The Complex and Varied Challenges of Commercial Real Estate in 2024

By Austin Maxwell

There have been many terms used to describe the 2024 commercial real estate (CRE) landscape: transitional, uncertain, unpredictable – to name a few. No matter which word you choose to describe it, one thing is clear: the current CRE market is complex.

Why?

Whenever you have an economic climate in flux, such as what 2024 has demonstrated, it causes a rapid domino effect in the CRE market. Increased interest rates produce high costs; high costs lead to reduced availability of commercial assets; insurance costs skyrocket; zoning and compliance regulations change; and tenant risk rises.

The question on most everyone’s mind: When will the dominos cease to fall? It’s difficult to say with any certainty, however, most data points to the next 12 to 18 months before any true stabilization is realized.

Let’s take a look at some of the most prominent challenges within the commercial property sector, how they impact insurance costs, and how investors, developers, owners and tenants are responding.

Market Volatility and High Interest Rates 

Rising interest rates and the inflated cost of capital significantly impacted CRE in 2023, and they continue to do so in 2024. According to a recent Deloitte survey, “Average U.S. commercial mortgage rates topped 6.6% as of the second quarter [in 2023], nearly double the 3.8% rate at the beginning of 2022. Facing tightening loan standards, fewer lenders and higher borrowing costs, commercial real estate buyers could have more difficulty deploying capital for purchases in 2024.”

Rising interest rates and market volatility have hit the insurance market hard. Specifically, escalating catastrophe-exposed properties, re-insurance carriers, underinsured properties, commercial development delays and a rise in property loss have contributed to a rise in insurance premiums.

High Costs Lead to Limited Liquidity

Alongside climbing costs, liquidity limitations are making it difficult for buyers, owners and investors alike. Buyers are experiencing difficulty in securing financing, whereas owners are having challenges refinancing. According to Deloitte, a net of 67% of bank lenders surveyed by the Federal Reserve in April 2023, reported tightening lending standards for commercial mortgages.

The unpredictability of the market and future of property values combined with high interest rates and limited liquidity is causing sellers to hit the pause button and investors to rethink new investments.

In scenarios where liquidity is limited, it triggers an increased cashflow demand from policyholders, and eventually, insurance premiums rise. But that’s not all that’s instigating inflated insurance costs.

Rise of Insurance Costs

Rising insurance costs can occur due to various factors, including property value appreciation, changes in risk profiles or industry trends (as previously described). In 2024, there are three major causes of rising insurance commercial property costs:

•  An increase in secondary peril losses: secondary perils – in the insurance realm – refer to low-to-medium size losses (such as a hailstorm). Alternately, primary perils refer to catastrophic events (such as hurricanes and earthquakes). A rise in secondary perils, doubled with inflation hikes has compounded this issue as replacement and repair costs rise.
• Rise in reinsurance costs: Reinsurance, an agreement between a reinsurer and insurer continues to skyrocket, reflecting some of the highest costs in 2023, according to MMA’s 2024 Commercial Property Insurance Trends report.
• Pervasive underinsured properties: An influx of underinsured commercial properties has negatively impacted the CRE insurance market, largely due to increased claims not adequately covered by existing policies.

 Commercial property rate increases averaged 11% by the end of 2023, as demonstrated in MMA’s 2024 Commercial Property Insurance Trends report. Although the CRE market reflects indications of increased stability for the first time in several years, CRE investors should brace themselves for continued high insurance premiums for the time being. This is especially true for those with significant exposures and sustained losses, with potential rate hikes of 50% to 100%.

Similar to ensuring a development has the appropriate liability, property and building insurance coverage, investors should be cognizant of insurance policies covering renovations, upgrades and improvements to properties. This will also protect investments during construction or remodeling projects.

Confusion Surrounding Regulatory Compliance

Most investors know that to enter the commercial property market is to also contend with a host of compliance and regulatory processes. This often means navigating a fair share of challenges. Yet, the CRE industry in 2024 seems to continue to present varying and complex issues in this arena. Some of the most common include:

• Environmental compliance confusion: Focus remains steadfast on sustainable development such as energy efficiency and reducing overall carbon footprint. As a result, stricter guidelines and building codes are being enforced. An estimated 60% of CRE firms admitted to lacking the data, processes and internal controls to meet the compliance standards required.
• Zoning change impacts: Significant changes have impacted CRE zoning, particularly in urban infill areas and adaptive reuse projects, challenging developers to be vigilant regarding zoning code revisions.

It’s imperative to understand and comply with the requirements of these regulatory and compliance areas for several reasons. If commercial property stakeholders fail to do so, they risk penalties imposed by lenders, local regulatory governance. They also risk losing insurance coverage for noncompliance.

Tenant Risk

The success of a commercial property is heavily dependent on its occupants. Two major areas in which owners and developers must remain vigilant are risk management and the quality of their tenant relationships.

• Assessing risk: If a tenant vacates the property or defaults on their lease, it can have a major impact on the property's cash flow. Alternatively, if an owner and developer default on their loan it can negatively affect the tenant's business. Owner and tenant must both assess the risks that come with the current market to ensure a shared, healthy symbiosis.
• Appraising the investor/tenant relationship: Tenants can help sustain positive cash flow, but to maintain that positive net income, it’s equally important for investors to make sure their tenant’s needs are being satisfied. Diversifying tenants has been a strategy some owners have found helpful in creating a balanced equilibrium and revenue stream.

MMA’s Solutions for CRE’s Greatest Challenges

MMA recognizes the breadth and extent of challenges affecting the CRE market. Our expert-led team has devised solutions and strategies to help businesses of all shapes and sizes navigate the complexities of the current economic landscape.

Discover our comprehensive range of business insurance, employee health and benefits, retirement and private client insurance solutions tailored to both businesses and individuals. Connect with an MMA representative today to explore how we can serve your unique needs.