The 2024 Real Estate Opportunities Report
3 Timely Financial Opportunities to Consider
Survival mode is over
Private real estate companies are saying goodbye to survival mode and thinking about what’s next. Eightyseven percent surveyed saw either modest or significant growth in 2023 compared to the prior year. Sixty-seven percent are optimistic about the economy over the next 12 months.
Let us pause to reflect on that sea change. After a period of high interest rates and vacancies, this is improvement. No doubt we will still see more disruption — this year, $929 billion in commercial mortgages will come due and test already distressed commercial assets. And those
assets may test regional banks. It also remains unclear whether the markets have stabilized. (Can offices recover?) But working with real estate firms, we believe now is the moment to make opportunistic moves.
In this first-ever “opportunities report,” we explore the financial opportunities that lie within major trends now buffeting the market. It is drawn from original surveys and research, third-party market data, and our many years of experience working with some of the largest private real estate organizations.
Mark M. Mindick Partner and Real Estate Industry Practice Leader Citrin Cooperman
Citrin Cooperman: Helping clients clients explore opportunities
Citrin Cooperman is one of the nation’s largest professional services firms, helping companies and high net worth individuals find smart solutions. Whether your operations and assets are located around the corner or across the globe, we can provide new perspectives on strategies that will help you achieve your short- and long-term goals.
Most data is from our Private Company Performance Report
The state of real estate: Unbalanced but improving
Today’s real estate market defies simple summary. Some indicators are up, others are down. But within that unevenness, some trendlines are clear.
We are seeing a slowed decline in vacancy rates (albeit from quite high numbers) and rising rents. There is a continued, albeit diminished, interest among institutions in using 1031 exchanges, which peaked during the late pandemic. We are also hearing that real estate companies are disproportionately worried about the cost of capital compared to peers in other sectors, and their commercial investments continue to suffer.
Nevertheless, 81% of real estate companies said they saw net operating income (NOI) growth last year, though they were twice as likely as other industries to say they saw no growth.
Let us explore eight facets of the market right now.
The residential market is performing well
56% of real estate companies are “extremely” or “moderately” concerned about the cost of capital 1031s are down modestly from a record high
Commercial vacancies are volatile with no clear trendline
Consider the rather vexing heat map pictured, which compares Q1 2023 to Q1 2024. It’s difficult to tell one clear story, but in it, we see flickers of stabilization — particularly in markets like Miami.
Let us begin with the office market, which remains down. It still suffers the same issues that began during the early pandemic, and vacancies have continued to rise. Chicago vacancies are high and rising whereas Miami’s are falling, likely due to its success attracting talent and businesses from other metros.
Multifamily shows positive fundamentals. The vacancy rates are up, but only modestly, while absorption and rents are rising. In LA, vacancy exceeds the longterm average. In Chicago, a shortage has led to rent growth, and job opportunities in Miami have created housing demand.
Industrial remains strong and in a relatively stable state despite rising vacancy. The increased rents are a positive sign. And though LA’s vacancy is at an all-time high, it’s still the largest industrial sector in the country and nearby ports remain busy, with container rates up.
Performance, Q1 2024 vs Q1 2023
Sources: CBRE, Colliers, Marcus & Millichap
OFFICE MULT
Offices show little sign of improvement
What will our cities look like in the next five years? Everyone’s asking the question. Unfortunately, the data affords us no answers. People are working from home at the same level (53%) since the 2022 peak, whereas just 21% of jobs are fully onsite (of jobs where remote and hybrid are possible). Office asking prices have continued to decline modestly. Nationwide office vacancies rose to 19.6% in the final quarter of 2023.
These declining office values have complicated the debt markets. In 2024, $206 billion of office real estate loans will mature, though the market widely expects they’ll be extended to 2025 and beyond. Banks are advising owners to optimize for liquidity. All this uncertainty has thrown market value into question and delayed deals. But now, transactions are occurring, albeit at severe discounts for sellers and lenders.
53% of jobs are now hybrid, stable since November 2022
- Gallup 30% of companies have enacted a return to office mandate
- University of Pittsburgh
$206 billion of office real estate loans will mature in 2024
- CBRE
Industrial real estate continues to outperform
Over the past year, industrial prices are up 6% according to MCSI’s commercial prices index, amid an overall 2.2% decline (major metros declined far more than non-major metros). The commercial sector nearly broke even (0.7%), and office spaces — specifically, office spaces in commercial city centers — have continued to fall.
