December 7, 2023
Prophia offers unparalleled accuracy and speed through the commercial due diligence process. See why this will matter so much in 2024 and the years to come.
Economic difficulties, such as reduced deal flow and financial pressures, have markedly affected CRE transactions in the last 18 months. This has resulted in an uncharacteristically slow year for CRE with far less leasing activity than executives and CRE professionals would like to see. But this could all change in the coming months.
Although 2023 has been a relatively sluggish year in the realm of CRE, investors and executives are going to need to take action in 2024 and approach economic constraints as an opportunity for business innovation. However, seizing the momentum requires modernizing fundamental processes, such as due diligence and data reconciliation to bolster a more imaginative investment strategy.
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The CRE Landscape of Today
Looking to 2024 and Beyond
Repairing Holes in Business Intelligence
Tackling CRE Due Diligence With AI
The CRE Landscape of Today: Growth Opportunities and Lingering Hesitancy
Navigating CRE in 2023 requires industry leaders to listen to market nuances like never before. Due to decreased deal flow, capital strains, vacancy challenges, etc., figuring out the most effective investment and growth strategy can feel like walking a tightrope. But while many of CRE’s most lucrative segments faced challenges long before 2023, many experts are looking forward to the year ahead as an opportunity to take action.
Mergers and acquisitions.
As interest rates peaked this year, mega-deals nearly vanished from the market, and new lease signings of over 1 million square feet or more dropped 36% YoY in the first half of 2023. One M&A option that showed resilience however was mid-market transactions—deals valued at $20 million to $50 million—and the trend continues to surge as we approach 2024.
The success of these mid-market deals shouldn’t come as a surprise to anyone versed in the cyclical nature of the CRE market. They offer owners and investors relatively low exposure and faster deal execution in an economic landscape where capital is scarce and deals are slow. What’s more, CEOs responded to the momentum by pursuing more strategic acquisitions and portfolio diversification—a move that will ultimately contribute to a more dynamic M&A environment in 2024.
Unbalanced supply and demand.
Supply and demand dynamics in the CRE market are undergoing a delicate balancing act. Both office and retail inventories are projected to grow modestly by 1% this year. However, differing demand for these two sectors is causing distinct outcomes leading into 2024.
While office space demand has been sluggish since 2019, the retail sector is surging. This surge has translated into two consecutive years of decreasing vacancy rates and rent growth, highlighting the adaptability of the retail segment. Additionally, an uptick in mixed-use projects in major metros around the country and an increase in foot traffic point to continued signs of growth for retail while office still tries to generate demand post-pandemic.
While many mixed-use projects are kicking off, construction starts still face some challenges due to an 8% interest rate on construction loans. Nevertheless, the outlook for apartments, retail, industrial, and niche property types remains promising, indicating potential areas for strategic investments and a leveling-out of supply and demand.
Capital challenges and deal flow.
CRE lending reached an all-time high in 2021, just before the Fed hiked interest rates in 2022. Thanks to this move to combat inflation, the loan-to-value ratio became much lower and the lending landscape much tighter than it was just 22 months ago. This has led to a myriad of environmental factors that are slowing deal flow and stagnating capital.
For one, borrowers are contending with difficulties when refinancing loans amidst declining property values and escalating interest costs. Between 2023 and 2025, an estimated $1.36 trillion in CRE loans will mature, with a quarter of this amount tied to office collateral. This scenario heightened concerns and caution in CRE lending, particularly affecting smaller regional banks that inherently face higher exposure.
Additionally, office values are dropping by nearly 20% for Class A properties and, in some instances, 60% for lower-quality properties. And while CRE owners explore other viable options for their office collateral, such as conversion into residential or simply surrendering the loan back to the lenders, cash and deals are struggling to flow in this environment.
Innovation woes.
Executives continue to have a nuanced relationship with advanced analytics and AI as 2023 closes. A Deloitte survey underscores a prevalent discomfort among executives, with 67% expressing hesitancy in accessing or using data from advanced analytic systems. Even in organizations with robust data-driven cultures, 37% of respondents admit to discomfort, highlighting a wide-reaching skepticism.
KPMG further reveals that 67% of CEOs often prefer relying on intuition and experience over insights generated through data analytics. This skepticism extends to a lack of trust in data, analytics, and AI, with uncertainty about accountability for errors and misuse. Bridging this trust gap and fostering a collaborative relationship between executives and data scientists remains a crucial task for organizations seeking to leverage the full potential of AI.
