2024 is set to be a defining year for commercial real estate (CRE) as the industry continues to transform to meet post-pandemic demands and a challenging economic market. Looking ahead, property owners and investors should expect the roller coaster experiences of recent years to persist, opening the door for creative solutions and cost-saving measures. Following are the key commercial real estate trends to watch in the new year.

CRE loans cost more — and they’re becoming harder to find

Since March 2022, rising interest rates have been challenging, particularly after relatively low rates throughout the 2010s and the all-time low rates immediately following the pandemic. The interest rate environment amplifies the challenge for commercial real estate investors who typically need to refinance every few years.

The situation is even more complex as many banks have significantly tightened their commercial lending standards in recent months. Experts anticipate the conservative approach to lending to continue in 2024, which means that, in addition to paying higher rates, loans will be more difficult for CRE investors to obtain. As a result, the commercial property sales volume is down significantly, including a 53% year-over-year drop for $1 million-plus properties in the first half of 2023.

However, as we move into the second quarter of 2024, we may see all of that change, assuming:

1. Liquidity in the marketplace stays strong, which is highly dependent on what happens with office properties and valuations
2. Interest rates are trending down and may continue to do so through 2024
3. Demographics still drive the need for more housing

Surges in construction costs drive higher property insurance premiums

The combination of inflation, labor shortages and higher costs for materials has produced historically high construction costs across the U.S. in recent years. When combined with other factors, including rising catastrophic claims, the impact on property insurance rates has been dramatic. Commercial property insurance saw average premium increases of 17% in the third quarter of 2023, according to The Council of Insurance Agents & Brokers Market Index.

Along with rising insurance premiums, construction inflation also contributes to gaps in coverage if policies are not updated to reflect current replacement costs. Construction inflation is expected to continue through 2024. While the cost of materials will begin to stabilize, labor shortages and regional demand may offset any savings.

Privatized student housing opportunities stand out in a challenging market

As average office vacancy rates continue to hover around 15% across the U.S. and rent growth for multi-family properties slows significantly from double-digit growth rates in recent years, privatized student housing offers an appealing option for commercial real estate investors. Historically, demand for student housing is relatively steady through economic downturns, and occupancy rates even remained stable during the pandemic. Today, many campuses are seeing increased enrollments and corresponding increases in demand for housing, especially at top research universities and schools in high-earning athletic conferences.

Limited supply also adds to the appeal for investors in the years ahead. Higher interest rates limit financing for new construction, and some schools have few sites available for building. As a result, schools are turning to private investors to take on the responsibilities of upgrading and managing existing properties. In turn, the limited supply and upgrades allow property owners to increase rental rates. Notably, rental rate increases for purpose-built student housing grew faster than multi-family rates through the first half of 2023.

New incentives projected to spur office-to-residential conversions

With almost 1 billion square feet of unoccupied office space in the U.S., competition for tenants is high. For their part, tenants are consolidating space to align with hybrid work strategies and opting for higher-quality properties, causing increasing pressures to raise property taxes. That leaves commercial property owners and investors to consider their options to upgrade the office class or convert the space to other uses that may have more value than office and retail.

Right now, conversions can be difficult due to financing, zoning restrictions and building regulations. However, legislators see an opportunity to address the shortage of affordable multifamily housing by facilitating the conversion of office space. For investors, multifamily properties continue to create profitable opportunities when keeping a pulse on economic and risk-related trends, especially when considering state budget gaps. With localities looking to multifamily housing as a source of new revenue, elected officials at the state and local levels are developing incentives and tax abatements aimed at increasing office-to-housing conversions. With incentives in the works, these types of conversions are expected to increase over the next few years.

Cost segregation studies remain a smart way to reduce tax liabilities

A cost segregation study accelerates depreciation deductions for real estate, identifying building components for shorter depreciation periods. The process, involving engineering analysis and tax expertise, reclassifies elements like non-structural features into 5-, 7- or 15-year categories, resulting in substantial early tax savings on the property.

All types of commercial properties can achieve tax advantages from a cost segregation study. Generally, property owners who construct, renovate or acquire commercial real estate benefit most from cost segregation, but any company that makes building upgrades exceeding $500,000 is typically a good candidate. Evolving tax laws and compliance requirements make the choice of a cost segregation partner crucial.

The dedicated commercial real estate team at CBIZ can help you optimize your strategies and explore opportunities in 2024. Connect with a member of our team and gain access to more resources here. 

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