Higher interest rates, inflation and rising construction costs – plus the hybrid work environment – are all creating challenges for the commercial real estate industry.
New developments are harder to finance because borrowing costs are higher, as is the cost to build. And the post-COVID remote and hybrid work landscape has considerably weakened demand for office space.
To find out how commercial real estate developers and brokers are navigating those challenges, BizTimes Media brought together a panel of experts for its annual Commercial Real Estate and Development Conference at the Brookfield Conference Center on Friday, Nov. 17. The panelists include: Transwestern executive vice president Marianne Burish, New Land Enterprises managing director Tim Gokhman, Royal Capital Group chief executive officer Kevin Newell and Three Leaf Partners chief operating officer Derek Taylor.
In advance of the event, BizTimes Milwaukee asked the panelists to respond to a series of questions.
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BizTimes: How are the capital markets for commercial real estate affecting your business right now, especially with higher interest rates?
Burish: “Unevenly. Prevailing higher rates are a concern for building owners with renewing notes having higher LTVs (loan-to-value), compounded by many lenders retreating from office lending and/or just being pencils down. Seven percent to 9% prevailing loan rates for new and renewing loans, minimum 60% LTV and often 50% LTVs. Conditions are further exacerbated by lower building valuations due to higher interest rates/cap rates.
“Expect more capital calls and foreclosures in 2024. The strong will survive but weaker borrowers or owners with significant vacancy will be vulnerable. 2023 had a few casualties but if employers continue to struggle with getting folks back to the office – such that the negative (office) absorption stats keep increasing – expect more owners to be on the struggle bus in 2024. As usual, not as bad in Milwaukee as other markets nationally but still, there will be casualties.”
Gokhman: “There are major challenges with both higher interest rates and a decreasing number of options for capital. Capital is still available for the best projects that make sense, but I think we’ll see a huge drop in housing production in Milwaukee (consistent with national trends).”
Newell: “My capital markets lead teammate, Brian Mays, has been actively watching and sourcing in the markets and has helped to ensure that we have ready capital for projects that have immediate horizons. This includes the residential phase of ThriveOn King, where – despite the historically high interest environment – he led efforts on securing $40 million of committed capital which is set to close in November 2023. Creativity, company track record and strong relationships nationally have been critical to our success.”
Taylor: “Debt markets have certainly constricted. That said, we have worked diligently through our close relationships with lenders in Wisconsin to bring debt to our new construction projects that have broken ground this year, including The Atwater in Shorewood (39 units), Theatre Terrace in Kenosha (71 units), The Fitz on the East side of Milwaukee, with partner Michael DeMichele (55 units), Saukville, and soon, West Allis (247 units). The impacts of higher interest rates are felt in our projects and by our investors, but, when available, the availability of tax incremental financing in strong submarkets with development-minded communities has helped make these projects a reality. We’re also exploring other debt sources, including life insurance company debt, HUD, debt funds and other sources which are now more viable as traditional banks have pulled back.”
What is keeping you up at night lately?
Burish: “1) The work-from-home and hybrid work trend and increasing impact on office occupancy and hence demand. 2) Domestic and global political risk and attendant economic impacts and instability. Historically, the U.S. has had low to nonexistent risk on this front, making us one of the world’s favorite places to invest. Still very good comparatively speaking but increasing political dysfunction domestically adds unwelcome uncertainty to decision-making, which is counterproductive to investing and general economic prosperity. 3) (Higher) interest rates further increases risk of a not-soft landing whereas a small retreat over the year of anywhere from 50 to 100 basis points would likely avert a material amount of foreclosure activity.”
Gokhman: “Our kids, the pressure to help build a better Milwaukee, and simultaneously a rapidly broadening national/international scope of our work in mass timber. Not necessarily in that order.”
Newell: “The geopolitical environment is in the midst of a conflict level that we have not seen in some time. This combined with an aggressive domestic Fed policy and upcoming elections presents significant challenges to the macroeconomy. Significant damage can be done if the appropriate guardrails are not managed appropriately.”
Taylor: “Availability of debt for new construction in 2024. The Fed’s continued rate hikes have forced many traditional banks to the sidelines. I think and strategize often with our team about how to approach lenders in the debt market for our upcoming new construction projects.”
Where do you see the greatest opportunity right now?
Burish: “Office bargain hunters for older product with redevelopment potential, increasing consideration (or need) of sale-leasebacks across all asset classes, solid leasing in the best buildings in the best locations.”
Gokhman: “Mass timber. And I think Milwaukee could be a leader in the national conversation on urban renewal by continuing to make bold decisions (and investments) into workforce housing and public infrastructure.”
Newell: “I believe that we have a significant opportunity to stabilize our inner city neighborhoods with the appropriate public-private partnerships. With Mayor (Cavalier) Johnson and County Executive (David) Crowley leading the way, I foresee the neighborhoods having a very similar transformation as we have witnessed here in the downtown and near-downtown neighborhoods.”
Taylor: “We recently launched an industrial asset class strategy to acquire value-add assets. We closed on our first acquisition at the end of October and have another Wisconsin opportunity on the heels in mid-November. These opportunities provide our investors with an opportunity to invest in a stable asset, with long-term, in-place leases and rising annual rent bumps. When combined with future cap rate compression once the economy stabilizes, we believe these assets will generate value for our investors as we continue to solve the challenging debt markets for new construction opportunities. We may expand this strategy to multifamily acquisitions in 2024.”
