3 Effects of The CRE Slowdown and How Technology Can Help
2022 started off fairly positive for the commercial real estate industry – that is, until the Fed started raising rates again. We saw cap rates widen, spreads increase, and property valuations decrease. With uncertainty throughout the commercial real estate market that has continued into 2023, companies must now focus on strategic asset-level decision making in order to meet the evolving needs of investors, tenants, and regulators. We’re no longer operating as we have over the last five years where we could sit back and rely on the appreciation of assets.
According to a survey conducted by Deloitte of 450 CFOs, 40% said they expect their revenues to increase in 2023, 48% are expecting a decrease, and 12% said they expect no change. Thirty-three percent of respondents said they plan to cut costs in 2023. It seems that many investors and CFOs are waiting to get a sense of relative stability, which may have an impact on transaction volumes and overall property valuation. This decrease in transaction volumes and overall property valuation is what we’re calling “The Slowdown”.
Slowdown Effect 1: Decreased Transaction Volume
In 2020, transaction volumes took a big hit, but once the pandemic started to slow down in 2021, the transaction volume nearly doubled. Values of real estate started rising exponentially, which made people really excited to trade. However, in the middle of 2022, things started to change. Interest rates rose, caps rates widened, and values started to come down. The interest rates on loans that were taken out five or ten years ago are now coming due and have increased from 2-3% to 7-8%, which lowers net operating income (NOI) and valuation of property.
It’s not fair to say that the situation is all “doom and gloom”, however. Even though transaction volumes are reduced from 2021, the volume of transactions is still running above the 17-year average. It is anticipated that the transaction volume will rise again in 2024, as long as the gap between buyers’ expectations and sellers’ expectations is closed.
Slowdown Effect 2: Volatile Interest Rates
While interest rates have increased in the past couple of years, they may not continue to do so. According to data acquired from Thirty Capital Performance Group, we believe interest rates will plateau at around 5%, and later – in about twelve months – settle at around 4.75%. It’s important for borrowers to leverage current data to update their modeling and scenarios and evaluate their proformas. Now may be a good time for borrowers to meet with a third-party provider to help decide when they should refinance, sell, or hold.
Slowdown Effect 3: Reduced Cashflow
Now is also the time to start re-evaluating your expenses. As we go through this environment of inflation and rising interest rates, simply increasing rent alone will not be sustainable. Your expenses will likely outpace your rent increases.
Expenses are the silent killer of many proformas, contribute to the erosion of returns, and can be an obstacle to getting to your promote. Over the last year, we’ve seen almost a double-digit growth in expense percentages in the United States, particularly in insurance, maintenance, and utility expenses. These jumps in expenses are concerning for cashflow, regardless of asset type. Lobby CRE can help break down your expenses line-by-line and compare your portfolio to similar portfolios in your local markets and sub-markets. Being able to see where your portfolio falls in the benchmark against your comps can be helpful when it comes to re-evaluating and adjusting your expenses and optimizing your cashflow.
The Next Steps: Optimizing Cashflow
In order to manage, predict, and act on the performance of your CRE portfolio, there is a strong need for cashflow management to effectively drive investment returns and protect the promote for your General Partners. As we look at the three years ahead, we anticipate a reset of the market – where commercial real estate will return to a market-based interest rate and pricing environment for assets. It’s more important now than ever to monitor your expenses and seek guidance on whether it’s time to refinance, sell, or hold your assets.
About Lobby CRE
Lobby CRE is an asset management software that can be useful when implementing a new cashflow management strategy. Asset management technology is a powerful tool that can be used to track and manage your property’s income and expenses in real-time. Having on-demand access to income data means that the firm can easily track its profitability and quickly pivot to a new cashflow management strategy if needed. By using either custom-built or templated dashboards, you can keep a pulse on your portfolio’s financial performance and health.
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