Market Snapshot from Nova Sales Team
As we recap broader commercial real estate trends from 2023, uncertainty is the best way to describe the year. Lenders found it challenging to execute loans that could pencil for their risk and financial tolerance in the debt and capital markets space. Conversely, borrowers wanted to avoid selling their properties and taking a loss, thus resulting in fewer property trades. Although commercial real estate transaction volume was down nearly 60% YTD in 2023, Nova's Due Diligence teams still performed extraordinarily well considering the market. In addition, our vision to diversify our scopes helped protect revenue and increase profit in a challenging market. We continue to outperform our competitors in our work, developing new scopes, and forging new relationships, propelling Nova to become one of the largest and most prominent due diligence firms in the U.S. and Europe.
2023 Capital Markets and 2024 Forecast
GSE (Government Sponsored Enterprises): Although a final origination tally has not been finalized, it is predicted that Fannie Mae and Freddie Mac will finish 2023 between $50 billion and $59 billion in originations ($100B - $110B total), respectively, for each agency, drastically down from the federal allocation budget of $75 billion ($150B total) for each agency. A majority of the transactions were refinanced for borrowers faced with loan maturity. Fannie Mae and Freddie Mac released their volume caps at $140 billion for 2024 ($70B each), which provides debt-liquidity optimism for an asset class (multifamily) that has an enormous amount of upcoming loan maturity ($682B in multifamily loans mature between 2023 and 2025)
Life Companies: Our Life Insurance clients, who are extra conservative in nature, pulled back their balance sheet allocation towards commercial real estate. To combat risk, borrower quality and asset quality/location remain the top priority for life companies.
Commercial/Regional (Balance Sheet) Banks: Regional and money-center banks have been far less active in commercial real estate due to less liquidity and tightening credit requirements. In 2023, several regional and commercial banks collapsed (Signature Bank, First Republic, Silicon Valley Bank). It is rumored that there will be more "stress tests" for commercial and regional banks in 2024 and more pain in the sector. As we look towards 2024, expect smaller regional banks to continue to quote construction and bridge (floating rate) debt; however, they will be selective towards quality borrowers/preferred assets and a heightened standard for DSCR (Debt Service Coverage Ratio).
Commercial Mortgage Bank Securities (CMBS): As seen in December and early January through a few of our CMBS clients (Citi, Morgan Stanley, Barclays, UBS), work has picked up in this sector. The driving force for the uptick in CMBS requests is borrowers searching for shorter-term (5 & 7-year) fixed-rate debt. The drop in the 10-year Treasury Rate (4.23%) has also caused spreads to tighten in CMBS. In addition, approximately $120 billion in CMBS loans maturing in 2024.
Subordinate Debt/Preferred Equity: Our typical lenders are debt funds and private equity companies. Since borrowers have experienced trouble in compliance with their loan covenants, they have had to rely on subordinate debt to "rightsize" their loans. These are typically mezzanine and Preferred Equity loans. While rates range between 12-18% for this type of debt, it provides a quick onslaught of liquidity for borrowers looking to hold onto properties. The increase in subordinate debt has resulted in a decrease in properties going to special servicing or foreclosure.
Special Servicing/Foreclosure: Special Servicers jump into loans (predominately for CMBS loans) when borrowers default. While many troubled assets/deals are in the market, there has yet to be a significant uptick in special servicing/takeback properties as lenders have worked out loans with borrowers (as noted above). We suspect special servicing requests will increase in 2024.
Construction and Renovation Projects: Our Construction Services Group remained busy in a tumultuous environment. The team was busy with ongoing renovation projects for bridge lenders and new construction for BTR (Build to Rent) or SFR (Single Family Residential) developments. In 2024, there will be a decrease in construction projects for retail, hospitality, office, and market-rate multifamily; however, there will be an increase in BTR/SFR, life science, and industrial construction projects.
Peak and Carlson: Peak and Carlson were extremely busy in 2023 and expect 2024 to be another fantastic year.
- For Peak, project backlog and staff utilization in the Peak division remain high. Their work is fueled primarily by redevelopment clients and long-term regulatory-driven remediation work. The New Jersey Department of Environmental Protection (NJDEP) continues to revise site remediation regulations and guidance, increasing the value of our technical staff and seven Licensed Site Remediation Professionals (LSRP) to our clients. In addition to our core New Jersey workload, Peak continues to expand regional services into Pennsylvania, Maryland, and New York. In New York, Peak is actively engaging the NY City and NY State markets using our Qualified Environmental Professional (QEP) certifications, New York business credentials, and Professional Geologist (PG) license - giving Peak the ability to conduct remediations throughout the entire State.
- Carlson remained busy in 2023 with numerous projects going from an ESA to a Phase 2 to Remediation and onto obtaining a No Further Remediation (NFR) Letter. Carlson began several large-scale redevelopment projects in Illinois and Wisconsin that will continue for several years. These projects have environmental issues that will need to be addressed, and an NFR Letter or similar obtained for each. Carlson also continues to be busy with two RCRA closure sites that both appear likely to start active remediation in 2024.