Looking to 2024 and Beyond
Investor exuberance took a serious hit in 2023. As the year comes to a close, it isn’t surprising that the CRE world is looking forward to 2024 and even 2025. So what’s on the horizon? As capital markets hit their stride with a more dynamic and aggressive investment strategy (relatively speaking to 2023) CRE deals, M&A activity, and demand for dwindling asset classes will begin to pick up. Market challenges, supply, and demand are cyclical, manifesting in different ways from year to year.
Loan volume.
One of the most prevalent predictions for 2024 pertains to loan volume. Industry experts such as Kroll Bond Reporting Agency (KBRA) predict a 23% YoY increase in commercial loan origination. However, this prediction is predicated on interest rates steadying. Chief economist from Realtor.com, Danielle Hale, weighed in, “I expect the Fed to keep the option for an additional future rate hike on the table.”
Even though the likelihood of another rate hike is low, it isn’t off the table. So while all signs point to higher loan volume in 2024, lenders will proceed cautiously through the first half of the year and perhaps even into Q3.
Building resilience.
Over the years, commercial real estate has encountered various challenges, some more expected than others. These experiences have underscored the heightened importance, particularly for CRE leaders, of adopting resilient strategies and fostering creative growth in today's market. Take the retail sector, for instance, which has been navigating unforeseen challenges since the 2010s. As prominent brands like Nike, Starbucks, and Apple prioritize enhancing the in-store shopping experience, and major urban centers reinvest in downtown events to draw crowds, the retail industry is poised for continued strength in 2024. Consequently, other asset classes within CRE must also prioritize building resilience tailored to their unique market challenges.
Defining an AI strategy.
If 2023 was the year to talk about AI, 2024 will be the year to implement it. CRE leaders who continue to sideline available solutions or hold out on defining their AI strategy will be playing an increasingly dangerous game. In the coming year and years, CRE leaders will need to get serious about a comprehensive AI strategy to stay ahead of the curve in a competitive market and take advantage of every growth opportunity that comes their way.
The market today has placed so many hurdles between CRE professionals and deal execution and now more than ever, with growth opportunities on the horizon, leasing professionals, brokers, owners, and operating partners cannot leave data accuracy and reconciliation up to chance. Deal momentum, M&As, and portfolio diversification rely on efficient due diligence.
Repairing the Holes In ROI Activities and Business Intelligence
Today, many leading CRE teams already automate some level of their critical business processes and operations. Whether that includes automating data aggregation, reporting, or leasing, failing to address any gaps in ROI activities could waste valuable time or, at worst, cause deal momentum to die altogether.
If your growth strategy in 2024 and beyond involves acquisition, refinancing, divestment, or portfolio diversification, your team’s due diligence activities, in particular, have to be ironclad. There is no longer any room for careless errors that result in data gaps or excessive underwriting. Enter Prophia, an industry-leading portfolio intelligence platform built to provide CRE teams with a reliable and accurate source of truth for every critical ROI activity.
With five years of advanced AI training, our machine learning model possesses a nuanced understanding of CRE that is unmatched in the market today. This nuance makes Prophia the only AI solution today capable of deriving business intelligence from contract documentation in CRE portfolios to transform processes that improve your property’s cash flow, tenant relationships, and more.
Prophia Transforms CRE Due Diligence Into an Ironclad Business Activity
There is more to due diligence than simply red tape—it is a vital step in CRE portfolio optimization. However, the process can turn into a bureaucratic nightmare if there are any data inaccuracies or deal stakeholders aren’t on the same page.
In addition to better clarity, Prophia’s dedicated CRE platform accelerates deal flow by streamlining the once manual and time-intensive due diligence checklist. With innovative machine learning techniques, our AI quickly compiles digitized abstracts comprised of terms that are integral for performing each step of the DD process while minimizing your team’s risk exposure.
With the data reconciliation and accuracy Prophia offers, your team can safeguard project finances and ensure ROI activities like portfolio diversification or time-sensitive deals are closed on time and with every “I” dotted and “T” crossed. This type of insurance just doesn’t exist when doc reconciliation is carried out manually and important contractual obligations are passed through several hands.
By providing CRE teams with a structured and centralized source for portfolio intelligence, every party involved in DD decisions can get on the same page to facilitate a deal from beginning to end. Eliminate the guesswork from commercial due diligence and enable your team to seize growth opportunities as they arise.
If you would like to harness the power of next-generation AI and overcome some of today's and tomorrow's most daunting market challenges, contact the Prophia team to learn about platform adoption for CRE.