 4.25 percent by the end of this year. We are essentially in that range following the recent spurt of volatility, which saw yields in the mid-fours before settling in that range. We did enjoy a window this year with the 10-year moving down into the high threes, but holding in the lower fours has been consistent since the upward movement began in October. We should expect that level to remain consistent moving into the first quarter of next year. What happens after that will continue to be the subject of much speculation.
Policy speculation
Right now, the market is churning over what to expect from a new administration taking office in January 2025 and what that will mean for rates, inflation and the domestic economy. While preparation is on everyone’s mind, we will have to embrace a wait-and-see approach on the actual impacts of new policy and the subsequent direction of rates. Will the Fed continue on a rate reduction path, or will we see a pause or reverse for inflation control? Will treasuries hold, increase or fall in response to the months ahead? There isn’t a clear answer yet.
We should know more by the second quarter of next year, and before then, should have a good idea of new policy priorities and where rates are generally heading. The MBA hosts its annual meeting in April 2025, so we should have some more practical updates then. In the meantime, I expect we will see a range for the 10-year in the low to mid fours in the first quarter barring unforeseen geo-political or economic disruptions. Plan accordingly.
Asset and investment strategies
Currently, we are experiencing an oversupply of big box industrial, self storage and, in a major way, office. Multifamily in general has seen some softening as well. Retail seems to be holding strong. The climate for hospitality has continued to improve. We should consider 2025 as the “Year of Occupancy” as owners and managers focus on stabilizing their rent rolls and cash flows to meet debt service requirements for financing in the current cycle.
Personally, I am a believer that office will improve in 2025. How dramatic that improvement is we will have to wait and see. Several larger corporate operators have instituted back-to-office mandates. Will the private sector return spill over into the public sector? There are already expectations for the GSA to employ return to office strategies in 2025. Will these initiatives change the story on office? It’s hard to tell, but for the quality assets struggling with occupancy, it could make the difference while outdated and less relevant addresses continue to struggle with their ultimate relevance and true value.
New development
On the development side in 2024, we were getting back to normal building costs and normal amount of equity to build. But the question is now will there be enough demand to move forward? Demand in California is there for multifamily, for instance, in both urban and suburban markets. The issue is the cost of development is significant in California. New multifamily outside of California will probably take some time for market fundamentals to return to supporting new construction as a major post-COVID wave of new projects is absorbed. The market keeps hoping that office buildings will become ready targets for conversion to residential or new uses. We should expect that viable conversions won’t be abundant. In most cases, the cost to repurpose far outweighs the value created.
Distress
Loans are maturing and will need to transact. There will be a continuing wave of refinancing requirements in 2025 that will be challenged by debt service levels. If borrowers are not amortizing loans down, they should expect an equity check will be required without offsets through substantial rent growth. If that is not a feasible option, know we have essentially seen the end of extend and pretend. Lenders have been foreclosing on distressed assets in greater numbers in 2024, and that pace should increase in 2025.
Banks still need more time before they return as a primary source for new originations. There is still a significant volume of distress on their books, and until they have identified, strategized and moved forward with reconciliation, they will be more focused on mitigating loss over underwriting new loans. A range of capital sources have stepped up to fill the gaps, and we expect them to be as active in 2025—if not more.
Alternate lenders
The retreat of relationship bankers from new loan originations as they work through a crush of troubled loans has made identifying new debt sources a primary concern for most borrowers. This requires a deep dive into the myriads of debt programs from both private and institutional sources. At Gantry, we’ve built a roster including hundreds of vetted sources, with new players constantly emerging in the private sector and an active institutional market.
Life companies remain committed to their CRE lending programs and are a popular choice for lower leverage permanent financing. Their willingness to rate lock at application make them an appealing lender and many are planning to increase or at least hold the scope of their allocations to new CRE loan originations in 2025. CMBS has also made a strong comeback, with new five-year term options and higher leverage points supported by full term interest only to meet debt service thresholds. Private and institutional debt funds are being joined by family offices in placing CRE loans. Bridge debt is readily available from all these sources for assets still in transition or looking to land in a future lower rate climate. The key to the current market cycle? Liquidity from qualified sources stands ready to deploy.
Professional and peer perspective
As an industry, we are talking more, and that is a good thing. The conversations between clients and their financial advisers have become more relevant if not poignant in this volatile cycle. In a world where AI and automation are becoming more and more pervasive, it’s the people using the technology and knowing how to guide the decisions it prompts who are becoming more and more important to the process. Gantry has used this post-COVID period of disruption to grow our workforce and expand into new markets. Our greatest asset is the human capital that drives our operations, and I believe that remains true across the real estate and capital markets. So, to all my peers, family, friends and humanity at large, enjoy a happy holiday season as we all look to a new year ahead with optimism for the work to come.
Robert Slatt is a principal with Gantry.
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