Nova Ambiente: Amid 2023's uncertainty, Ambiente remained consistently busy. Ambiente completed a few large portfolios for Blackstone (Mileway) and Oxford Properties (M7) towards the end of the year, which boosted performance for the year. In addition, Ambiente is leading and developing sustainability scopes in mainland Europe, which has been well-received by clients. In the European property market, CBRE predicts the investment sales activity to rise by 10%, which should fuel work for our teams in England, Germany, Spain, Netherlands, France, and Portugal.
Equity: As mentioned, CRE acquisition volume was down significantly in 2023. As a result, our equity team was adversely affected, given their focus on acquisition-level due diligence. A shift in focus during the slow 2023 toward local law work like CA Balcony Assessments and NY Façade/Parking Garage Inspections proved extraordinarily fruitful and helped buoy revenues. Also, there will be continued adoption of climate scopes of work as the ASTM provides guidance. For 2024, we have already seen a few of our larger private equity (Apollo, FPA, Blackstone, Related) clients jump back into the market. Pent-up demand coupled with solid liquidity and positive movement in the bid-ask spread will result in higher acquisition volumes.
Energy/SEG: Continued strong demand for GHG/Decarbonization work resulted in another strong year for Energy scopes of work. We are excited to continue exploring how Nova's energy/sustainability products can be assisted in "vendor due diligence" as companies put pressure on their supply chain for measurement and action.
IH/HMG: Steady hazardous materials work and increased radon requirements to supplement due diligence resulted in an excellent year for HMG. The investment and expansion into supporting performance verification and testing for Green Certifications showed promise. Nova is actively pursuing clients who desire BREAAM certification.
Environmental Compliance: Compliance work has remained steady due to Nova's expertise and high quality of service. Significant opportunity for compliance exists as Nova explores vendor due diligence supporting companies on their supply chain evaluation.
Dive into Asset Classes
Office: Class A office performs well, while Class C/B office space is in trouble. Although vacancy numbers have likely peaked, the office market is the most troubled asset in CRE.
Industrial: Demand/supply is balanced and performing well, particularly on the east and west coast.
Multifamily: Multifamily is still a strong asset class; however, there is worry that the Sunbelt region has too many properties coming online and, thus, an oversupply in that region. Overall, the most considerable supply of apartments (in decades) is hitting the market in 2024, and experts predict this will temper rent growth and increase vacancy rates.
Hospitality: Leisure hospitality remains strong, extensive CBD/business hospitality continues to perform, whereas tertiary hospitality is struggling. Hospitality will continue to face headwinds from other lodging options, such as Airbnb, cruise lines, etc.
Retail: Small retail continues to increase performance, whereas big-box retail and large malls continue to underperform. Retail fundamentals are expected to increase in 2024. Expect demand for suburban (smaller) retail centers to increase, and other retail (malls) borrowers will need to explore new use cases.
Client 2024 Forecast
CMBS Originator: "2023 was very slow in the first half of the year as people adjusted to the new normal of the interest rate environment, and acquisitions were relatively non-existent. As the year progressed, people who had to refinance decided to move forward, leading to some demand in the back half of the year. With rates down 125 bps in the last 90 days, activity has picked up quite a bit for the start of 2024. Most CRE market participants expect rates to reduce or at least stay flat for 2024. While there is still a bid-ask gap in the investment sales market, I think people are more comfortable moving forward with refinance activity today as it feels as if we have hit a "ceiling" regarding how high rates can get for the current period. While there is much money on the sideline, there still needs to be more certainty in the market, and it remains to be seen when buyer conviction resurfaces. The office market is particularly challenged while other asset classes are relatively okay but may have a floating rate loan that presents an operational challenge for owners that purchased the property in mid-2021 to mid-2022."
Real Estate Private Equity: "2020 - 2023 were unprecedented periods of 'kicking the can' across various sectors of the market. From 2020 - (early) 2022, financing markets were accommodating, and lenders were either willing to extend or the equity had ample liquidity to backfill. 2023 was different as it was the end of the road for a lot of funds on the equity side, whereas debt did not want to extend or backfill. Combine that with deteriorating performance across almost every sector (office, life science, industrial, multi, and hospitality), led to a virtually frozen market. The lenders did not want to deal with it in 2023 and were only willing to capitulate on office, where they had already written off the loans. So, they kicked the can again on everything besides office properties. The lending market is not unfrozen, but rates have ticked down a bit, and it gives an off-ramp for banks and equity to sell off at losses, which will boost next generation investment. We will start to see some trades for an attractive basis in 2024, and transaction volume will pick up quickly once there are new marks. Lastly, there is still some price reduction that needs to materialize, but cap rates have started to jump up. It's an excellent time to buy and a wrong time to own unless you have a lot of terms."
| 
