U.S. Real Estate Debt Market Perspectives

In our view, high yields, attractive spreads, impending debt maturities, and a retrenchment from banks have created favorable conditions for private real estate debt investors.

Senior real estate debt produced strong, positive total returns in the final quarter of 2023 (4.6%), as benchmark interest rates dropped while spreads held steady.[1] Calendar-year 2023 returns (5.6%) were up sharply from 2022 (see Exhibit).[2]


Exhibit: Senior Commercial Real Estate Debt Total Returns

Source: Giliberto-Levy. As of December 2023.


Real estate fundamentals softened somewhat. Vacancy rates increased to 6.0% in the fourth quarter from 5.3% a year earlier, although they remained well below their 20-year average (8.2%).[3] Weakness was concentrated in the office sector, as remote work and tech-industry layoffs hampered demand. The Industrial and Apartment sectors also cooled as a post-COVID normalization of demand collided with a wave of new construction. Retail, largely devoid of new supply, was more resilient. Despite the slowdown, net operating income (NOI) grew 5.4% year-over in the fourth quarter, fueled by a 12.2% increase in the Industrial sector.[3]

Loan performance largely reflected trends in the underlying fundamentals. Delinquency rates on real estate loans remained historically low in the banking sector, although they edged higher (to 1.1% from 0.7% the year before).[4] Deterioration was more visible in the commercial mortgage-backed securities (CMBS) market, almost entirely concentrated in the office sector.[5]

Originations were down about 50% in 2023, moving in lockstep with overall real estate transaction volumes.[6] However, activity stabilized, at lower levels, over the course of the year. Banks reported a modest uptick in demand for loans in the second half of the year but no easing in lending standards.[4]

Spreads on senior real estate loans remained stable in the fourth quarter (220 basis points), up about 60 basis points from a year earlier but in line with historical norms.[7] However, given the notable spread compression in listed credit markets, the gap between yields on private real estate debt and investment-grade corporate bonds widened to its highest levels since the global financial crisis (GFC).[8]

In our view, high yields, attractive spreads, impending debt maturities, and a retrenchment from banks have created favorable conditions for private real estate debt investors.

 

Additional Resources

U.S. Real Estate: Risk or Opportunity?

Doomsday headlines may persist, but do not be fooled: The outlook for real estate is getting brighter.

Retail sector shines as the U.S. consumer remains resilient

We believe that structurally tight labor markets and robust household finances — together with low current vacancies and limited new construction — will continue to underpin healthy retail fundamentals for the foreseeable future.

2024 Real Estate Outlook

We believe that 2024 will mark a turning point for U.S. real estate, as easing financial conditions offset a soft patch for fundamentals.

1. Giliberto-Levy. As of December 2023.

2. Giliberto-Levy (real estate debt); NCREIF (core equity real estate). As of December 2023.

3. NCREIF. As of December 2023.

4. Federal Reserve. As of December 2023.

5. Moody’s. As of December 2023.

6. Mortgage Bankers Association (originations); MSCI (transactions). As of December 2023.

7. ACLI. As of December 2023.

8. ACLI (real estate); Moody’s (corporate bonds); DWS calculations. As of December 2023.

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An investment in real assets involves a high degree of risk, including possible loss of principal amount invested, and is suitable only for sophisticated investors who can bear such losses. The value of shares/ units and their derived income may fall or rise.

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