NEW YORK, Aug. 28, 2024 /PRNewswire/ — In recent months, the headlines around commercial real estate (CRE) have been alarming. From continued warnings of an impending “severe crash” in U.S. office prices to concerns over a potential “time bomb” on Wall Street, the narrative seems relentlessly negative. However, we see a different story unfolding.
Yes, it’s true that CRE property prices have seen a decline of about 60% since peaking in 2019. The rapid pace of Federal Reserve rate hikes—the fastest since the early 1980s—has driven this correction, marking the third significant downturn in the past 30 years. And some segments, like the so-called “zombie offices,” have been hit hard by shifts in work patterns.
Yet, amidst this landscape, we see immense opportunity as the Federal Reserve lowers interest rates, office demand returning to pre-covid levels and supply rapidly shrinking due to office to residential conversions. Here’s why:
1. A Unique Market Correction with the Lowering of Interest Rates
Unlike previous downturns, this CRE market correction is characterized by resilient cash flows despite falling property values. Capitalization rates (cap rates)—a key measure of CRE investment value—have adjusted, but the real question for investors is whether they’ve risen enough to justify the perceived risk. Gregory Kraut, CEO of KPG Funds explains “Interest rates going lower equals higher pricing for commercial buildings. Commercial buildings trade on capitalization rates which are directly tied to interest rates. if interest rates fall 200 basis points then capitalization rates will drop in sync.”
While some may argue that CRE appears overpriced when compared to Treasury yields, it’s important to remember that investment decisions should not be made based on cap rates alone. Our analysis shows that cash flows, or net operating income (NOI), remain robust, aligning with peak levels from previous cycles. We believe this resilience in cash flows and lower interest rates, will eventually lead to a rebound in valuations.
2. Robust office market demand has returned
Office leasing demand has started to increase to pre-pandemic levels. We have had several recent quarters of positive leasing activity that has been on par with pre-pandemic levels.
There’s significant variation in performance across different segments—office, industrial, retail, and residential real estate are all telling different stories. Even within a sector like office space, some properties are thriving while others are struggling. For example, while vacancy rates are up in some cities, high end office buildings which KPG Funds specialize in New York City are nearly fully leased and experiencing strong growth in NOI. This disparity presents a range of investment opportunities for those who know where to look.
KPG Funds‘ recent developments in Soho, the Lower East Side, and other key neighborhoods exemplify this trend. The company’s focus on providing state-of-the-art facilities with amenities like wellness centers, high-tech infrastructure, and aesthetic design has positioned them as a leader in meeting the evolving needs of modern businesses.
“Companies are looking for more than just office space—they want an environment that reflects their brand, values, and commitment to their employees,” says Kraut. “Our approach to developing premium office spaces is aligned with these expectations, and it’s why we continue to see robust interest from tenants.
While some sectors of the commercial real estate market have faced hurdles, the story in New York City is more nuanced. Gregory Kraut, CEO of KPG Funds, believes that reports of the market’s decline have been greatly exaggerated. “New York City remains a global hub for business and culture, and that foundation is not easily shaken,” Kraut explains. “We’re seeing continued demand for quality office spaces, especially those offering top-tier amenities and a prime location.”
KPG Funds, known for transforming undervalued properties into premium office spaces, has observed a distinct “flight to quality” in the market. Businesses are prioritizing spaces that not only meet their operational needs but also offer an environment conducive to innovation, collaboration, and employee satisfaction. This trend has kept demand for luxury office spaces strong, even as other segments face challenges.
3. Office Supply: A rapidly shrinking CRE class due to recent residential conversions
Office to residential conversions are taking significant office space off the market. We are trending towards a supply constrained market in late 2025 through 2026. Kraut also notes that the conversion of commercial spaces to residential units has played a role in balancing the market. With fewer commercial properties available, those that offer high-quality, well-located office space are in greater demand. This dynamic has contributed to stabilizing prices in the premium segment, even as other areas experience volatility.
“As the market adapts, we’re seeing opportunities for growth, particularly in the premium office space sector,” Kraut adds. “Our strategy of focusing on quality and innovation ensures that we’re well-positioned to meet this demand and continue delivering value to our tenants and investors.”
Conclusion: Time to Reconsider CRE Exposure – Especially in NYC!
In our view, the recent sell-off in CRE may have run its course. As the Federal Reserve moves towards easing interest rates, we anticipate a favorable shift in the market dynamics—stabilized property values, continued resilience in cash flows, and improving credit conditions.
We remain optimistic about the future of commercial real estate and believe that, despite the headlines, now is a time of opportunity. Learn more at KPGFunds.com.
Media Contact:
Greg Kraut
(646) 665-4508
[email protected]
SOURCE KPG Funds
