Costello Expects CRE Debt to Outperform GFC

Jim Costello at NAREE 2023. Image by Suzann D. Silverman

The big challenges for commercial real estate will occur this year and the next, according to Jim Costello. And they depend upon when loans come due, how much financing is available and whether the debt markets shut down as they did during the Great Financial Crisis. However, he does not expect recovery to mimic that from the last downturn, advising the need for a different toolset this time around.

Indeed, debt is still available, the chief economist at MSCI Real Assets told the audience at the National Association of Real Estate Editors annual conference last week. But commercial assets face negative leverage, making it too costly to use debt today. “There’s another shoe to drop in pricing,” he cautioned, noting that owners need to stop waiting for mortgage rates to go back down and give up some pricing so cap rates can go back up.

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While the first quarter saw higher-than-average sales performance, and retail essentially matched the average, in April every sector saw negative growth in deal volume year-over-year, he found. And that change in deal activity was low enough to bring the year-over-year change into negative territory for year-to-date volumes, as well. Total volume in April, at $17.6 billion, dropped 72 percent on a year-over-year basis; year-to-date sales, at $106.8 billion, dropped 59 percent.

Year-to-date, the office and apartment sectors tied for the greatest drop of 66 percent each (with $14.3 billion and $33.6 billion total volume, respectively), while senior housing and care experienced the lowest decline of 29 percent (but just $3 billion in properties traded). There were double-digit decreases across major, secondary and tertiary markets.

$2 trillion in loans to be refinanced through 2027

In all, $2 trillion in loans will need to be refinanced in the years through 2027, according to Costello. And while CMBS continues to supply the largest portion of debt financing, last year marked a change in lender composition: Banks’ share increased to 27 percent of all lending, local and regional banks in particular assuming a larger—though still relatively small—portion. Expect that share to continue to grow, though, as deal activity shifts to the smaller markets where they are the more dominant players.

However, he views that as a natural circumstance of the market. “It’s not something to be scared of,” Costello affirmed. “It’s just the markets moving away … to a more sustainable market situation.”