Lauren Romeo: Following two years of double-digit declines in both asset values and transactions, the commercial real estate (CRE) market appears to be showing some signs of market stabilization. Volume metrics are declining at a slower pace, and there has been an uptick in inventory coming to the market at more realistic values, as it appears the passage of time has allowed buyers and sellers to recalibrate expectations of a “higher for longer” interest rate environment. Outside the big city office building segment, supply/demand conditions in other key property categories are favorable (e.g., industrial/logistics and retail) or should be rebalancing over the next few years as the higher cost of capital and inflated construction costs slow new development.

There is also a record amount of capital on the sideline—estimated at $200-$300 billion—which should provide liquidity to fill in some of the financing void created by regional banks’ reining in CRE lending. As green shoots continue to emerge, this capital should provide a tailwind for high-quality real estate businesses with currently depressed stock prices. For example, commercial brokerage Marcus & Millichap, the market share leader in CRE transactions of $10 million or less, which are often driven by circumstances irrespective of the market, such as death, divorce, and tax strategies. Real estate investment firm Kennedy Wilson is shifting its emphasis toward its capital light, high return, fee income-driven investment management platform to continue its proven track record of investing into CRE market dislocations. The transaction-driven capital markets arm of real estate services firm Colliers International Group is poised for a rebound, while its recurring revenue businesses that account for greater than 60% of EBITDA—Outsourcing & Advisory and Investment Management—continue to deliver strong cash flows that management has consistently reinvested via acquisitions that yield attractive returns and strengthen Colliers’s market positions.

Jay Kaplan: I see more potential for negative surprises than positive right now, with the caveat that there is an even greater amount of uncertainty than usual, whether the topic is the market, the economy, or the world as a whole, which makes any prediction suspect.

We are all growing accustomed to interest rates being “higher for longer,” and the Fed seems unlikely to cut rates more than once between July and the end of the year—and there is a reasonable possibility that they don’t cut rates at all this year. The Fed has been open about the fact that it wants to see sustained inflation at 2% before any cut takes place, and so far this year the pace of moderating inflation has been extremely slow (and pretty bumpy as well). But the market doesn’t seem to believe the Fed, at least not yet. And if the Fed does cut, it may mean that the economy has taken a clear turn for the worse, which needless to say would not be good news for stocks.

Along with the uncertainty about the next moves for the Fed and the economy, I’d add the upcoming election in a divided country, ongoing wars in the Ukraine and the Middle East, and the odd fact that we’re at the end of a Fed tightening cycle during which unemployment has remained low—which makes this cycle a bit of an anomaly. We are also in a market still dominated by a small handful of mega-caps, which is unhealthy, and where many valuations look unsustainably high. In this context, I’m happy to be holding a number of what I think are high-quality companies with strong balance sheets and positive cash flows that look well positioned to withstand a challenging environment.

Steven McBoyle: Entering the back half of the year, I believe fundamental risks generally rest in revenue dynamics between both short cycle versus long cycle and price versus volume composition. I think we may see a positive surprise in terms of strength, as well as a natural offset to the risks, as the inventory cycle returns to normal and perhaps grows even stronger. The “Great Digestion” as it relates to pandemic-induced inventory over buying has all but normalized at this point as companies reduced their safety stock and are now returning to a more historically normal supply / demand parity.

As is typical, the pendulum might have actually swung too far to the conservative side as lead times on supply shortened so quickly, and companies were hesitant to build inventory back to normal levels, given the ongoing macro debate about the state of the economy. Specifically, days sales of inventory are at extremely low levels—which serves as a strong demand driver for a number of our companies in 2024’s second half if customers realize that the pendulum has swung to the “wrong” position.

Two high quality companies that I think will benefit from this theme are Rogers Corporation and Littelfuse. Rogers is a specialty chemicals company serving high growth, niche applications including 5G wireless base stations, ADAS (advanced driver assistance systems) and EV/HEV (electric and hybrid electric vehicles.) While its EMS (Elastomeric Material Solutions) and EV segments continue to grow, steady demand and inventory re-stocking in ceramic substrates and general industrial end markets (1/3 of the business) should provide a nice uplift. Littlefuse is a market leading, high specification electrical components manufacturer with a proven capital allocation framework. Its products are often viewed as the gold standard in circuit protection. Littelfuse has already seen a bottoming in the inventory channel for passive components and quite likely will see a return to favorable inventory dynamics on the part of their OEM (original equipment manufacturer) and distributor customers in active electronics.

Miles Lewis: We think that investors may be mistaken in thinking that the current “higher-for-longer” rate environment will be a negative for banks, including an adverse impact on their fundamentals. However, we think a longer-term view reveals that we are seeing a positive normalization of the bank operating environment. It is true that the speed with which rates rose over the past two years was difficult for banks on both the asset and liability sides of their balance sheets, but that is now in the rearview mirror. What matters most for our investments is the forward looking view, and in reality moving away from the zero interest rate period (“ZIRP”) is structurally better for banks.

ZIRP was difficult in that it flooded banks with deposits when money was essentially free. Looking at simple supply/demand dynamics, this meant that there was increasing capital chasing loans, which compressed yields and led to weaker terms. In other words, the banks were forced to mostly compete on price in such a high supply market. Now that we have moved away from ZIRP, the opposite holds true. We are now seeing our bank holdings being able to not only move rates higher on loans, but to also increase the spreads as they price more appropriately relative to the risk.

Throughout the history of financial markets, there have been many analogous situations—those in which fundamentals worsened when capital was flooding the industry, and then fundamentals improved dramatically as capital was fleeing the industry. The energy sector offers a recent example where capital discipline has been instilled before financial returns dramatically improved.

It is also quite interesting that when we ask bank CEO’s whether they would prefer to operate in the ZIRP environment or a “higher-for-longer” environment, they all affirm that a normalized rate environment is much better. The only remaining challenge is the inverted yield curve. However, it can’t stay inverted forever, and we think that once the curve normalizes this will highlight the improved spread fundamentals that we’re discussing here.

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