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Capital Markets Forecast Calls For Cap Rate Stabilization, More Transactions

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Forecasts are helpful, but how accurate they are is what ultimately counts.

CBRE undertook a review of the forecasts it made at the beginning of the year and updated its outlook through year-end and into 2024.  For the most part, the company has nailed the trends that have been occurring in the CRE capital markets, with a few exceptions.

Namely, it has altered its prediction about the timing of a recession due to the resilient economy and persistent inflation. It now predicts if one happens it will occur in late 2023 or in the first quarter of 2024, one quarter later than it originally thought. A recession may bring a mild increase in unemployment to about 5%. Other headwinds of higher interest rates may affect growth negatively in this year’s second half and the restart of student loan payments may pare consumer spending. CBRE has adjusted its 2023 GDP growth forecast upward to 0.6% and 2024 growth forecast downward to 1.3%.

Investors have been cautious so far this year in their transactions, with volume down by 60% year-over-year in the second quarter. Uncertainty about interest rates and the outlook and tighter credit conditions are expected to continue to be hurdles to deal flow, but more stable conditions are coming, it predicts, before year-end. That should bring pick-up in investment activity, CBRE says.

Cap rates have increased by about 125 basis points for most property types but variations occur by market and are closer to 200 bps for office assets. By early 2024 there should be cap rate stabilization for all property types, except offices, which won’t stabilize until next mid-year.

Investment volume is forecast to decline by 37% year-over-year this year and increase by 15% next year due to greater certainty about interest rates and as the economic outlook supports stronger purchasing activity.

Finally, an interest rate cut is not expected until early 2024 and the 10-year Treasury rate will end this year at 3.8% before falling closer to 3% late next year.

 

Source:  GlobeSt.

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$626B In CRE Debt Maturing In The Next Two Years Is Potentially Troubled

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A somber portrait of the state of U.S. capital markets and their impact on CRE has emerged from Newmark’s second quarter Capital Report.

It depicts a landscape of low loan originations, fewer lenders, underwater loans, troubled debt about to mature, and rising cap rates across a wide swath of the CRE spectrum.

Loans are hard to get in this new world. CRE debt origination is down 52% in 1H 2023 compared to the prior year and 31% compared to before the pandemic. Equally concerning, there are 32% fewer active lenders in the market today compared to a year ago.

“The small and regional bank lending engine that has driven the CRE market is rapidly slowing with no clear replacement,” the report noted. 

And this is affecting the entire banking industry, not just regional banks. All property types and lending sectors are affected, “though office, debt funds and CMBS/CRE CLOs (commercial real estate collateralized loan obligations) are negative outliers.” Loan originations are down most dramatically for multifamily.

Furthermore, banks are being more restrictive about whom they lend to and the assets they are willing to consider.

And if loans are hard to get, some of those that were made in the good times and are coming due will create new headaches. Newmark predicts that $1.4 trillion in debt will mature in 2023-2025 — but with significantly higher debt costs than when the loans were originated. On top of that, many loans are actually or nearly underwater, especially recently issued property and office debt.

The report also identified clear increases in transaction cap rates, “which now appear distinctly unattractive relative to the cost of debt capital, possibly excepting office REITs.”

 

Source:  GlobeSt.

 

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Institutional Investors Upping Interest In Industrial Outdoor Storage

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Industrial outdoor storage (IOS) is emerging as an increasingly popular property sector among institutional and other types of investors.

Interest in the sector ramped up during the pandemic as space was needed for container storage to relieve backlogged ports. Estimates from the experts WMRE interviewed suggest that the U.S. IOS market, which represents a niche within the larger industrial asset class, ranges somewhere between $130 billion and $200 billion in value.

Zoned for industrial use, IOS sites typically house vehicles, construction equipment, building materials and even shipping containers on an interim basis and range in size from two to 10 acres, often including a small building. The sector has been referred to as a “beautiful ugly duckling” by Green Street’s Vince Tibone since the properties are just lots with storage containers and construction equipment that have delivered “exceptional” returns over the last three years and brought in more institutional investors for funds raising hundreds of millions of dollars to target IOS.

While the sector is not immune to the same forces that are affecting other property types in the current environment, Tibone said he remains bullish on IOS over the next five to 10 years. Investor demand for IOS has been buoyed by strong recent operating results, favorable long-term supply/demand dynamics and a minimal cap-ex burden with an option to use the land for a higher and better use at some future time.