An insight: Industrial real estate may be benefiting from the growing success of manufacturers and distributors. Our recent survey of these businesses (the leaseholders) reveals that they are nearshoring and diversifying. Ninety percent said their supply chains had stabilized in 2023, 57% derive three-quarters of their sales from e-commerce (which has not declined post-pandemic), and 52% attribute their success to diversifying suppliers. Their inventory is increasing, but so are sales. They need more industrial space than before.
90% 57% said their supply chains had stabilized in 2023 derive 3/4 of their sales from ecommerce
The residential market is performing well
Multifamily inventory is up 3.4% since 2020, and expenses have risen by 6.5% year-over-year, primarily driven by a 36% increase in insurance costs. However, the outlook seems positive: renting has become less expensive relative to homeownership by some measures, and that’s despite the fact that rents have increased by 30.4% since 2019.
Meanwhile, demand in the single-family home market remains closely tied to interest rates. As long as rates remain high (7.1% for individual homebuyers at the time of writing), homebuyer purchasing power — and thus demand — will remain low. Many homeowners with low
mortgage rates are unwilling to trade for higher mortgages and are waiting on the sidelines for prices to drop. Home supply is up 14% year-over-year, sales volume is down 1.9%, and fewer homes are selling above list price.
“With these statistics and the delayed deliveries for 2025 and beyond, we are likely to see continued rising demand for multifamily, with less supply. This will continue to fuel the market.”
Mark M. Mindick Partner and Real Estate Industry Practice Leader Citrin Cooperman
Home supply increase year-over-year 14%
56% of real estate companies are “extremely” or “moderately” concerned about the cost of capital
The Federal Reserve maintained rate hikes in 2022 and 2023, which probably contributed to a minor banking crisis, and has continued to defer any rate reductions. This means we are entering a third year of expensive capital and volatile costs, disproportionately affecting real estate firms and projects.
“Because mezzanine debt and preferred equity are now yielding a rate of return closer to equity, investors are flocking to those. From a risk-adjusted perspective, it just makes more sense.”
Mark M. Mindick Partner and Real Estate Industry Practice Leader Citrin Cooperman
1031s are down modestly from a record high
During the pandemic, real estate firms took advantage of rockbottom interest rates with “like-kind” 1031 exchanges to reinvest their capital. “This is a major behavior change for private equity firms especially,” says Gary Zhang, Partner at Citrin Cooperman.
“Traditionally, their goal was to buy, hold, and sell property so they could return profits. But we saw a major surge in them exploring much more complicated 1031s and rolling proceeds over.”
These exchanges require more complicated multiparty agreements, structures, and forethought. In good times when money is cheap, they make financial sense. But when borrowing becomes expensive, firms may move their capital out of real estate. This challenges real estate firms — reducing transaction volume, liquidity, and available capital.
This is anecdotal, but Citrin Cooperman saw requests for help with 1031 exchanges peak in 2022, then fall by two-thirds. That said, they remain more popular than they were prior to the pandemic, when they accounted for 10% to 20% of deals.
“The decline is mainly due to pressure from high interest rates and the fact that investors are hesitant to reinvest their money in real estate, which makes raising equity relatively more difficult compared to 2–3 years ago,” says Zhang. “Yet, they remain a valuable and perhaps underused tool.”
“1031 exchanges remain a valuable and perhaps underused tool.”
Gary Zhang Partner, Real Estate Industry Practice Citrin Cooperman
The use of REITs is rising, after a brief decline
The use of real estate investment trusts (REITs) has risen over the past year following a general decline since 2017. There is now $1.37 trillion invested in REITs in the U.S., which is somewhat lower than the peak in 2021. REITs remain a useful tool for aggregating properties in a portfolio to make them more attractive to investors.
“REITs provide many tax advantages to investors in structuring partnerships. Umbrella partnerships or operating
(UPREITs)
partnerships
are the most popular today because they’re effective for acquiring real estate and dealing with sellers in a tax-deferred manner.”
Stephen Lee Tax Partner Citrin Cooperman
8
Outside real estate, revenues and EBITDA are soaring
According to financial executives at large private companies across all industries, revenues and EBITDA are growing quickly. Supply shocks, disruption from international conflicts, and economic uncertainty have not appeared to slow down these companies or the broader economy. In the long term, this bodes well for a real estate recovery. However, the gains will be unevenly distributed; capital will move to whichever areas or instruments offer the best returns.
