“I think I’m a little contrarian in the sense that I still believe in the position,” says KDM Financial CEO Holly MacDonald-Korth. Fortune. And she has put her money where her mouth is. Macdonald-Korth, CEO of KDM Financial, a Miami-based mortgage lender, launched a $250 million fund earlier this year, with a 20% allocation to non-residential commercial properties; in other words, offices.
“We’re currently in a depression… But I don’t think (in the) long term, offices are going to disappear forever.”
The collapse of office property values and the threat of an urban “doom loop” stemming from remote work have dominated the headlines recently (including at least Fortune). But strong fundamentals in other commercial real estate subsectors (such as industrial and retail properties), as well as signs of an office rebound in specific regional markets, are sending “value” to private equity.
Consider Paul Kelly, global head of alternatives at DWS Group, who sees value in commercial real estate, but not necessarily of the cubicle kind. “We think office (real estate) will continue to have structural challenges, at least through 2024, and probably through 2025 as well. But there are other areas within the commercial real estate space that we are much more built on in the U.S.,” he said. Kelly. Fortune. “I would like to point to industrial space, residential space and to some extent retail as well.” Kelly, who previously worked at Blackstone and JPMorgan, recently flagged CRE as a potential value sector in his annual letter to DWS investors.
Record commercial property vacancy rates, more than half a trillion dollars in property value losses and high interest rates have squeezed homeowners’ margins and put pressure on developers looking to refinance. This has frozen the flow of capital into the sector: last November, CBRE Group estimated there would be just $389 billion in deals by 2024, the lowest total in more than a decade.
But a key factor that has pushed the market down could be about to push it back up. High interest rates have made it prohibitively expensive for homeowners to refinance properties, threatening a wave of defaults. If the Federal Reserve begins to lower interest rates later this year, as markets expect, the CRE market would feel those effects immediately.
“In CRE lending, we are on the front lines of the impacts of rate changes,” MacDonald-Korth said. “Things will get better when interest rates go down.”
Although office properties have generated the most negative news in the sector, they represent a smaller percentage of the commercial market than one might expect: of the roughly $1 trillion in commercial real estate debt maturing next year, only about $200 million is for office properties. According to Kelly. While the office real estate sector faces a more challenging path to recovery, the broader commercial sector will benefit from relatively strong fundamentals, a lower interest rate environment and an infusion of private capital, Kelly says.
“Real estate fundamentals, with the exception of offices, are essentially strong, and tight supply may drive strong rental growth in the coming years,” Kelly wrote in his annual letter to investors. “Market conditions are creating a unique short- and medium-term opportunity for real estate debt.”
However, the gains are likely not to be distributed equally. Experts predict a bifurcation in the property market, with newer, luxury properties attracting demand at the expense of older, less premium properties, which could face demolition. That differentiation will also be reflected geographically: Kelly and MacDonald-Korth pointed to the South, the Sunbelt and the Midwest as potential growth areas.
“There are places in the country where (people) are returning to work more quickly than others,” Kelly said. “I think the Southeast is much more office-centric than areas like San Francisco or Portland on the West Coast.”
Explaining his relative optimism about the CRE market, Kelly nodded to JPMorgan Chase CEO Jamie Dimon’s recent comments on the topic. The dean of Wall Street CEOs downplayed concerns about the CRE market during an interview with CNBC on Monday, characterizing the rise in defaults as a “normalization” and insisting that “most people will be able to muddle through.” “.
And Kelly pays attention to the dean, he acknowledged. Fortune. “Frankly, Jamie (Dimon) sees a lot more in JPMorgan than I do,” Kelly said. “If what you’re seeing within your customer franchise doesn’t alarm you, but really looks more like a healthy market that’s overcoming some challenges, then I think that’s a good indicator of where things probably are.”
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