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Securing the right financing is one of the most crucial aspects of exploring commercial real estate (CRE) opportunities. Helping clients accomplish this goal comes down to understanding the options available based on their unique requirements.
The Most Viable CRE Financing Options in 2024
There are various ways investors can finance their next CRE investment. Which ones you recommend to clients depends on your understanding of the market and external economic factors.
Commercial Mortgages
Traditional loans remain the most common form of financing in commercial real estate despite recent upheavals in interest and inflation figures. Interest rates have been oscillating between 6% and 7% since 2023, making securing a conventional mortgage costly.
However, the Fed is expected to cumulatively slash interest rates by 25 basis points for the last quarter of 2024, potentially bringing it down below 5% by year-end. This would make borrowing more appealing to investors and a practical recommendation for CRE financing.
Bridge Loans
Bridge loan volumes increased 59% in 2023, highlighting the appeal as a CRE acquisition method. Lender sentiment is positive, so investors likely have a wider pool of financing options. The increased market competition also means finding lenders offering the right terms for your clients’ needs is easier.
Commercial Mortgage-Backed Securities (CMBS)
CMBS issuance pretty much limped through 2023, recording significant dips across four quarters. Things are quite different this year. According to Bloomberg, transactions have soared 170% in 2024, valued at $24.6 billion. Several factors contribute to this, but a critical one is the slowly fading fears of recession and higher interest rates. With inflation generally cooling and rate cuts on the horizon, a largely stagnant market for commercial properties is likely to see more deals in the near future.
Construction Loans
Construction loans represent the most common financing option for multifamily home developments and are still a practical recommendation in 2024. Lender confidence remains high, evidenced by a monthly declining backlog for all building categories below $100 million. Additionally, funding from the Inflation Reduction and Investment and Jobs Acts is expected to flow into the industry from 2024 onwards, so there’s reasonable assurance of market liquidity.
Commercial Real Estate Investment Trusts (REITs)
REITs are ideal for clients unwilling or unable to own the CRE outright. The ROI is pretty decent, too, from above-market returns to their 90% dividend payouts. Nasdaq data shows REITs have outperformed the S&P 500 by 3.8% in the past 25 years.
Key Considerations for Commercial Real Estate Financing
Commercial property financing looks much different than it did a few years ago. There is more perceived risk in the market, especially now that it’s abundantly clear the post-pandemic “return to office” movement is not as successful as previously thought.
Consequently, occupancy rates are lower than ever before, casting uncertainty about the possibility of recouping an investment in due time. However, this may be a boon for buyers, as these properties are readily available at more affordable prices.
Another consideration is the state of natural catastrophes in the area. Disaster-prone regions typically have higher capital and recurring expenses due to the higher risk exposure. For instance, CRE insurance rates increased by roughly 5.3% in Florida following the events of Hurricane Ian in 2022.
How well the loan aligns with the client’s needs is also critical. With recession talk still pervasive, borrower confidence and risk appetite will likely remain slightly subdued until the market is more stable. That means lenders should be prepared to offer more flexibility and attractive features in their loan arrangements.
Lastly, consider the ease of obtaining financing. The adoption of AI in determining creditworthiness means lenders will likely decide on loan applications quicker and streamline funds flow. Nevertheless, your clients must still meet all the eligibility requirements, however relaxed or stringent they may be.
Due Diligence Is Key
CRE projects represent substantial investments and even make up a significant portion of the U.S. GDP. Due diligence is necessary in these matters from both client and adviser sides. Beyond interest rates and cuts, assessing market risks is essential for making informed recommendations. Stay informed about economic indicators impacting property values to endorse the best options for your clients’ investment goals.
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