Outlook: Crow Holdings’ Roberts sees growing market bifurcation  

Despite uncertainties looming over the office sector, investors can leverage diverse tailwinds across various real estate segments. 

Mark Roberts, managing director of research at Dallas-based manager Crow Holdings, is seeing a growing bifurcation in the commercial real estate market shaped shaped by a greater differentiation between property types and markets. 

One of the key areas in which this is happening is the office sector, where fundamentals are weaker, and valuations are unclear. With the office occupancy rate standing at 8-10 percent below its long-term average, Roberts believes the sector is expected to see a near-term reset as a few transactions have come through the pipeline.

An area of particular concern is the outlook for loans backed by class B and C properties which remain on bank balance sheets. “For office, we either have to have a massive return to the office, or it’s going to be a long time to work out,” Roberts said.

Still, Roberts noted investors are also seeing multiple tailwinds across markets and property types.

“It’s a little bit unfortunate that real estate gets a broad brush with this office overview, because I can give you all the stats on the industrial market, where it is just the opposite of the office market as occupancy rates are well above average in that sector,” he said.  

Multiple tailwinds 

Over the past 12-18 months, the Federal Reserve’s interest rate hikes have changed the landscape of commercial real estate, leaving the borrowing costs elevated. At the same time, banks and other lenders have been withdrawing from the market. 

Roberts noted one impact of the rising interest rates was the reduced amount of new construction. As the supply reduction started with the onset of the covid-19 pandemic, its lasting momentum is poised to intensify demand for existing properties, he added. 

“We see less new development in industrial and apartments, [and] there’s very negligible amount in office. Because of all the on-line shopping during covid, there was a very limited amount of supply in retail – when we have that set against pretty decent job growth, it can mean good things,” Roberts said. 

Roberts added the population growth and income growth in the Sunbelt region has been driving the demand for retail in the region. Meanwhile, the housing affordability issues have created much higher occupancy rates and future demands in manufactured housing, where the cost of housing is one-half of what it is in an apartment market. 

“The new things that we’ll start talking about that do influence some of the other specialty sectors, [is] what’s going on with onshoring and reshoring, along with greater interest in several specialty sectors,” Roberts added.

He said more companies have started shifting production to Mexico, where there are dozens of new manufacturing plants. As these plants come on-line, higher trade with Mexico could influence the property markets in Southern California, Texas, and Arizona in a positive way. 

In addition, onshoring investment highlights some new themes that are focused on the AI and technology fields. Under the broader digitalization umbrella, the market will also see rising demand in developments such as data centers and cell towers, Roberts said.  

Risk aversion and new opportunities 

Roberts said investors have become more risk-averse given how the market has fared under the rising interest rates, and this trend will continue into 2024.  

“As the amount of debt available is more limited out there, investors are looking to deploy more equity on a low leverage basis or no leverage basis, so some of the asset sizes are much smaller than what you would see in large CBDs. Without access to more debt, investors may focus on smaller average asset sizes as opposed to large office buildings in central business districts or regional malls,” Roberts said.  

He continued to note value-add investments in properties’ capital stacks could provide more optionality for lenders as to whether they can step in to control the repositioning of the asset.

“When we talk about the value-add [opportunity] in the capital stack, I would interpret that as realizing the compensation for the risk [investors are] taking, which is easier to do when cap rates are between five and 6 percent, as they are now, than just a couple of years ago when cap rates were three and a half to 4 percent. [Because] you have this margin of safety to help exploit some of those opportunities today,” Roberts added. 

On a more macro level, Roberts sees more transaction activity happening when capital on the sidelines returns to the commercial real estate market, but he also noted investors should take a bifurcated approach when examining specific markets or properties.   

“When cap rates and interest rates are falling, it doesn’t take a lot of creativity to get some good results and some returns. But as we head into this, just sharpen your pencil on which property sectors you’re and which ones you decide to avoid and be critical about the cities that you’re investing in,” he said.