Commercial Real Estate Challenges & Problems (+ How To Overcome)

Rising interest rates and shifting workplace trends pose significant challenges to the commercial real estate market. Developers must understand these risks deeply and develop strategies to mitigate their impact. This article explores some of the biggest challenges facing the commercial real estate market and suggests ways to overcome them.  

Challenges in Securing CRE Financing

Rising interest rates, increased regulatory scrutiny, and shifting market dynamics have all made it more difficult for developers to secure financing. Banks have become more selective in response to the challenges as the number of delinquent loans and high-volatility loans continues to rise. These issues have forced many lenders to tighten their lending requirements significantly for CRE developments. 

Solutions to securing financing

Securing a CRE loan nowadays requires developers to focus more on their balance sheets, especially their debt-to-income ratio and revenue, and get creative with how they finance their projects. Instead of securing a construction loan, developers should look to other financing like revenue-based financing, term loans, or lines of credit to complete their work. These loans often have similar flexible terms as construction loans and may be easier to acquire, depending on the lender. 

Government Regulations & Zoning

Local zoning, land use, and permitting requirements are a significant cost for any development. Permitting costs are rising as cities across the U.S. try to grapple with a shortage of affordable homes and implement new green energy requirements. Permitting costs–as well as zoning and land use requirements–can vary widely, making it difficult for developers to predict their building costs accurately. Some land use codes can be incompatible with a building’s intended use, impacting a project’s overall cost and timeline. 

Solutions for regulations and zoning

Developers and construction managers must conduct due diligence early in the project planning to identify potential regulatory roadblocks before beginning the entitlement process. This can help avoid costly delays from permitting issues and other legal problems. But the work doesn’t end there. Developers need a team dedicated to ushering their projects through the entitlement phase. That means following up with permitting authorities about any issues with their permit applications, discussing potential roadblocks with zoning and land use administrators, and attending public hearings to respond to community feedback. 

Environmental and Sustainability Concerns

Governments have implemented new Environmental, Social, and Governance (ESG) regulations to blunt the impact of climate change on the built environment and to reduce the real estate industry’s contributions to climate change. Despite the noble aim, these regulations can create legal and financial issues for commercial developers, such as requiring additional environmental impact studies. The rules can also force developers to use climate-friendly technology, adding to a building’s price point. 

Solutions for environmental concerns during development

Developers should embrace ESG instead of trying to hide from it. Embracing it can help a firm attract new investors who may not have been interested in commercial real estate before, making a project’s capital stack more flexible. Providing investors with data related to a building’s water or energy consumption, carbon emissions, or social impact can give investors confidence that a project team is managing the risks of a development well. It can also open pathways for a development firm to forge new partnerships with other businesses or development groups. 

Impact of Market Volatility

The primary driver of the commercial real estate market’s recent volatility is high borrowing costs resulting from rising interest rates. Even though inflation has cooled significantly, the Fed’s benchmark interest rate is nearly twice as high as before the Covid pandemic. Additionally, the pandemic disrupted demand trends for commercial products like offices and retail spaces as work-from-home opportunities flourished. 

Diversification products and focusing on tenant retention are two ways developers can combat the recent market volatility. For instance, retail and industrial developers may see an opportunity to blend the two uses and add experiential elements to their buildings to attract new tenants. 

Long-Term Business Strategies for Overcoming CRE Hurdles

Strategy #1: Be an early mover

It can be challenging for commercial developers to innovate, but innovation is the key to success in today’s market. The rapid advancement of technology has given developers many new tools to perform many time-consuming tasks, such as analyzing market data. Being an early mover allows developers to tailor new technology to fit their business needs. The same is true for early adopters of new trends. In today’s market, developers should build buildings that accommodate multiple use cases instead of more transitional spaces.  

Strategy #2: Collaborate 

Developers also need to find ways to deepen their relationships with lenders and other construction firms to maximize their chances of success in today’s market. Partnering with lenders can open new financing opportunities, and forging relationships with other firms may create opportunities to build innovative products. 

Future of CRE Development

Materials and Techniques

Many tenants want to know that their building can help protect them from infectious diseases, and because of this, air ventilation and sterilization systems have gained renewed attention. Outfitting your building with a medial- or hospital-grade air ventilation system can help ensure it receives top dollar in the marketplace. 

Similarly, the pandemic exposed many issues tied to the shortage of affordable housing in the U.S. To combat these issues, developers should use adaptive reuse techniques to transform obsolete building uses into housing units. 

The Role of CRE in the Post-Pandemic Hybrid Work Environment

Commercial real estate in the post-pandemic environment is something to experience, not a destination. Before the pandemic, workers could arguably spend more time in an office than at home. Hybrid work has changed that dynamic completely. Coming to the office is just one part of a worker’s day, not something they have to balance their entire schedule around. Workplaces need to reflect this flexibility by focusing on collaborative spaces and offering amenities supporting their employees’ overall well-being. 

FAQs

What is the biggest challenge facing commercial real estate?

Financing. The rapid rise of interest rates to combat inflation caused commercial real estate lenders to tighten their lending requirements. It also made securing capital for new builds, renovations, and property purchases more expensive, significantly hindering market activity. 

What are the weaknesses of commercial real estate?

Commercial real estate has several weaknesses compared to residential real estate. It is more expensive to enter the market and maintain a property, and commercial real estate is subject to a more complex web of regulations. There is also an increased risk of damage and liability because more people visit commercial buildings than residential ones. 

What is a risk in the commercial real estate industry?

One of the key risks in the commercial real estate industry is tenant or borrower default, which occurs when either entity can no longer pay their rent or mortgage. The upstream effects of default can significantly impact local economies, as illustrated during the coronavirus pandemic. 

What is the biggest challenge facing the real estate industry?

Rising interest rates are one of the real estate industry’s biggest challenges because they influence both the supply and demand for homes and commercial properties. 

Bottom Line/Conclusion

Overcoming the challenges facing the commercial real estate industry requires a deep understanding of the issue and a clear strategy to mitigate its impact. Challenges can arise anywhere from the job site to the banker’s office, so developers must develop strategies for each scenario.