Remote Work And Rising Interest Rates Are Changing The Landscape Of Commercial Real Estate

As interest rates increase, it becomes more difficult for investors and lenders to generate profits from debt-based investments, and commercial real estate falls into this classification.
Data shows that recessions have minimal influence on the long-term value of real estate investments, similar to how one may consider the performance of index funds over periods that eclipse recession time frames.
As companies create strategies to integrate remote and in-office working styles harmoniously, we’ll see a decrease in 9-to-5 shifts and an increase in corporate outings, corporate events, and corporate activities in key urban centers that include a significant amount of commercial real estate activity.

Commercial real estate in America is financed through various channels, including commercial banks and private lenders. However, the ongoing increase in interest rates by the federal reserve poses challenges for these entities to generate a return on investment (ROI) through loan issuance. Consequently, they are exhibiting reluctance in engaging in lending activities, and this is having an impact on people’s ability to finance and grow commercial real estate. This directly impacts the future of work as organizations reimagine their office environments.

The state of investments in the real estate market

Compared to residential mortgages, commercial real estate is perceived as semi-risky. Investors with long-term goals seek commercial real estate opportunities as it has a steady cash flow due to the long lease terms in place for tenants. Conversely, commercial real estate has been bearing the brunt of the work from home explosion, leading it to a double factor of difficulty when it comes to generating profits for its investors: less use and less finance-ability. According to The Economist, in Spring of 2022, commercial real estate investments in Western Europe and the United States fell to all-time lows since before the start of the pandemic.

This does not reflect the overall condition of the real estate market. William Patterson, the head of real estate research and strategy team at MetLife Investment Management (MIM), stated in a podcast that long-term investments are still trending up. Data shows that recessions have minimal influence on the long-term value of real estate investments, similar to how one may consider the performance of index funds over periods that eclipse recession time frames.

The ultimate question, however, is how long it takes for these asset classes to generate an ROI. Few real estate investors want to wait two whole decades to see financial results. The bottom line is, as interest rates increase, it becomes more difficult for investors and lenders to generate profits from debt-based investments, and commercial real estate falls into this classification.

Banking turmoil vs. commercial real estate loans

Xander Snyder, a senior commercial real estate economist at First American, discussed in a CNN interview that bank lending had already begun to decline over a month before the Silicon Valley Bank failure occurred. In the past few months, multiple banks went out of business or were seized by regulators. This lack of stability in the financial sector will impact the banks’ willingness to lend to an asset class to which they already have significant exposure.

Regional Banks have consistently leveraged commercial real estate asset classes as a means to enhance liquidity through significant international funds and government-sponsored enterprises (GSEs) such as Fannie Mae and Freddie Mac. These enterprises play a significant role by providing market liquidity through the acquisition or guaranteeing of loans from the regional banks. However, with the heightened regulatory scrutiny, accessing these funds is likely to become more challenging. These decisions are not purely financial, human interactions also have a role to play.

The importance of human interactions

Despite the efficiency and effectiveness of video conferring tools, it remains crucial for individuals to engage in face-to-face interactions. In commercial real estate, the digital age has introduced novel solutions that may not be as suitable to the industry without imposing additional burden for internal teams.

While the traditional cubicle concept is diminishing, technology is still far behind in-person experiences. As a result, companies have started creating strategies to integrate remote and in-office working styles harmoniously. This means we’ll see a decrease in 9-to-5 shifts and an increase in corporate outings, corporate events, and corporate activities in key urban centers that include a significant amount of commercial real estate activity.

As an owner of a business, I can serve an anecdotal example. I recently invested significant sums of money to get 15 key employees to attend a 5-day workshop in New York City from all around the world. We had participants from the Middle East, Latin America, the USA, and Asia. I did the math, and I spent approximately 4 months worth of rent in travel costs, hotel fees, and catering fees, which was all done in Midtown Manhattan. So, while the future of commercial real estate will definitely change, its fundamental impact on the future of work may not. It is difficult to predict exactly what this impact will be, but we are all expecting a significant change.