Real Estate Resilience Amidst the Feds’ Policy Shift in 2024
By William “Brad” Blash, Managing Partner at Crossbeam Capital
In 2023, researchers raised concerns as $682 billion of apartment loans were predicted to mature within the next two years, with a significant portion facing potential challenges. By November, U.S. prices saw their first decline in over 3 1/2 years, pushing annual inflation below 3% and increasing speculation for a Federal Reserve interest rate cut in March 2024. This economic backdrop sets the stage for a transformative period in the real estate market.
2023 Real Estate Transactions Turbulence
Crossbeam Capital has been busy since the beginning of 2023, raising our new fund and underwriting over 200 multifamily transactions. The truth is that underwriting and assessing value is a complex exercise in uncertain times. It is an art and science involving a combination of accurate financial projections and the culmination of 30+ years of experience to find the buying signals at pricing that makes sense.
The question until now has been moot... as transaction activity for the last year has ground to a halt - a frozen field.
The trade activity data supports this, trailing 12-month sales off by roughly 70%. What has traded has been in 1031 transactions in which an acquisition must be made to hold off paying taxes or from all cash purchasers buying and holding long term. The lending side of the story is similar, with the majority of the activity focused on refinance transactions for lowly leveraged deals. Agency lending volume (Fannie Mae & Freddie Mac) through November 23’ is off roughly 50% year over year.
APEX Apartment Complex in Boulder, Colorado | View Project
Multifamily Homeowners Under Pressure
Sleepless nights visit owners of multifamily assets with floating-rate debt right now. Rates have moved from roughly 3% to north of 7% in roughly a year, which has more than doubled your mortgage payment. Add to this the fact that there has been little or no increase in rents, a moderate increase in vacancies, and expenses are increasing from upward pressure on taxes and insurance.
The borrowers face much higher operating reserves from lenders above and beyond what was assumed when they closed the loan. These borrowers may break even or have negative cash flow at the property level. There is likely no profit, only risk and potential loss going forward. The best option for these owners is to sell and get what you can before it worsens.
The buyer selects from the narrower list of bidders must have surety to close, and therefore, they need to have discretionary capital and a good reputation for closing in all markets. The cost is very high if the wrong buyer is chosen, as the next buyer will likely offer less.
You can’t win a fight with the Fed
The issue has been a large gap between what buyers in an uncertain interest rate environment are willing to pay and the owners thinking fondly about pricing from the peak of 2020’ and holding out. With “tough talk” from the Fed matched by the largest and most frequent short-term rate increases seen in years, it was easy to ignore the old adage “You can’t win a fight with the Fed.”
The Fed has gone from an aggressive stance and rhetoric that we must slay inflation to an accommodative stance based on inflation moderation into a zone more in line with the 2% long-term target.
What does this mean for transaction activity?
In Crossbeam’s experience, we see some thawing in the ice sheet, which spells opportunity in the next 12-24 months. With little trade activity, there is a surplus of sellers on the sidelines. On the buy side, there has been a significant winnowing out of bidders as investment capital has slowed and is no longer available to one-off-bidders who have survived on the cheap cost of equity capital and the lowest debt rates in a generation.
To Crossbeam, this is welcome news as these are usually the high-fliers who disrupt the markets in high times by underwriting hockey stick projections and utilizing cheap debt and equity.
"In 2024, it’s game time! Owners and lenders are going to have to come to terms as to where values are, where debt needs to be, and right-sizing capital structures for these buildings to be successful." -Scott Rechler, CEO of RXR Realty, quoted from The Wall Street Journal article on December 19, 2023
The opportunity to invest with credible long-term players in a market is upon us. Credible players with discretionary capital and who are known to sellers will win the day when transactions do return. The beginning of the cycle will be led by sellers focused on loss mitigation and fear.
Breaking Risks with Resilience
The Fed’s policy change that they will be cutting rates in the new year is a significant sign to the markets. The thaw we are seeing is the downward recent movement on the 10-year treasury, the mortgage benchmark.
Since the peak of the market, the 10-year treasury has moved from a peak of 4.98% to 3.9% as of the writing of this article. Mortgage rates are a combination of the benchmark rate and the “spread” on top of the benchmark rate as set by the lender. With the Fed’s rhetoric thawing, the market sentiment has moved on the lending side from increasing spreads to offset the risk to lowering spreads to gain market share. That is a good sign!
Thaw and Flow: 2024 Optimism in Motion
Recently, we have seen agency spreads come to the tune of 25+ basis points. All told new rates being quoted are in the mid to high 5% range, which is a big change from 7%+. The Fed has indicated that they are looking at multiple rate cuts in 2024 if the data trend continues. As these cuts materialize, it will again spur market optimism, and that will, in turn, drive down the yield of the 10-year treasury rate.
Crossbeam believes the pending distressed market window will be relatively short as the employment situation, the largest driver of apartment demand, solidifies. Some moderation in employment is expected, but from record-high employment levels, it is a far cry from the 16 million jobs lost during the Global Financial Crisis (GFC). Starting from this position of relative strength, add that the nation is significantly undersupplied in terms of housing units, and you have a solid platform from which to start.
The gap between buyers and sellers is closing, but rates need to come in a bit more to offset the increases in expenses. The thaw is upon us. It is time to allocate if you want access to the fast-flowing distressed markets.
About the Author
William “Brad” Blash is a Managing Partner at Crossbeam Capital. He is a national leader in transformative housing investments. He has experience across multiple real estate cycles, over $5 billion in invested capital, and 26 investment markets across the US.
About Crossbeam Capital
Crossbeam Capital is a private real estate firm focused on multifamily developments and strategic acquisitions. The firm comprises leaders with over 100 years of combined real estate experience and a promising record since 2010.