Advisors weighing real estate options as rates remain elevated

The world continues to wait for the commercial real estate shoe to drop. So what, if anything, should financial advisors be doing as it dangles?

Rich Byrne, president of real estate credit giant Benefit Street Partners, says the situation in commercial real estate is going to get a lot worse before it gets better. He continues to see less demand for office space as employees who had been coming in five days a week are now coming in only four days, or maybe even three.

“We are way oversupplied in office,” he said. “Of course, the better properties will fare better, with the good quality, class A doing better than the weaker Class B and C. But as a general rule, there has to be a rationalization of all that office space.”

As to what happens next, Byrne believes the weaker properties are going to close. The owners that don't have the capital to keep bringing in new tenants will simply not be able to afford to keep them up.

The good news, he said, is there's no new capital going into office construction right now, which should help cure the oversupply problem over the long term.

On the flip side, Byrne is finding opportunities on the residential side, particularly multifamily housing, as a result of the continuing undersupply of available homes. Also supporting residential home prices is the recent move up in interest rates, which he says keeps people in their homes and kids living with mom and dad because rents are too darn high.

“Nobody's put any shovels in the ground for properties once rates started going up,” Byrne said. “So I think for the intermediate term, it starts to get really positive for multifamily.” 

Matt Malone, president and head of investment management at Opto Investments, is also staying cautious on commercial real estate given the potential for a “higher for longer" interest-rate environment. Since rates have increased, he has seen transaction volume muted and price discovery limited on his private market investment platform. 

“Traditional real estate managers that rely on positive leverage to generate returns have been challenged in this environment,” Malone said. “We are more constructive on capacity-constrained opportunistic debt or equity strategies in this environment, particularly on new portfolios without legacy assets.”

In terms of residential real estate, he expects transaction volume on his platform to decrease with elevated interest rates, as buyers will be challenged to meet pricing expectations.

“Longer duration of residential mortgages should allow this market to muddle through the higher interest-rate environment without significant forced selling,” Malone said.

Meanwhile, David Gottlieb, wealth manager at Savvy Advisors, is reminding clients about the benefits of diversification, and that includes real estate holdings. With regard to commercial real estate, he has a cautiously optimistic outlook compared to some of his counterparts. 

“Sources of trepidation for CRE include the remote work solutions leading to declining office space demand and retail pain due to dominance in internet retail and e-commerce,” Gottlieb said. “However, other areas of CRE are intriguing and promising, such as: grocery stores, biomedical office buildings, storage facilities, and industrial properties consisting of warehouses and distribution centers.”

Gottlieb is more bullish on residential real estate than CRE, but similarly “with conditions.” In his view, it comes back to the traditional three rules of investing in property: location, location, location.

“Location circumstances provide a number of investment quality determinants,” he said. “States and municipalities with relatively stronger support for tenants than others have hamstrung landlords with regard to hurdles toward eviction, rent collection, rent increases, environmental regulations, and more. Meanwhile, other areas of the country hold more protective legal environments for the landlords of residential properties.”

Other location-related concerns for Gottlieb include demographic trends, infrastructural integrity, microeconomic measurements and trends, crime rates, and employer proximity.

The entry price for both sectors is also crucial for current investors, in his view, and the collapse of the commercial real estate market is certainly making it a buyer’s market.

“The interest environment has led to devastating effects on loan affordability whose rate caps expired,” Gottlieb said. “Particularly for developers and investors who locked in rate caps prior to Q2 2022 that are expiring over a couple years, there is a bit of distressed selling. Now is an opportune time to seek those scenarios as a buyer in this environment.”

Ted Brooks, founder of Nordwand Capital, notes that given the severe challenge to the affordability of single-family homes, multifamily demand appears poised to produce strong growth that will support attractive return and cash-flow profiles. 

“For residential development, it’s all about market dynamics in the sub-markets you are exposed to, understanding your partners and the terms of your economic exposure and drivers of return. In the right places, there’s a lot to like about residential real estate exposure,” Brooks said.