According to Citrin Cooperman’s 2024 Private Company Performance Report:
• 92% of all companies saw moderate to strong growth in revenue/assets under management (AUM).
• 89% of all companies saw moderate to strong EBITDA growth.
• 68% of all leaders are optimistic about the economy.
So where are the opportunities?
Next, we explore the opportunities for conversions, restructuring, financial modeling, and scenario planning that can help you make the most of this market.
Consider an office-to-residential conversion
Despite an aggressive effort to get workers to return to the office, a significant portion of the U.S. workforce still works from home.
One-third of those with this option do so all the time, accounting for 14% of all workers. It is unclear whether the resulting rise in office vacancy is here to stay, but the numbers do not suggest any sudden reversal.
Before the pandemic, office vacancy rates hovered around 12%. By the fourth quarter of 2023, it was 17% nationwide, and as high as 30% in some markets like San Francisco.
High borrowing costs and a pervasive sense of uncertainty have kept commercial leaseholders away. The office sector now continues to register the largest monthly and annual declines across all property sectors. Unless some outside force drives sudden new excitement around office investment, asset owners who need immediate liquidity will have to suffer declining sale prices, says Jim Costello, Executive Director at MSCI Research.
Meanwhile, demand for residential housing — as well as affordable housing — is growing.
The opportunity: Residential conversions
Office-to-residential conversions offer one way out of a bad market. Both state and federal governments are increasingly eager to help. A proposal currently before the City of New York would relax conversion regulations for any office building built after 1990. The Mayor’s office predicts this will generate an additional 20,000 homes over the next decade. California attempted but failed to pass a similar legislation in 2023. At the federal level, a bill in the House would require the government to annually review its properties and consider converting some into affordable housing.
Conversions can work with the right structure
Conversions are expensive — many offices have large floor plates and no easy way to meet window and ventilation requirements without expensive reconstruction. Yet, many are pursuing conversions in major metropolitan city centers where vacancies are highest, such as New York.
Commercial-to-residential conversions carry several tax implications, such as changes to the depreciation of the
converted property. Commercial property is generally depreciated over 39 to 40 years; however, residential property is depreciated over a shorter period, 27.5 to 30 years. A converted, mixed-use building that generates at least 80% of gross rents from dwelling units is considered a residential rental property.
If a change-in-use occurs, taxpayers can adjust their depreciation.
If nonresidential property is successfully converted to residential property, a change-in-use is deemed to have occurred. If a change-in-use results in a shorter recovery period, the taxpayer can compute depreciation over the shorter period or elect to continue computing depreciation as though no change occurred. This is an opportunity for you to consider whether to accelerate deductions.
Also be aware that with some condo conversions, you may acquire “dealer” status, and be unable to apply Section 168(k) bonus depreciation. Proceeds from selling condos is considered ordinary income.
Action: Consider investing in related subsectors
High-performing subsectors may offer returns at scale in ways general commercial real estate cannot. For example, energy infrastructure, data centers, sports facilities, and live entertainment.
Action:
Consider other geographies
Look beyond the national averages. The multifamily market is particularly strong in sunbelt states, for example, and commercial gains and losses have been unevenly distributed across major metros.
Reduce risk by telling a better financial story
Real estate risk is high, and investors know it. Many are shaken.
However, you can manage that risk on two fronts — by changing your capital stack to reduce your reliance on equity, and by using those capital stack improvements to tell a better (and still true) story to investors and limited partners.
The capital stack is shifting to the sandwiched center
We are seeing real estate firms moving away from equity and toward debt. They are opting to use mezzanine debt or “bridge loans” and preferred equity.
“Preferred equity has grown more attractive because it offers firms more flexibility in accomplishing their objectives,” says Mindick.
“Many companies are more comfortable with that sandwich in the capital stack rather than the risk of being solely on the equity side. Things are not like the old days when you had a predictable chance of hitting your numbers.”
Preferred equity and mezzanine debt can effectively reshuffle the risk and make previously unpalatable deals attractive. For investors, it means they need not be fully exposed on equity — they could hold preferred debt and earn their interest rate without the risk. This has also made real estate more attractive to investors generally, and can draw new lenders into the market.
