By Andrew Markey, Valley National Bank
The New Jersey and Pennsylvania commercial real estate markets have been more resilient than expected given the aggressive stance the Fed has taken on inflation.
The multi-family market has held up well. Occupancy levels have remained fairly consistent. And while rent increases haven’t been what developers and banks were used to over the past several years, they are still increasing at roughly the new, lower, inflation levels of 3%-4% annually. Cap rates have increased, along with borrowing rates, reducing values commensurately. We are seeing a similar story play out in the industrial space, with vacancy being remarkably low. However, due in part to increased supply, rents have not increased and are not expected to increase at the exponential levels they have over the past few years.
Brick and mortar retail has fought the good fight to survive. About 85% of all retail sales in the U.S. are at brick-and-mortar stores. Internet sales continue to increase each year at a quicker pace than overall retail sales, but that rate of increase has decelerated somewhat. Developers and owners have done a great job of repositioning retail centers when location, zoning, and demographics have allowed them the opportunity. More centers throughout the region are being filled with entertainment venues, restaurants, etc. With that said, it feels as though shopping centers without good anchors, those not well located (e.g. poor visibility, on highways without a traffic light, etc.) are becoming obsolete. Empirically speaking, urban retail in the 2k-5k sf range appears to be struggling, due likely to oversupply. The idea of ground floor retail at multi-family buildings will likely have to be re-imagined.
The slow decline in office valuations, which probably started 20 years ago, was obviously accelerated by the Pandemic and the resulting work-from-home trend. Developers have done an admirable job trying to position office space as best as possible to fight this macro trend, but it remains an uphill battle. Perhaps at some point, a supply/demand equilibrium will be reached as more and more office buildings are razed to make room for multi-family or industrial building, but I suspect this equilibrium will not be achieved for years to come.
Signs point towards a stable market in New Jersey and Pennsylvania for 2024. There is still a strong demand for good, affordable housing throughout the region. Industrial will remain strong. Developers and bankers will likely have to get used to slower rent increases, higher cap rates, etc. Well located and/or well anchored retail remains resilient. There will always be a need for good, well located, well managed office space. The question remains at what rent and occupancy levels?
In terms of financing commercial real estate into 2024 and beyond, I believe banks will stay active. Underwriting will remain conservative as reflected in lower leverage and higher DSCR requirements. Higher cap rates and financing rates will be baked into the projections. While it felt as though the financing market had slowed down in 2023, Valley’s CRE portfolio will likely grow in the 10% range, which is an aggressive level. We remained in the market, ensuring that we had the capital and products for our best customers.
The Fed seems to be near the end of their rate increase cycle; the larger question remains if the Fed will cut rates in 2024. If and/or when the yield curve becomes less inverted and ultimately takes on a more “normal” shape, this could be a real boost to banks and the financing market for a couple of reasons.
First, an inverted yield curve implies a recession is possible, thus a flattening of the curve would imply improved confidence in the economy, which historically spurs growth. The other reason why a flattening of the curve could be helpful to the CRE debt market is that the prolonged inverted curve has required banks to pay a relatively high amount for deposits, which has put upward pressure on lending rates which consequently reduces the profitability and viability of certain projects.
Andrew Markey is senior vice president of the New Jersey and Pennsylvania Commercial Real Estate Division of Valley National Bank.
Markey heads leads a team of bankers focusing on generating new business and cultivating longstanding relationships with customers. Markey has more than 30 years of CRE experience having spent most of his career at Wells Fargo. Markey also worked for the Office of the Comptroller of the Currency (OCC) as Associate National Bank Examiner. He holds a BA in finance and an MBA from Rutgers University and resides in Randolph, NJ.
This article is for informational purposes only. Any views, thoughts, and opinions expressed herein are solely that of the writer and do not necessarily reflect the views and opinions of Valley National Bank.