Trends Watch: Middle Market Commercial Real Estate Investing

EisnerAmper’s Trends Watch is a weekly entry to our Alternative Investments Intelligence blog, featuring the views and insights of executives from alternative investment firms. If you’re interested in being featured, please contact Elana Margulies-Snyderman.   

This week, Elana talks with Steen Watson, CEO, Chestnut Funds.  

What is your outlook for middle market commercial real estate investing?  

Middle market commercial real estate is likely to perform similarly to the broader commercial real estate market. Apart from office properties, most commercial real estate sectors have maintained high occupancy levels and increasing rental rates. We expect liquidity to increase in 2025 as lenders become more active. Following value declines of 15% to 20% from peak values in 2022, recently we’ve seen cap rates begin to decline, most notably in medical outpatient buildings, a sector that we focus on.  

Where do you see the greatest opportunities and why?  

Due to limited liquidity in recent years, many investors who traditionally targeted larger investments and properties increasingly turned their attention to middle market assets. As liquidity improves, we anticipate the potential for capitalizing on the historically higher initial yields characteristic of middle market real estate to return. Currently, with asset values and returns resembling those from 2016 and 2017, there are opportunities to acquire value-add properties at attractive basis levels and at returns that align with the associated risk. This contrasts with most of the previous decade, where returns on value-add investments were often not markedly different from those on stabilized properties.  

What are the greatest challenges you face and why?  

The capital formation environment has been and continues to be challenging. Fundraising levels are very low, and debt financing remains constrained. As debt matures, we expect it will be a challenge to refinance loans without investing additional equity capital. Fortunately, the operating environment is strong in terms of income and occupancy so that refinancing challenges are primarily due to higher interest rates and cap rates.  

What keeps you up at night?  

Our investment activity focuses on sectors where demographic trends are supportive of demand. This includes health care and housing. Both sectors, though, have experienced tremendous increases in cost resulting in housing and health care are becoming increasingly unaffordable for many. While real estate owners have benefitted from increasing rental rates and resulting higher asset values, I am concerned that the lack of affordability will, in addition to the negative impact on those least able to afford health care and housing, reduce demand in those sectors. 

The views and opinions expressed above are of the interviewee only, and do not/are not intended to reflect the views of EisnerAmper.