Lenders are bullish on Rochester’s commercial real estate market outlook

Lease data, vacancy rates and loan activity can provide a pretty accurate assessment of the state of Rochester’s commercial real estate market.

But perhaps the best barometer? When lenders hire, according to experts who participated in Rochester Business Journal’s April 24 State of Real Estate virtual panel discussion sponsored by ESL Federal Credit Union and NexTier Bank.

ESL Federal Credit Union has expanded its real estate team with the addition of a senior relationship manager, an indication the Rochester-based lender is bullish on the local CRE industry.

“Rochester has many very experienced and successful real estate developers,” said Jon Fogle, manager of ESL’s commercial banking division. “Given such, we are expecting another very busy year for our real estate team.”

There’s no doubt 2023 and 2024 presented challenges, and there remains anxiety within the industry due to tariff threats. But lenders see positive indicators for development, whether within the still-strong industrial and multifamily sectors or through the repurposing of buildings within the still-stagnant office sector.

“Challenges experienced in 2023 and 2024 seem to be stabilizing or getting better, most supply chains have corrected, and the borrowing rates have rescinded some,” Fogle said. “We started seeing more acquisition activity, especially in the $2 million and under range.”

Interest rates obviously will play a role in how developers proceed. Many that are eager to move on projects are just waiting for the right moment, according to John Klatte, senior vice president of commercial lending at NexTier Bank.

“There’s certainly a lot of people that have been sitting on the sideline with a lot of liquidity and a lot of pent-up demand and deal volume,” Klatte said. “Additionally, there are deals that were on floating rates for construction or are coming up for repricing maturities that a lot of people are going to jump on.”

That includes loans coming up for refinancing. If interest rates in the 6 to 7 percent range become the norm, then current loans that are at 3 and 4 percent and are coming up for repricing could be in jeopardy.

But the misfortune of some opens the door for others “to swoop in and buy bank-owned assets or properties that current owners deem to be non-performing assets, Klatte said.

Within asset classes, neighborhood retail is still strong, and food and in-person, service-based entities are still thriving, Klatte said. Also, warehouse and industrial flex are still very much in demand, especially for small bay and logistics space.

“Even large-space buildings have come into play,” Klatte said. “It’s very hard for users that require large space to build those types of facilities for what they can buy and renovate existing space. As those bigger units have come on the market, investors are gobbling them up.”

When it comes to multifamily, bigger can also be better right now. Klatte said that it’s more difficult to make the numbers work on smaller projects “so we’re seeing a lot of projects being scaled up, typically with more unit-counts and more of one-bedroom unit mixes to make the economics work from an investors standpoint.”

Uncertainty is still the rule within the office sector “given that work-from-home models have not fully cycled through lease terms,” Fogle said. “We will be seeing more lease maturities. What will the renewal activity look like? What is the impact on the project’s cash flow? Could this lead to more repurposing projects?”

Klatte believes so since space that is Class B or below just isn’t attractive to tenants. And tenants also don’t want to make long-term commitments to an office.

“Obsolete buildings are going to face long-term challenges or be part of conversions,” Klatte said. “We’ve seen many buildings in the downtown area that used to serve as office space being converted to multifamily (on certain floors).”

The current economy, especially with higher interest rates, is changing the way banks lend.

Fogle said developers with larger cash reserves or lower-leveraged portfolios were more active last year because they could get projects to “model out” with more equity injected.

In recent years, banks required a minimum debt service coverage ratio, maximum loan to cost ratio and maximum loan to value ratio in the range of 75 to 80 percent. Now, they’ve shifted to cash flow coverage, say 1.2 times coverage or loan to cost ratios, Fogle said.

Borrowers also are willing to gamble now that rates will be lower in coming years.

“There is a potential for some rate cuts by the Fed expected in 2025,” Klatte said. “Movements in short-term rates have not really correlated with long-term rates, so we’re seeing a steepening of the yield curve between short-term rates and long-term rates.

That has prompted investors to stay shorter on the curve, Klatte said. Rather than locking in rates for 10 years, they are taking floating rates or short-term five-year rates and accepting the risk on the back end when rates adjust.

While there remains a need for multifamily, construction of more single family homes can’t come soon enough for the residential real estate market.

“If there are any investors, or even would-be investors, who have the wherewithal with respect to putting properties together, this is the time for you to take up that mantle,” said Christopher Thomas, founder/broker at New 2 U Homes. “I guarantee if you put together a decent house, I will sell it.”

Thomas estimates that supply can meet only about 25 percent of the current market demand, with first-time buyers — the consumer group Thomas primarily serves — struggling to find anything in their price range.

High-range homes are selling close to asking. But those listed around $175,000 to $375,000 are receiving offers tens of thousands about asking.

“I personally am seeing, with multiple clients, egregiously over-over-asking price offers,” Thomas said. “That makes it really, really difficult for people who are trying to enter the market.

“There was a time when, if we didn’t get 5 to 10 percent off on the price (as agents), we thought we weren’t doing a good job (for the client). Now, if we can get something for 30 percent over asking, we’re still doing OK.”

Even so, waiting to buy isn’t necessarily a good idea.

“The best time to get into the market is right now, because that house you saw today will likely be 30 percent higher in three months, with the current rate of appreciation we’re seeing now, so it’s always the right time,” Thomas said.

That’s because in the Rochester market “we don’t have scenarios where we go backwards in valuation.”

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