What To Watch For in 2024?

As we start a new year we look to reflect on the past with an eye to the future. In the investing arena, we have selected three topics to watch for that have the potential to impact the U.S. economy in 2024. First, there is trouble brewing in the commercial real estate market that has the potential to impact local banks, which could impact lending to small businesses. Secondly, America’s largest trading partner, China, has seen a significant slowdown in economic growth. Will the trouble in China have knock-on effects on the U.S. economy? Finally, inflation hasn’t been beaten yet and new price shocks may be ahead, so higher interest rates may be around for longer than expected. 

What’s Next for Commercial Real Estate?

Sooner or later, commercial real estate's day of reckoning had to come. An era of cheap money—"quantitative easing”—stretching all the way back to the 2008 housing crash and the Great Financial Crisis fueled a bubble that coincided with an age of growing urbanization and the rise of mega-valuable office buildings. For this sector, the higher interest rates of 2023 were a huge shock. Along with higher vacancy rates, it's largely this higher interest rate environment that has caused the substantial distress experienced thus far, amounting to what the research firm Capital Economics estimates as a $590 billion loss in commercial real estate property values in 2023.

But how much worse will things get in the new year? Capital Economics, for its part, predicts another $480 billion wipeout in commercial real estate values next year, and an additional $120 billion loss in 2025, for a 24% peak-to-trough value decline.

The failure of a mass return to the office is the poster child for the woes of commercial properties post-pandemic, and it is going to take time for it to normalize and discover what its future holds. Older and less desirable offices are taking the biggest hit, according to Al Brooks, JPMorgan Chase’s head of commercial real estate. Some of those office buildings will likely need to be repurposed. Brooks doesn’t see offices being converted to housing on a large scale.

An obvious sign of trouble ahead is increased delinquencies as borrowers fail to make their loan payments, which appear in commercial mortgage-backed securities data, according to Kiran Raichura, Capital Economics’ chief property economist. Over time, he suspects banks and other lenders will have to take over some of these delinquent properties, and more office space will come to the market, some at a substantial discount.

Delinquency rates for office buildings have been on the rise for the past five quarters. In the third quarter of 2022, only 1.5% of the balance of office property loans were 30 days or more delinquent, while in the fourth quarter of 2023, already 6.5% of loans were delinquent, according to the Mortgage Bankers Association. See the chart “Office Property Loans Delinquency Rates” for details.

Also, commercial real estate loan maturities will be a significant factor in 2024, as a greater amount of debt, compared to 2023, will be coming due at a time when refinancing is only possible at higher rates. Most office buildings were built over the last 30 years and have mortgages with interest rates of less than 4%. However, since the Federal Reserve has raised its target rate to 5.5%, mortgage refinancing for risky commercial real estate properties is likely to be around 9 to 11%. So, many buildings will not be economically viable, according to an interview with Kevin O’Leary, a well-known businessman and Shark Tank host.

Why it Matters in 2024: The commercial real estate sector's challenges could impact local banks, potentially affecting the availability of credit for small businesses, which are vital for the U.S. economy.

Chinese Market Meltdown 

Chinese shares haven’t just had a challenging start to 2024; it’s been rough going since February 2021, marking significant losses totaling about $6 trillion over the past three years, equivalent to roughly twice Britain’s annual economic output, according to CNN Business. The Chinese stock index Hang Seng (HSI) has declined by a staggering 45% since February 2021, when it stood at 28,893 points. In comparison, on January 26, 2024, the index stood at only 15.592 points. See the chart “HIS Chinese Stock Index Decline” for details. 

These astonishing losses, reminiscent of the 2015 and 2016 Chinese stock market crash, underscore a crisis of confidence among investors concerned about the country’s future. China faces a myriad of problems, including a record downturn in real estate, deflation, debt, a falling birthrate, a shrinking workforce, and a shift towards ideology-driven policies that have rattled the private sector and scared away foreign firms.

What's driving the meltdown? In short, investors worry about the lack of effective policies from Beijing to spark a sustainable economic recovery. China’s economy grew 5.2% in 2023, its slowest pace of expansion since 1990, excluding the three pandemic years through 2022. International economists widely expect the country’s growth to slow further this year to around 4.5% and drop below 4% in the medium term.

While this growth may seem reasonable for a major economy, it is far below China’s double-digit growth of the past decades. Analysts suggest the country may be facing decades of stagnation ahead, as the slowdown is structural in nature and won’t be easily reversed.

The most recent blow to investor confidence in China is the liquidation order of Evergrande Group, the world’s most indebted property developer. The liquidation order, made by Hong Kong’s High Court on January 29, 2024, comes after the embattled Chinese real estate giant and its overseas creditors failed to agree on how to restructure the company’s massive debt during talks that lasted for 19 months. Overseas creditors are owed $25 billion of the $333 billion in total liabilities, according to Hong Kong court documents. 

Why it Matters in 2024: The Chinese economic slowdown and market challenges could have spillover effects on the U.S. economy, affecting trade, investment, and sales for U.S. businesses. 

Inflation

In December 2023, inflation has proven it isn’t dead yet, with an annualized Consumer Price Index (CPI) of 3.4%, compared to 3.1% one month earlier, according to the Labor Department. Increases in shelter costs contributed more than half of the overall rise in December, while energy costs, a major contributor to declines in inflation in recent months, played less of a role. Food costs moderated.

Although the CPI has sharply fallen from its peak of 9.1% in June 2022, it still exceeds the Fed's 2% annual target. In December 2023, the Fed decided to leave rates unchanged, but indicated three rate cuts for 2024.

Meanwhile, the risk of inflation spiking again has grown in recent weeks due to various factors, including supply chain disruptions and armed conflicts. A potential jolt to inflation could arise from widening violence in the oil-producing Middle East, where tensions are high amid the ongoing Israel-Hamas war.

Since mid-December 2023, attacks by Iran-backed Houthi militants on oil tankers and bulk carriers, which transport raw materials, have forced ships to avoid the Red Sea and the adjoining Suez Canal in favor of a longer route around Africa, sending shipping and insurance costs through the roof. Ships coming from Asia and heading to the U.S. East Coast are also impacted by these attacks. How long this situation will last is unknown, of course, but the initial shock will show up in prices soon.

Furthermore, Mary Callahan Erdoes, the CEO of JPMorgan Chase’s asset and wealth management unit, warned of another, subtler risk. As soon as the Fed starts lowering interest rates, “people feel better, they start spending more,” she said. “You can have more inflation, instantaneously.”

Why it Matters in 2024: The volatile Middle East situation could lead to a resurgence of inflation, driving up fuel prices and shipping costs. The Fed, though likely to lower interest rates, will proceed with caution.

What Does it Mean for Investors?

In the face of uncertainties surrounding the commercial real estate market in the U.S. and global markets in general, investors can turn to first trust deed lending for its distinct low-risk, high-return investment products. First trust deeds offer secured note options backed by tangible assets, providing a layer of protection with conservative average loan-to-value ratios of 65%. The competitive rates starting at 10% outpace inflation significantly. Notably, first trust deed investments eliminate liquidity risk, offering stability and peace of mind to investors during uncertain times.

With our team's two decades of experience, we are here to help you make the most of your investment opportunities. Call or email Safeguard today at 877-280-5771 and put your money to work for you!