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    How A Real Estate Asset Valuation Reset Will Impact CRE Developers

    A wide bid-ask spread has characterized the commercial real estate investment market this year. Due to the rampant rise in interest rates over the last 18 months, buyers and sellers cannot seem to get on the same page about asset values. Buyers expect—as is standard during an elevated interest rate environment—lower asset prices to offset the higher cost of capital. However, strong demand fundamentals, particularly in multifamily, have helped existing owners remain profitable and weather the interest rate storm. While sellers have given a little in recent months, overall, this has been an unprecedented standoff on pricing. 

    As we head into 2024, experts are calling for an end to the stalemate and a reset on commercial real estate asset values. Investors next year expect reasonable sticker prices will help to revive investment volumes, which are down more than 50% for the year. 

    A pricing reset will certainly impact developers, both on the front end, in terms of land prices and development sites, and on the back end, when selling a new construction property. 

    Calls for a Reset of Real Estate Values

    A report from the Urban Land Institute and PwC called for a “Great Reset” in real estate values next year. The primary objective of a widespread reset is to reprice assets to reflect the higher interest rate environment. The Federal Reserve has made it clear that investors should expect “higher for longer” interest rates. If property owners were holding out with the expectation that interest rates would come down, the report starkly says that it is time to give up hope and adapt to the new market conditions. 

    This is far from an unusual request. In a typical market, cap rates follow interest rates with a six-month lag. As interest rates move up, cap rates slowly follow. The current pricing standoff between buyers and sellers is uncharacteristic, and it’s likely the result of the very rapid rise in interest rates, which gave sellers no time to absorb the loss in value. While sellers will have to adjust to the new rate environment at some point—most likely when they have a loan maturity coming due—many are continuing to extend as long as possible. Counselors of Real Estate global chair William McCarthy has said the new industry motto has become “survive to 2025,” with owners hoping there will be some stabilization in rates at that time. 

    However, interest rates aren’t the only reason that ULI and PwC are calling for the Great Reset. Prices also need to reflect cultural shifts in the ways that we use real estate and places people are congregating. Remote work has impacted office properties, as well as central business districts and the urban core, which were built around live-work-play concepts. While the change in use will ultimately provide good opportunities for developers to reimagine cityscapes and how people move through them, it will require property owners to adjust pricing to reflect reduced demand to support that transition. 

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    Good News for Land Prices and Redevelopment Sites 

    For developers, a pricing adjustment will include reduced prices for land and redevelopment sites. This decrease in pricing has already started. It is difficult to characterize the exact adjustment in pricing at this point—and, of course, it is largely dependent on location and asset class—but many experts say that prices have fallen about 30% this year with much more room to go. No one quite knows where the pricing trough will land, but certainly prices will continue to decline as interest rates climb. 

    A pricing reset may mean sellers give in to higher interest rates, but it’s also good news for buyers. The Emerging Trends Barometer has registered its highest “buy” rating for 2024 since 2010—the year when real estate was beginning to recover following the Great Financial Crisis. Next year, the barometer expects prices to become attractive for buyers, and most industry players agree. Survey results show that investors expect cap rates to rise next year as a result of low prices. 

    The downward pricing trend should also help push new construction starts in 2024, as land prices come down in step with asset pricing. Non-residential new construction starts were down 3% for the year in October, according to research from Dodge Construction. However, the research also noted expectations that new construction starts would increase next year.  

    Pricing Adjustments Impact Exit Plans

    While a pricing readjustment is good news on the buy side for developers at the beginning of a project, developers will have to adjust proforma pricing expectations at the exit. For developers starting a new project, this is an easier adjustment as they can simply work the new pricing into the underwriting on a deal. Of course, with high construction costs and capital costs, that could mean a challenge making deals pencil. On an existing deal, however, developers will likely fall below pricing projections on the investment. 

    In an interview on The REV, Bill Shopoff said that most of the time improved pricing on the buy side will offset lower pricing on the sell side. As he said, he gives a little in a project sale and makes up for it on a new deal. McCarthy agreed that developers can balance portfolios in this way by repositioning into new assets that have more upside potential. In some cases, however, developers will have to extend hold times to reflect the adjustment in pricing. If the developer can hold and operate the asset, they can potentially make up the pricing difference with the revenue generated by the asset.

    Technology tools like Northspyre will also help developers offset pricing declines on the sell side simply by improving financial efficiency throughout the development cycle. Developers that use Northspyre improve both bottom-line budgets as well as reduced overages and improved timelines thanks to the efficiency created by automating tasks and giving developers easy access to track the progress of a project in a centralized command center. The combination generates substantial cost savings that can help to mitigate the impacts of a pricing reset. 

    This is a transformative time for real estate developers—but experts on the subject are clear. Developers who can tap into a creative capital stack and use all of the tools at their disposal—including new technologies—will curb competition and push successful deals forward. 

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