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Are We In A Shifting Market?

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We have been in a Seller’s market for the last several years. Properties have been sold at values that have not been seen since before the great recession of 2007-2008.  The Federal Reserve has artificially kept the interest rates low and the President in 2020 and 2021 pumped billions of dollars into the economy.  Yes, this helped some people during the pandemic, but also prevented the normal cycle we have seen over the last 40+ years.

In South Florida, every 10 to 12 years, we have seen a down swing in property values, adjustments and corrections for a few years.  The downcycle was due to change around 2020, but, instead, the market heated up.  Why? Due to the movement of large corporations, senior level executives and large private investors moving to South Florida.  This was due in part to the pandemic and no personal income tax.  This kept home prices from declining and values dramatically increasing.  They also sold their investment properties in the high tax states such as NY, NJ, California, Pennsylvania, etc. and purchased replacement properties in Florida.

Why is the market starting to shift now?  Because the Fed is looking at multiple rate increases (4) this year of  75 basis points each meeting. We could see interest rates as high as 6% to 7%, before the end of the year.  This means that Capitalization (Cap) rates must also move up, which will cause the pricing to decline.  We have seen this already occurring in other states in recent weeks.  This will make Buyers happy and put Seller’s in a state of reverse sticker shock, and, in some cases, they may even pass on good sale prices because they do not believe prices are declining.  Buyers are already refusing to accept some of the low cap rates on non-credit tenant transactions.  Transactions will slow in the third and fourth quarter of this year except for seller’s that are now trying to complete their 1031 exchanges.  These only will happen on truly all cash sales with no debt as the current rates are in the 4.75% to 5.5% range from banks and you can’t buy a property with leverage at a 4% to 4.75% cap rate.  The returns are breakeven to negative.

So, I believe we are entering a stabilizing market, we will see adjustments in the next 12 to 18 months, but not a crash.  It won’t be a Sellers or a Buyers’ market, but a market at equilibrium.  This means that both sides will walk away giving a little to make a transaction happen.

If you are a seller there is still time to take advantage of this market, but you need to be realistic and move quickly. Properties need to be properly unwritten with management fees (5%), vacancy and collection rates (5%), reserves for replacements, adjustments for increased property taxes based on sale, and a reasonable cap rate.

SperryCGA can help you still take advantage of the market. We have 60 offices throughout the US, with 8 offices here in Florida.

 

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CRE Investment Performance Has Been Sizzling

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If you’ve been invested in commercial real estate, you’ve had a superb trailing four quarters—on average. But that depends on what properties your money sat. As for the future, that’s looking uncertain.

Aegon Asset Management, in its June 2022 US CRE market insights, gave the initial data credit to the National Council of Real Estate Fiduciaries (NCREIF) Property Index. For the four quarters that ended in March, try a 21.9% total return: income return of 4.2% and capital appreciation, 17.2%. That’s better than the previous 17.7% in 2021.

Aegon called it “a continuation of the extraordinary total returns produced during 2021.” Hard to argue with the wording. But, depending on the property type, things split out quite differently.

Industrial was on top with a total of 51.9%. Multifamily, which has been second mentioned by many in the field, saw 24.1%. But remove those standouts from the average and the returns of other property types didn’t have the pizazz. Retail only managed 7.1%, and office, 6.8%.

Time for a breath, because after “these stunning results … investors are eyeing the challenges above,” Aegon noted.

The big and immediate elephant in the room is the Federal Reserve’s response to inflation. The agency is trying to manage a double challenge in its mandate: cool inflation without sending the economy into a recession and setting unemployment numbers sailing.

But the ongoing strength of the jobs market, with roughly 2 empty jobs for every person looking, likely means, as Fed watchers are saying, a higher interest rate hike than the 50 basis points that had seemed to be in the cards. Back in January, Fed Chair Jerome Powell said at a Senate Banking Committee hearing, “If we see inflation persisting at high levels, longer than expected, if we have to raise interest rates more over time, then we will.”

With the increasing pace of inflation, there’s a strong chance that the Fed will raise its benchmark interest rate by 75 to even, yes, 100 basis points.

“Commercial mortgage lenders are absorbing some of the rate increase by squeezing spreads but borrowing costs are increasing albeit with ready availability,” Aegon wrote. “The increase will make it tougher for investors to hit performance targets if historically low borrowing costs had been assumed to continue indefinitely.”

A faster increase in interest rates could also set off a so-called hard landing, especially considering ongoing supply chain problems, the war in Ukraine, and ongoing Covid problems in some major manufacturing areas, like China.

Then there’s also uncertainty about whether companies will use office space the way they used to, what will happen in housing as prices continue to rise faster than household incomes, and how some big industrial space users are backing off from what had until recently been a warehouse acquisition mania. And, of course, if consumers are being hit in the wallet, retail will eventually share the pain.

 

Source:  GlobeSt.
 

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