IOS sites located in infill submarkets in particular can deliver risk-adjusted returns “that are superior to those available on most other commercial real estate investments, including traditional industrial,” Tibone said. However, the fragmented, non-institutional ownership structure of the sector today makes it difficult to invest at scale, he noted.

“IOS portfolios do not come on the market often and the best returns are likely available through one-off deals, where there could be operational upside left on the table from the prior owner,” Tibone said. “Those with the patience and wherewithal to aggregate infill IOS sites over time should be rewarded with robust total returns relative to other property types.”

Among investors that are currently raising funds and targeting acquisitions in the IOS marketplace is EverWest Real Estate Investors, a Denver-headquartered real estate investment advisor with $5.2 billion in assets under management, including in the industrial, multifamily, office and retail sectors.

EverWest operates open-end funds and three single–client accounts with industrial strategies focused on IOS. The average size of the deals it has completed ranges between $10 million and $25 million.

So far in 2023, EverWest acquired two IOS sites—39.6 acres south of Atlanta for $12 million and 4.12 acres in Miami for $12.5 million, according to John Maurer, EverWest’s senior managing director and head of portfolio management. In May, the firm also invested in an industrial asset in Carlson, Calif. that includes acreage that can be used for IOS.

Part of the appeal of the sector is that when U.S. industrial inventory tightens and rents rise, IOS sites rise in value as they become reliever locations for a wide range of logistics activity, Maurer noted. In addition, in a market where industrial assets are still often priced at a premium, with cap rates as low as 4.5%, an IOS site adjacent to such a traditional industrial asset will often sell at a cap rate that’s 50 basis points higher. Rental rates in the sector have also been rising by 3.5% to 4.0% a year, according to Maurer.

EverWest’s open-end fund, the Open End Diversified Core Equity Fund in the NFI-ODCE Index, has a target return of 10%. Like Tibone, Maurer noted that the IOS marketplace is less institutionalized than regular industrial and has more fragmented ownership.

“We think because it’s difficult to acquire these sites that are smaller, if you aggregate portfolios in a target market that there’s going to be a cap rate compression,” Maurer said.

As a result, EverWest aims to aggregate a number of acquisitions from different sellers to build up its IOS holdings. Over the past 12 to 18 months, the firm has invested about $200 million in the IOS sector and it hopes to double that volume in the next 12 to 18 months. EverWest is also planning to launch an enhanced fund with a higher return strategy in the near future that will have a significant IOS component, according to Maurer. The firm is hoping to build off its current investor base of public and private pension plans, foundations and endowments, insurance companies and financial advisors for the fund, Maurer said.

However, Maurer admitted that EverWest’s transaction volume is currently about 15% off what it was a year ago because the increase in interest rates has made the firm more selective in making new purchases.

“There are some compelling opportunities in the marketplace in terms of attractive return potential, given where rates are today versus they were 12 months ago,” Maurer said. “We always want to look at where pricing is going and take advantage of correctly priced opportunities. What we see is sellers ultimately capitulate and need liquidity, so they will sell at market-clearing prices based on our new model for interest rates in the current environment.”

Assuming a leverage level of 40% to 40%, EverWest’s investments can deliver gross returns of 12% to 14% over a seven- to 10-year period, Maurer noted. That would require a barbell approach of doing straight up five-year lease IOS deals, he said. There would also need to be some value-add component for redevelopment in its strategy. About 20% of the IOS marketplace is about adding a warehouse over time, Maurer noted.

Change Is Coming

In the meantime, the number of institutional players involved in the sector is growing. For example, Brooklyn-based Zenith IOS, a builder and owner of outdoor storage properties, has partnered with institutional investors advised by J.P. Morgan Global Alternatives, to buy hundreds of millions of dollars of IOS properties last year. In February, J.P. Morgan and Zenith IOS announced a $700 million joint venture to buy more IOS assets.

Another active participant in the marketplace is Alterra IOS, which is part of Philadelphia-based Alterra Property Group, a real estate investment and development company that, according to reports, made more than $850 million in acquisitions over the past year.

In its most recent announcement, dated June 22nd, the firm expanded its presence in Las Vegas by acquiring a six-acre site for $7 million—its third in the marketplace.

Alterra declined to comment on its current fundraising effort, instead referring to a public filing from the Ventura County Employees’ Retirement Association (VCERA). The filing contained a recommendation to commit $35 million from the pension fund to Alterra’s IOS Venture III fund. Alterra’s goal has been to raise $750 million for the fund targeting IOS properties, according to IPE Real Assets. A previous Alterra fund raised $524 million in 2022, exceeding the firm’s goal of $400 million.