Preferred equity: Equity that functions as subordinate debt. The equity holder receives a fixed return without a share in the profits, and also holds a proportional stake in the entity.
Mezzanine debt: A secondary loan, similar to a second mortgage, where the building serves as collateral and the debt issuer does not own a stake in the entity. It is serviced after the senior debt but offers a higher rate of return.
“Preferred
equity has become the primary focus of our daily tracking. Many have ceased traditional purchases, reminiscent of the debt funds from a decade ago.”
Laurie Morfin
Senior Managing Director
NewPoint
Real Estate Capital
Source: Feldman Equities
of the general partnerled market in 2022 was preferred equity, compared to 2021. ~15% up 6%
- Lazard, Secondary Market Report 2022
“With banks tightening credit standards and scaling back on commercial real estate lending, there’s higher demand for non-traditional lending. Many real estate firms that were historically commercial real estate syndicators and investors have fulfilled this demand by also becoming lenders through debt fund structures.”
Mark M. Mindick Partner and Real Estate Industry Practice Leader Citrin Cooperman
Action:
Explore mezzanine debt or preferred equity
If you need an alternative source of financing, are exposed to high interest rates, or are facing a debt maturity, mezzanine debt or preferred equity can provide high returns with downside protections that don’t exist in typical equity investments.
Action:
Consider a private credit lender
As banks have tightened credit standards, private credit lenders have grown much more active. Private lenders may offer more flexible, tailored financing solutions.
Action: Explore a C-PACE loan for your development project
Commercial property-assessed clean energy (C-PACE) loans are an alternative source of financing with fixed-rate funding that is higher than traditional debt but lower than mezzanine debt. They are structured as tax assessments, can be transferred upon sale, do not grant foreclosure or property rights to capital providers, and are typically available on 25- or 30-year terms.
Potential qualified C-PACE improvements include:
• Energy
• Lighting
• HVAC
• Cool roofs
• Appliances
• Plumbing
• Elevators/escalators
• Seismic retrofitting
“For new construction and property redevelopment, in particular, you can package a traditional construction loan with a C-PACE to close a funding gap,” says William F. Saya, Partner at Citrin Cooperman. “They’re growing in popularity because they’re flexible and can be applied to a variety of qualified improvements.”
Upgrade and secure your technology systems now
Real estate has long been slow to adopt technology. Until very recently, developers paid interns to tally cars in parking lots as a proxy for location data.
Today, only 32% of real estate firms have fully implemented data analytics tools and processes. That is changing — 48% are working on implementing analytics. However, from our position working with real estate companies, we see them underusing existing technologies; there is much more they could do, such as advanced forecasts and studies. Moreover, we see a looming gap between their security setup and the increasing wave of cyber threats. Technology is coming, and driven by tenants and buyers
Real estate firms are now adopting more technology, partly driven by both residential and commercial tenants, as well as buyers. Ninety-nine percent of people use the internet when searching for
homes. Payments, property management, heating and cooling systems, lights, tenant relationships, feasibility studies, and contracts are increasingly digital — amenities that now factor into multifamily property classifications. Marketing and leasing processes are also going digital.
More software means more data and possibilities. But is your firm prepared to take advantage of it? Our research suggests that most are not. Sixty-one percent of real estate companies are “extremely” or “moderately” concerned about the speed of change, and 63% are “extremely” or “moderately” concerned about the impact of AI. Sixty percent of real estate firms remain heavily reliant on “legacy technology and infrastructure” that prevent them from adopting emerging technologies such as AI.
Of real estate companies:
are concerned about the speed of technological change
are concerned about the impact of AI
Top barrier to AI adoption?
Integrations with existing systems Quality of data in our systems Understanding
An outdated ERP can block AI initiatives
According to 42% of real estate companies, the number one blocker to adopting AI is “integrations with existing enterprise resource planning (ERP) systems.” This is because large language models (LLMs) require structured data; they must be trained on a truth set and have access to current operational data. If that data is of low quality (inaccurate, incomplete, outdated, inconsistent), the training produces ineffective models and outcomes. Or, if the data repository is very old, the data may not even be accessible.
Cybersecurity is an increasing risk
As mentioned, real estate firms are adopting more technology. Eighty-seven percent say they have made at least “some progress” in establishing upskilling programs for technical or digital skills. And, 60% of real estate companies say they have the
reporting and analytical capabilities to evaluate and maximize the value of current and future intelligent automation investments.
