Commercial real estate and restaurant industry hit hard by current economic trends

Recent economic trends have profoundly impacted both the commercial real estate industry and the restaurant and hospitality sector. These key industries are grappling with increased debt burdens exacerbated by the highest interest rates in decades, alongside evolving consumer behaviors accelerated by the COVID-19 pandemic and escalating inflation. 

A recent survey underscores industry sentiment. In the second quarter of 2024, 66.7% of respondents identified rising interest rates as the most potent threat to the near-term economy In that same survey, 100% of respondents identified Accommodation & Food Service among the top three sectors likely to experience volatility in the coming months.

The past four years have been difficult on both industries, but as inflation begins to slow and a door opens to a potential interest-rate cut, they may finally see some relief. The most recent “consumer-price index,” a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services, rose only .1% in June 2024, the mildest increase since January 2021, and is down from its highest points in late 2022 and early 2023.

An Omen of What Is To Come in the Commercial Real Estate Industry — Or a Long- Awaited Turn Around?

Banks have begun offloading their portfolios of commercial real estate loans amidst concerns that struggling office buildings will not be able to meet their mortgage obligations. While this represents a fraction of the nearly $2.5 trillion in outstanding loans, it signals broader distress within the industry.

During and after the COVID-19 pandemic, banks grudgingly followed an “extend and pretend” policy, granting property owners mortgage covenant extensions to facilitate financial recovery. However, recent transactions indicate a shift as investors seek to minimize losses by divesting commercial portfolios.

High interest rates have compounded challenges in the commercial real estate sector, particularly for loans nearing maturity. Approximately $2.75 trillion in commercial mortgage loans are set to mature between 2023 and 2027, potentially leaving borrowers with properties unable to cover their carrying costs.

With an expectation that interest rates will begin to decrease in 2024, many investors are predicting a recovery in the commercial real estate industry. According to Invesco, a lower fed
funds rate may cause “a chain reaction” that will ultimately increase prices: a welcome balm for an industry that has struggled since early 2020.

Same Headwinds, Different Industry

The restaurant industry faces parallel challenges, grappling with rising operational costs and dwindling consumer demand. For chain restaurants operating under franchise models, traditional capital infusions have included stringent financial covenants based on cash flow and
profitability. These conditions have proven increasingly difficult for franchisees to meet,
prompting a shift towards more expensive asset-based lending facilities. Additionally, the squeeze of high interest rates is felt especially in the restaurant industry, where already thin
margins are further undercut by increasingly expensive debt service. 

At the same time, steep inflation has increased the cost of raw materials, and simultaneously eroded the disposable income of the low- and middle-income consumers who frequent chain restaurants. In 2023, restaurant operators reported that rising inventory costs was their primary source of financial strain.

Additionally, changing consumer behavior as a result of the Covid-19 pandemic, and specifically the persistence of remote and hybrid working environments has reduced foot traffic for the fine
dining and chain restaurants that traditionally relied on weekday office traffic.

The industry’s challenges are underscored by high-profile bankruptcies and closures among major chain restaurants, including Red Lobster, Rubio’s, Tijuana Flats, Sticky Fingers and Foxtrot/Dom’s Kitchen. Even industry giants like Applebee’s, TGI Fridays, Denny’s and Cracker Barrel have announced closures amidst economic uncertainties.

Despite these setbacks, the restaurant sector has shown resilience. In 2023, sales from the top 500 restaurant chains grew by approximately 7.8%, and the domestic footprint increased by 1.8%. Although these promising numbers are largely driven by a handful of key players, and higher sales may be attributed to higher prices, the success of certain “industry darlings,” such as fast-casual Cava and Chipotle proves that there is still a path forward for the restaurant industry.

Conclusion

The commercial real estate and restaurant industries continue to navigate a complex economic landscape shaped by rising interest rates, inflationary pressures, and evolving consumer behaviors. While challenges persist, there are promising signs of adaptation and resilience within both sectors.

The anticipation of interest rate cuts in 2024 offers hope for market stabilization and recovery efforts, while both industries respond creatively to the challenges they face. The journey ahead may be arduous, but it also presents opportunities for innovation and renewal across these vital sectors.