It’s a Whole New Ball Game for Commercial Real Estate

By Greg Friedman, managing principal and chief executive officer, Peachtree Group

With a new administration taking office this month, the stock market remains volatile, and the most recent round of interest rate cuts has yet to provide relief to borrowers. Amid these shifts, speculation continues about when the struggling commercial real estate market will hit bottom and begin its recovery.

There is no doubt that today’s commercial real estate environment is exceptionally challenged, with elevated interest rates and an impending wall of debt maturities presenting clear headwinds to investors, lenders, and developers. Some commentators, though, have expressed optimism about entering a “new inning” in commercial real estate, one in which property prices will revert to pre-2022 levels and borrowing costs will stabilize. This is a fundamentally misguided view, and one that will only delay the inevitable reckoning.

The era of near-zero interest rates is over and won’t return. That extraordinarily friendly environment was the artificial result of a post-pandemic recovery, and the current, harsher environment is the new normal by every metric: As of this writing, the federal funds rate is steady between 4% and 5% (compared to 0.08% three years ago), the 10-year Treasury yield is hovering at 4.5% (up from 1.5% three years ago), and interest rates are expected to remain elevated for longer.

There is no reason to believe that these trends will reverse themselves any time soon. The difference between short-term and long-term interest rates, which serves as a market signal for investor caution, has been negative since 2022. Around $1.5 trillion in commercial real estate loans will come due over the next 18 months, exacerbating liquidity challenges. And on the national stage, the incoming administration seems poised to advance growth-centric policies that – while loosening regulations and driving new development projects – historically have had inflationary effects and will likely prolong “higher for longer” rates.

The reality is that commercial real estate isn’t hitting a bottom – it’s recalibrating to a new reality altogether. Investors and borrowers should adjust their perspective accordingly: The true worth of assets, based on cash flow and adjusted for risk, will need to be recalculated in this costly borrowing landscape. Commercial real estate professionals will have to acknowledge that property prices (which have fallen about 20% from their peak) aren’t simply at a deep discount but are reaching “fair value” now that financing costs are higher. Banks will need to abandon their “extend and pretend” strategy for distressed loans so that the market can accurately price in the risk of defaults. Broadly, commercial real estate must stop burying its head in the sand.

Though the path to stability may be a longer one than some of the most bullish prognosticators suggest, this isn’t necessarily bad news for savvy and patient players in the space. Smart investors who can capitalize on mispriced risk and outdated valuations can reap the benefits of an uncertain landscape. Private credit may be a particularly attractive opportunity now, offering yields that align with recalculated intrinsic values and proposing a lending alternative to cash-strapped banks. On the equity side, it’s possible that this year brings more favorable deals as prices more fully align with the “higher-for-longer” environment.

The commercial real estate landscape faces a great many unknowns over the next few years, but one thing is clear: there is no “new inning” in store for commercial real estate. We are in an entirely new game, and the first players to recognize this will be best positioned to navigate a challenging environment and come out stronger on the other side.

Since co-founding Peachtree Group in 2007, Greg Friedman has successfully overseen investments of over $10 billion in commercial real estate and various other enterprises. With over 24 years of experience, he brings extensive credit and equity investing expertise, particularly in hotels and other commercial real estate assets. Greg was formerly senior vice president of business development for Specialty Finance Group, originating more than $2 billion of credit transactions. Previously, Greg was vice president of business development for GMAC commercial mortgage asset-backed lending division. During his six-year tenure, he originated, closed and funded more than 300 hospitality FF&E financing transactions with an aggregate capital structure exceeding $10 billion. Greg is a graduate of the University of Texas at Austin and is a board member of the American Hotel & Lodging Association. He also serves on the real estate fund advisory board for the Texas McCombs School of Business at the University of Texas at Austin.

The views and opinions expressed in the preceding article are those of the author and do not necessarily reflect the views of The DI Wire.

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