But the flipside of digital is everything is vulnerable to cyberattacks. Many companies lack policies for governing all the ways employees use technology — both sanctioned and illicit, onsite and remote. Cyberattacks have risen in proportion to remote work, and cyber insurance premiums rose 28% in 2022 alone. Employees are also often the single largest point of failure; 62% of workers say they use the AI chat tool ChatGPT, which invites them to share sensitive information publicly. Several Samsung employees entered source code into ChatGPT before executives caught the leak. And, an Arup employee wired $25 million to scammers after joining a Zoom call with deep fake AI replicas of the company’s executives.
Real estate firms that have migrated sensitive data into the cloud — including tenant Social Security numbers and payment information, as well as private company data — likely need to invest more in cybersecurity. Especially if they rely heavily on many small subcontractors who may not have any security safeguards in place.
“It’s crucial that real estate firms not confuse ‘IT’ with ‘cybersecurity,’” says Kevin Ricci, Partner at Citrin Cooperman’s Technology, Risk Advisory and Cybersecurity (TRAC) Practice. “They are fundamentally different skill sets and you cannot expect someone who considers security a part-time responsibility to thwart hackers who consider it their full-time purpose. The most effective eyes are often those of a stranger’s.”
“It’s crucial that real estate firms not confuse ‘IT’ with ‘cybersecurity.’ They are fundamentally different skill sets.”
Kevin Ricci Partner, Technology, Risk Advisory and Cybersecurity (TRAC) Industry Practice
Citrin Cooperman
Action: Audit your ERP
Nearly one in three (31%) firms upgraded their ERP more than five years ago. Much has changed since then. When that installation occurred, only 6% of companies were using AI. Now, 73% use it or plan to use it. An outside expert may help you evaluate whether the current implementation is functioning and will continue to serve you as new technologies emerge.
Action:
Seek outside experts to help you explore AI
You may want to enlist outside experts to help you evaluate your ERP for efficiency, and examine the processes it supports. Many companies implement an ERP then fail to continuously invest in it. There could be newer releases your team isn’t aware of. This is especially important to find out if yours is upto-date now given the rapid pace of change and the need to incorporate AI.
Example projects:
• Assess your existing ERP and business processes.
• Create an AI roadmap within your ERP.
• Add integrations to other systems to increase the efficiency and accuracy of your data.
• Build an analytics strategy across multiple platforms.
• Conduct an internal controls analysis within your ERP.
Potential outcomes:
• Reduce manual work
• Reduce financial risk
• Make better predictive decisions
• Improve the customer experience
• Faster month-end closing
• Integrate acquisitions faster
• Reduce security risk
• Reduce the cost to carry inventory
Action:
Get a cybersecurity audit and benchmark
It is difficult to evaluate unknown unknowns, or threats your team is not yet aware of. Outside experts can apply the knowledge of hundreds of incidents and recommend better policies, programs, and software. For example, does your company properly evaluate all new tools, including AI? Do you require SOC compliance? How about uniform service-level agreements (SLAs)?
Acting on opportunities in the present market
Real estate has not yet roared back, but there are encouraging signs. Despite persistently high inflation and interest rates, there are opportunities. Likely, the gains will go to those firms that consider new, smart ways to finance conversions, reduce their risk by adjusting their capital stack, and address the twin challenges of technology — better tech and more secure tech.
About Citrin Cooperman
Citrin Cooperman is one of the nation’s largest professional services firms, helping companies and high net worth individuals find smart solutions. Whether your operations and assets are located around the corner or across the globe, we can provide new perspectives on strategies that will help you achieve your short- and long-term goals.
“Citrin Cooperman” is the brand under which Citrin Cooperman & Company, LLP, a licensed independent CPA firm, and Citrin Cooperman Advisors LLC serve clients’ business needs. The two firms operate as separate legal entities in an alternative practice structure. The entities of Citrin Cooperman & Company, LLP and Citrin Cooperman Advisors LLC are independent member firms of the Moore North America, Inc. (MNA) Association, which is itself a regional member of Moore Global Network Limited (MGNL). All the firms associated with MNA are independently owned and managed entities. Their membership in, or association with, MNA should not be construed as constituting or implying any partnership between them.