IOS Venture III will target smaller, infill IOS assets operating on triple net leases. Part of the value proposition of these assets, according to VCERA’s filing, is that they are typically owned by single owner-operators and have escaped the attention of most institutional investors. Alterra also plans to leverage its in-house management and leasing expertise to pursue value-add strategies for the assets. The firm estimates that it will generate from 30% to 40% of its total returns through the assets’ current cash flow, creating annual cash flow yields of 6% to 8%.

The fund has an eight-year horizon, with two one-year extension options, and will offer a preferred return to investors of 9%, with a carried interest of 20%. The fund’s net IRR target is between 14% and 16%, with a leverage ratio of 65%.

In addition to VCERA, Alterra’s equity investors include other public pension funds, foundations, endowments, insurance companies and family offices, both domestic and foreign, according to Managing Director Matthew Pfeiffer.

“Investors are finding IOS an attractive proposition right now because, unlike with a number of other real estate assets, supply is structurally muted, with municipalities not being incentivized to add new zoned land for outdoor storage,” Pfeiffer said.

He also mentioned the attraction of low cap-ex.

“Beyond the favorable supply and demand dynamics, IOS also benefits from being a very low capital expenditure business translating into low frictional leasing costs to put new tenants in the space,” Pfeiffer noted. “Lastly, the tenant profile is largely credit and national, under a triple-net lease structure that further entices institutional capital’s interest in the space,”

According to BJ Feller, managing director and senior vice president at Northmarq, cap rates on traditional industrial properties have gotten so aggressive in recent years that institutional capital was looking for opportunities with a similar profile, but more attractive cap rates.

“Once they’ve been able to establish their credibility and track record in the segment, we’ve seen operators have great access to the capital sources who want to play in this asset class,” Feller said.

He added that while equity inflows to the sector have “cooled to a certain degree” on a year-over-year basis, they remain robust relative to other property types.

“Most of the decline has been a reaction to caution that cap rates may be going mildly higher and offer better acquisition opportunities in the months ahead,” Fuller said.

 

Source: Wealth Management

 

 

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Sale Leaseback Cap Rates Continue To Attract Investors

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While pricing has widened, early indications in 2023 point to a growing return to confidence for the sale leaseback market, according to a market update report from SLB Capital Advisors.

The report cites “strong credits and robust business models achieving successful processes with large interest from investors”, even in non-core markets, particularly industrial.

Due to the current interest rate environment and companies’ overall cost of capital, the SLB cap rates offer a more attractive cost-of-capital solution than ever, according to the report.

“SLB rates remain well inside of many companies’ WACCs and today, in more cases than not inside companies’ current cost of debt financing, making the sale leaseback an incredibly attractive financing alternative,” it stated.

There continues to be an attractive value arbitrage across various industry sectors driven by the delta between business and real estate multiples. The multiple implied by average SLB cap rates (i.e., 6.25% to 8.25%) implies a multiple of over 12x to 16x.

This compares favorably to general middle market transactions which averaged 6.9x LTM EBITDA for 2022. Attractive arbitrage opportunities are generally prevalent across many middle-market sub-sectors, the report said.

 

Source:  GlobeSt.

 

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Hotels Are ‘Hottest’ Asset Class So Far In 2023

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It’s been a tremendous start to 2023 for hotel investors who are enjoying record sales for quality assets in highly desirable and growing markets, according to a report from JLL.

The $850 million sale of the Diplomat Beach Resort (pictured above) in Hollywood, Florida, was the third-largest single-asset sale in US history.

The recent closing of the AC Hotel Phoenix Biltmore set a record price-per-key for upscale select-service assets in the Phoenix market.

Kevin Davis, Americas CEO, JLL Hotels & Hospitality Group, said in prepared remarks that investors are buying into the thesis that long-term growth trends in certain markets will outweigh near-term capital markets dislocation.

“As a result, these investors are willing to buy at cap rates that are lower than the cost of debt because the growth story is so compelling.”

 

The ‘Hottest Asset Class’

Brandon Lewe, vice president of Sales at Ten-X, tells GlobeSt.com that overall, hotels are currently the “hottest” asset class on Ten-X, with momentum building year over year, further highlighting a strong hotel sales outlook.

“Buyers love the category,” Lewe said. “Last year hotels had the highest trade rate (62%) of any asset class and this year, even more investors want to buy.”

Hotel properties had twice the number of bidders per property as the next most popular asset class, he said. “And the trade rate has climbed 10 percentage points – to 72% – for properties that have gone to auction this year.

