Capital Markets Overview
The continued interest rates increase by the Federal Reserve will make debt and equity much more expensive in the coming quarters and continue to put a damper on transactions. CRE debt origination activity has declined sharply since May 2022, opportunistic refinancing disappeared, and acquisition financing decelerated. Investor allocations are heavily tilted towards multifamily and industrial assets. The looming recession is causing institutional investors to pause, but regional banks still fund assets that are performing well. As the year ends, it is expected that buyers and sellers will take a wait-and-see approach. With the benefits of leverage severely limited and owners who are not being forced to sell, the price expectations gap between sellers and potential buyers has been wide enough to limit deal closings.
- The coupon on a 7/10yr fixed rate commercial mortgage reached 5.7% in September, the highest level since 2011
- For multifamily assets, mortgage rates averaged 4.7%, the highest since 2019
- The rising cost of financing and historically low cap rates have forced some investors to walk away from deals
- There has been an increase in bridge lending transactions
- Over $1 trillion in loans are coming due over the next two years
Multifamily is a tried-and-true investment class despite market volatility. Rent growth is still strong, and sales activity is recorded well above pre-pandemic levels. Over the last 12 months, 21,206 transactions have registered nearly $240 billion in volume. Dallas-Fort Worth and New York are two markets that investors have targeted in 2022, taking the top two sports in terms of transaction volume, with Houston and Phoenix not far behind. As the elevated costs of debt impact highly leveraged buyers, more institutional capital sources and well-capitalized private buyers have come to the table.
The retail market has faced its fair share of challenges in 2022, adjusting to new consumer preferences and supply chain issues. In the wake of higher interest rates, retail capital markets have slowed considerably. While retail property sales recorded the fourth-largest quarterly total in Q3 2022, over $23 billion, activity was comparatively slow in the other quarters. Retail property sales have declined for six consecutive months, and loan rates on stabilized retail assets have increased by 150 – 200 basis points. Investors still target well-performing assets, but buyer and seller expectations are unbalanced. Net lease assets have witnessed considerable pullback as the spread between valuation and transaction cap rates has grown. Neighborhood centers have been heavily targeted in 2022, recording 28 percent of all retail property sales in Q3 2022. These centers have continued to see strong demand for shop and anchor space, and the vacancy rate has reached a record low of six percent.
According to CoStar, the markets where investment activity has been centered include gateway markets such as New York, Los Angeles, and Chicago, as well as high-growth markets such as Dallas, Atlanta, Phoenix, and Houston.
Compared to 2021, quarterly sales volume in 2022 fell in the office sector but is still, on average, near the levels seen pre-pandemic. Sales volume in 2022 recorded nearly $110 billion, the average price per square foot climbed to $337, and cap rates ended the year at around seven percent, ten basis points below the pre-pandemic average. However, these positive figures do not represent the current reality of office space, which is experiencing market shifts from economic headwinds. Borrowers are facing higher interest rates and tighter underwriting standards, triggering distress in the market. As such, fundamentals are expected to soften in 2023 as work from home dynamics widen bid/ask spreads and weigh on valuations. Many properties face lease rollover risk in the coming year, alongside long-term leases expiring.
CoStar’s analysis of market capitalization of public office REITs indicates that values have fallen approximately 35 percent, with a corresponding rise in cap rates of 200 basis points.
Despite the rising interest rate market, the industrial sector is still going strong as buyer demand continues to outpace sellers. Sales volume recorded nearly $112 billion in 2022, and cap rates have averaged six percent. It is anticipated that transaction volume will slow in the months ahead, and cap rates will flat-line. Sale leaseback transactions remain attractive for investors looking to complete acquisitions with minimal friction with capital markets. According to CoStar, one of the most popular investment strategies in 2022 has involved targeting fully leased properties with below-market rents in place and lease expirations coming up during the buyer’s projected hold period. These investments offer buyers the opportunity to boost a property’s future net operating income.
Hospitality is an attractive asset during times of uncertainty as rooms can be repriced daily, compared to office or multifamily assets in more long-term leases. Additionally, cap rate compression in other asset classes makes hotels a relatively attractive investment. As such, regional banks are still funding regional sponsors for smaller deals. Large high-end hotels are still struggling, indicated by a slower transaction pace. Full-serve hotels were also hit hard by the pandemic but returned to business as usual in 2022 as people returned to offices, and events were added to schedules.