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Commercial Real Estate Financing: 2023's Transformation and What's in Store for 2024


By Brian Anderson, Progress Capital

The commercial real estate financing landscape underwent a roller-coaster ride of unprecedented changes and significant challenges in 2023. As we head into 2024, it’s important to understand how these shifts impacted the industry and what lies ahead.

2023: Riding the Interest Rate Roller Coaster

In 2023, the commercial real estate industry felt like a theme park roller coaster ride, taking unexpected twists and turns. For most of 2022, we were on a steep ascent as the Fed Funds Rate increased from 0.25% all the way up to 4.50%. 2023 has only seen an additional 1%, but treasuries and bank spreads continued to increase.

Banks had to contend with both the rising cost of borrowing from the Fed and the FHLB, while also struggling with increased costs on deposits. To stave off what felt like a nationwide bank run, many local and regional banks offered high-yielding CDs and money market accounts to entice customers to keep their deposits in-house instead of moving them to much larger national banks. By doing so, they’ve increased their own internal cost of capital, which is then reflected in the cost to borrow.

At the beginning of 2023, I was placing swaps with rates in the high 4s to low 5s, fixed for 5- years, with bank spreads between 150 and 200 basis points. Currently, these swap rates are pricing at around 6.50% to 7.0%, with spreads between 225 and 275 bps. Conventional balance sheet loan spreads have seen an even wider adjustment, moving from 185 to 200 bps over UST to over 300 bps.

2024: What Lies Ahead

As we head into the new year, it’s important to position ourselves for several factors that are sure to shape the commercial real estate financing sector:

Continued Interest Rate Uncertainty: The Fed still hasn’t signaled when this will come to an end, and the market is making general assumptions, while forward-looking yield curves continue to adjust to this uncertainty. One thing I believe will happen is that as high yield CDs burn off and banks can lower their internal cost of capital, we should see spreads tighten up towards the second half of 2024.

Value Correction: We’re starting to see the value of CRE assets slowly but surely correct. It will take time for sellers in today’s market to come to terms with what their properties are worth, given where we are in the cycle. The only way this correction occurs is if the Fed keeps rates elevated longer than people expect. The CRE market experienced a tremendous amount of cap rate compressions over the past few years, and there is no way that type of compression was sustainable for the long-term health of the industry.

Remember the Past: Historically speaking, where we are in today’s debt markets is average. When looking at 10-year treasuries dating back to 1963, the average yield stands at 5.80%. Even if I were to remove the rates from 1979 to 1984, when 10-year treasuries were over 10%, the average drops to 5.15%. Today, we are still below the historical average 10-year treasury by 100 basis points.

Brian Anderson is a managing director at Progress Capital.

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