“We see more inventory coming online and that inventory is high quality, coming from institutional investors. Two of the largest U.S. institutional investors are bringing an influx of new inventory to our platform. ‘SMILE’ states, especially Texas, are hot locations for sellers.”

 

Extended Stay Cap Rates Approaching Multifamily

Matt McElhare, senior director, Extended Stay Brands at Choice Hotels International, tells GlobeSt.com that generally, “everyone is looking to add exposure to the segment given industry performance and profitability relative to traditional hotels.”

Extended stay at a lower price point provides a different return and risk profile than a traditional hotel or upscale hotel.

“We’ve seen cap rates approaching multifamily levels of the last two years,” McElhare said.

“The demand picture (2x supply, emerging trends providing tailwinds e.g. relocations, reshoring of supply chains, infrastructure, etc.) is really strong, which, combined with the difficulty adding supply in the near/medium term due to higher cost of capital and construction costs, is creating a favorable picture for high performance continuing in the extended stay segment.”

He said the performance outlook is bolstering demand for the acquisition of existing extended-stay hotels despite low cap rates and high valuations, particularly in areas of growth such as the Carolinas, Florida, and Texas.

“Lenders have historically treated hospitality financing as one big bucket but we’re seeing encouraging changes there as lenders recognize the different risk/return profile and think about the segment differently,” McElhare said.

McElhare tells GlobeSt.com that activity for large institutional capital in the space has remained elevated despite the higher costs of capital and construction hard costs as well as evaluations for existing extended-stay product.

Higher Occupancy Means Hiring Challenges

The American Hotel & Lodging Association (AHLA) and Oxford Economics recently reported that it expects hotel-generated state and local tax revenue to set a record at $46.71 billion this year.

Additionally, it sees average U.S. hotel occupancy reaching 63.8% in 2023 – just shy of 2019’s level of 65.9%.

“Staffing is expected to remain a challenge for many U.S. hotels in 2023, as the industry continues to grow its workforce back to pre-pandemic levels,” AHLA said in a release.

Nearly 100,000 hotel jobs are currently open across the nation as of Q4 2022, according to Indeed, even as “national average hotel wages were at historic highs of over $23/hour and hotel benefits and flexibility are better than ever,” according to AHLA.

 

Source:  GlobeSt.

 

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Small Market, Suburban Office Sales Take The Lead

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Small market and suburban office sales lately are holding up better than their urban counterparts for three reasons: they are smaller assets, they are better basis plays, and they are typically occupied by users who are more likely to have returned to work, according to Craig Tomlinson, Senior Vice President of Northmarq.

He tells GlobeSt.com this and that for Q3 22 in the net lease office sector, there were 71 arm’s length sales in small markets and 90 large (primary) markets.

For small markets, the average deal size was 34,000 SF and avg sale price was about $8.5 million and modest $245.00 SF.

In large markets, Tomlinson said the buildings averaged 54,000 square feet, selling for $25.5 million, a “whopping” $480 per square foot,” Tomlinson said.

“Smaller loan amounts and lower basis muted the effects of negative leverage for these buyers,” he said. “Small market office buildings are typically occupied by tenant’s who decision makers are local and more likely to mandate return to work measures.”

Tomlinson said all these factors gave small market office a leg up and he expects the trend to continue.

Flight to Quality ‘Will Drive Tenancy for Foreseeable Future’

The Newmark Office Report finds that “overall transaction cap rates have been stable, but there have been some relatively notable shifts within the office market. The spread between central business district (CBD) and suburban cap rates had closed in 2022.

“Higher-quality, Class A assets in suburban markets have performed better than CBD office markets thus far in 2022,” according to Newmark. “Similarly, secondary office market yields have closed relative to major metros, highlighting the strength of non-gateway markets, including Dallas, Austin, Atlanta, etc.”

Furthermore, Newmark’s report said that flight to quality “will drive tenancy for the foreseeable future, though high-quality assets in dynamic suburban markets may hold an advantage over traditionally stable downtown assets.”

Relatively high availability, downward pressure on rents and greater demand for a vibrant worker experience will benefit the upper tier of the office market.

For those with more risk appetite, capitalizing on low pricing for Class B+/Class A- buildings with plans to modernize “could be attractive, along with build-to-core in markets structurally lacking in top-tier office space.”

 

Source:  GlobeSt.

 

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Industrial Cap Rates Expected To Rise But Outlook For Seasoned Investors Remains Strong

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Industrial has been on quite a tear over the past few years, as changes in consumer behavior have driven demand for more logistics and fulfillment facilities in key markets.

