Marcus & Millichap CEO sees hope for commercial real estate
The commercial real estate sector had a rough year in 2023 compounded by the regional bank shakeup. The sector has had to adapt to surging mortgage rates, volatile markets, and changing work setups for office employees. Commercial real estate could still bounce back on stabilizing certainty in markets and potential interest rate cuts by the Federal Reserve.
Marcus & Millichap (MMI) CEO Hessam Nadji joins Yahoo Finance to discuss why he believes the "worst of it" is behind the commercial real estate sector and why he believes investors should be cautiously optimistic going forward in the sector.
Nadji affirms his stance: "As interest rates either settle or start to come in, either one by the way, the industry doesn't need interest rates to come in that much to basically get going again. It's the variability from week-to-week of where the interest rate movement is going to be that's creating an obstacle for the business. Once that happens and the price adjustments continue, I don't think we're done... seeing the full effect of the interest rate shock. I think we're more than halfway there. So within the next couple of quarters, we think that price discovery will have run its course and there will be more certainly related to revaluing commercial real estate in this higher interest rate environment. And that will bring a lot more activity to the market. So is the worse is it of it behind us? Yes, I'm confident that it is."
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Editor's note: This article was written by Nicholas Jacobino
Video Transcript
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- It's no secret commercial real estate saw one of its most challenging years in 2023. And while the industry grapples with elevated interest rates and economic uncertainty, our next guest says that there's reasons to be cautiously optimistic in the year ahead. Here to discuss is Marcus & Millichap CEO Hessam Nadji. Hessam, thanks so much for taking the time here today. What are some of the reasons to be cautiously optimistic?
HESSAM NADJI: Good morning. Thanks for having me on the program. The reason is price adjustments. Commercial real estate has proven to be a great investment over time. It's outperformed the stock market in a 20-year time span. It has many tax advantages, of course. But the most important part of our cautious optimism is the fact that we're already a year or more into this phase of an interest rate shock causing value adjustments and for investors to rethink, basically, investment opportunities within commercial real estate from sector to sector.
And when you look at replacement costs, the cost and the difficulty of adding new space in any property type, whether it's apartments or shopping centers or warehouses, it's become much more constrained and much more difficult to add new supply of commercial real estate. So on a replacement cost basis today, we're seeing that the 2024, 2025 vintage of acquisition opportunities and capital deployment will end up being a very good vintage because of the price adjustments we're already seeing in the market.
- Hessam, I think the big question investors are trying to figure out right now and asking themselves is whether or not we've seen the worst of it when it comes to commercial real estate because, yes, there is reason to be optimistic in the longer term when you talk about the Fed starting to cut rates. But when you take a look at your recent earnings results with revenue falling more than 50%, is the worst yet to come or have you seen it?
HESSAM NADJI: Well, first you have to remember that our revenue, our business model, as a intermediary advisor broker to buyers and sellers and basically a facilitator of financing for borrowers and lenders, as an intermediary, we've had a very difficult time in determining the right value of real estate. In the last 12 to 18 months, there's been a lot of uncertainty because of the interest rate shock and the market pulling back to try and reassess what the interest rate component means to valuations.
That disconnect is the reason you're seeing our earnings being under pressure, our volumes being under pressure. We build a company that is so solid in terms of our balance sheet, in terms of 52 years of learning from these various cycles. It is a cyclical industry. So it is a temporary phenomenon to see this disconnect in the marketplace.
And as interest rates either settle or start to come in, either one by the way, the industry doesn't need interest rates to come in that much to, basically, get going again. It's the variability from week to week of where the interest rate movements going to be that's really creating an obstacle for the business.
Once that happens and the price adjustments continue, I don't think we're done to your question seeing the full effect of the interest rate shock. I think we're more than halfway there. So within the next couple of quarters we think that price discovery will have run its course. And there will be more certainty related to revaluing commercial real estate in this higher interest rate environment.
And that will bring a lot more activity to the market. So this is the worst of it behind us, yes. I'm confident that it is. But it's not a hockey stick recovery. It's still going to take time for some more price adjustments. And everyone is still waiting to see what the Fed does. Of course, the timing of the Fed easing has been pushed back for actually positive reasons.
The economy is doing well, the consumer is holding up fairly well. Those are good reasons for the Fed to have to wait. But unfortunately for our industry, it pushes back the timing of that recovery.
- Hessam, it's no secret, obviously, an extremely challenging time for your industry. There's been so much focus when we talk about commercial real estate. A lot of that focus has been on offices for good reason. But I also want to talk to you just about what you're seeing in terms of the multifamily subsector. Because just as the middle man there, what are you seeing valuation-wise and what those challenges realistically look like within multifamily today.
HESSAM NADJI: In multifamily historically has been the darling of the industry because of its stability. Everybody needs housing and shelter, of course. The positives on the multifamily side at a macro level number 1, it starts with a very solid set of internal fundamentals. Occupancies are still very strong. The rents are holding up actually. They've come down in the last 12 to 18 months a little bit after spiking almost 30% in the prior three years.
So we saw a big spike in rent growth and then somewhat of a pullback. And we're seeing a lot of supply. 400,000 units come to market this year. And that is creating a lot of concern. However, if you peel back and see where that additional inventory is being added, is mostly concentrated in 10 major metros.
And those metros such as Dallas, such as Austin such, as Atlanta also happen to be some of the job creation leading metros. So it's not a terrible situation with out of control over supply but there is softness in the market. And I'll say that probably the most interesting challenge I've seen for multifamily in 30 plus years of doing work in commercial real estate is that you have the biggest pricing disconnect between buyers and sellers because the yields on apartments were so low given that it was the most favored asset class.
When interest rates spiked, that created a very large price disconnect in apartments. And then we're working our way through that. That's where my comment about price adjustments and being more realistic about what is the value of any commercial real estate, not just apartments, has to get reset based on the higher interest rates.
- We've got to hustle to our finish here. But just lastly while we have, what is the largest post-pandemic use purpose shift that you've seen in commercial real estate? And does that materially alter the income profile because of the type of clientele that would be moving into those presences.
HESSAM NADJI: I have to say, there's record capital on the sideline waiting to come into commercial real estate. We're tracking it. It's a near record because there's so much interest in the sector. It just hasn't broken loose yet. As far as property types that have repositioned themselves, I would have to say it's retail. Because retail was well ahead of any other property type in the post-pandemic, basically, dislocation.
And retail reinvented itself. Very little new product. A reimagination of brick and mortar retail. And therefore, it's one of the leading property types coming out of the pandemic.
- Hessam Nadji, we thank you so much for taking the time once again to join us here at Yahoo Finance. CEO of Marcus & Millichap. Thanks so much, Hessam.
HESSAM NADJI: Thanks for having me.