And according to one industry expert, the sector should stay a favored asset class for experienced investors, despite rising capital costs.

“Post-pandemic consumer behavior has changed and the rate of growth in ecommerce has slowed which has already led to pullbacks by some companies,” says Greg Burns, Managing Director at Stonebriar Commercial Finance, noting Amazon’s recent announcements regarding its industrial portfolio. “Demand for industrial though was driven by other factors as well including a move toward onshoring and the disruption of just in time supply chains.”

With that said, however, Burns said “depending on the what and the where, I would not be surprised to see cap rates widen another 50 to 100 basis points.”

“The cost of debt and equity capital have increased and cap rate hurdles have increased for institutional buyers,” Burns says, adding that he recently saw an increase of 100 basis points in an appraisal for a property in a market where his firm closed a deal six months ago.

Burns will discuss what’s happening in the capital markets in a session at next month’s GlobeSt Industrial conference in Scottsdale, Ariz. He says Stonebriar’s definition of industrial includes not just warehouse and distribution facilities, but manufacturing, life sciences, cold storage and data centers as well, and notes that “each of those sub-categories have their own dynamic and, broadly, all are growing.”

“We prefer properties with multi-modal access, especially those near ports, with most opportunities we’ve seen recently being to the southeast of a line drawn from Baltimore to Phoenix,” Burns says. “We also pay attention to outdoor storage capacity as that has become a greater consideration for tenants. There have been several announcements of new manufacturing sites relating to microchip and electric vehicles which should lead to demand for new logistics properties nearby.”

As the costs of debt capital rise, Burns says Stonebriar’s underwriting will continue to focus on the sponsor, asset and market and “that won’t change.”

“We do few spec development deals and will likely be more granular on understanding the demand/supply side of a respective market,” Burns says.

Ultimately, a recession seems likely and Burns says the changing economic landscape will have “varying impacts” on investors and individual markets alike.

“From our perspective, there will be a premium on a sponsor’s experience and capacity,” Burns says. “I anticipate industrial will remain a favored asset class for investors although those with less experience in the sector could pull back until the economy recovers.”

 

Source: GlobeSt.

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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.

 

To receive more information on available properties and off-market listings, please complete the form below:

 

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Will Rising Interest Rates Also Propel Upward Movement In Commercial Real Estate Cap Rates?

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Interest-rate hikes from the Federal Reserve are expected this year. One key question still being debated by the commercial real estate industry: What do rising interest rates mean for capitalization rates?

One of the most commonly used valuation measures in commercial real estate, cap rates are determined by dividing a property’s net operating income by its current market value. Cap rates are often used to compare the rates of return on commercial properties, and also give insight into how much risk a property may carry.

Since the pandemic, cap-rate compression has been observed, especially, in white-hot sectors like industrial and multifamily.

There’s not a one-to-one correlation between cap rates and interest rates, although economists say the expected hikes coming this year could have some influence on where cap rates go in 2022.

Brian Bailey, commercial real estate subject-matter expert at the Federal Reserve Bank of Atlanta, said in a discussion this week hosted by commercial real estate software company Altus Group Ltd. that a rise in cap rates is prompted by many variables. But the prospect of rising interest rates does create risk for higher cap rates.

The risk associated with higher cap rates depends, too, on loan-to-value ratios at origination, Bailey said. Movement in cap rates in an 85% loan-to-value scenario creates a much greater risk of loan default, he said. In fact, any commercial loans that have an LTV ratio of 75% or greater may need to be closely monitored.

Bryan Doyle, managing director of capital markets at CBRE Group Inc., said during the Altus Group panel that the amount of capital waiting on the sidelines to be deployed into real estate should help keep cap rates stabilized, if not further compressing.

In fact, in a five-quarter period ending in the third quarter of 2021, long-term interest rates rose by more than 70 basis points while cap rates for industrial and multifamily compressed by 50 and 75 basis points, respectively, in the same period, CBRE said in a December report. Investors will have to consider whether an increase in cap rates will be offset by higher rents that’ll produce higher net operating-income growth, CBRE noted.

The office sector may be one to watch because of the significant, pandemic-induced changes it’s likely to see, Tim Savage, clinical assistant professor at New York University’s Schack Institute of Real Estate, said at the Altus Group discussion.

“That will impact NOI, and we know that will, therefore, impact cap rates,” he continued. “I would say, (probably), there will be slight upward pressure on cap rates going forward. They are not divorced from interest rates or, especially, from the Fed’s asset buying.”

 

Source:  SFBJ

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