How long before capital gets deployed to real estate again?

December 2, 2022 3 Minute Listen

Investment activity, asset values expected to drop

The slowdown in commercial real estate investment activity that began in the second half of 2022 will continue in the first half of 2023. Financing may be difficult to obtain as the cost of capital increases and lender appetite diminishes amid volatility in financial markets. However, capital is available for the right deals, such as high-quality multifamily, industrial and grocery-anchored retail, or with established, creditworthy borrowers. CBRE expects lenders will become more active as the macro-economic environment improves and interest rates stabilize.

The market will also benefit from the near-record amounts of equity capital that continue to target real estate investment despite the prospect of a moderate recession next year.

Figure 4: Global Dry Powder by Sector

Sources: Preqin, CBRE Research, October 2022.

Rising interest rates to impact values

Rents tend to keep pace with inflation over the long term, making commercial real estate relatively attractive in times of high inflation. However, real estate asset values fall when interest rates rise, as tighter financial conditions inhibit economic activity and real estate demand. Since bottoming in early 2022, cap rates are up by approximately 100 basis points (bps) across all property types, translating to a 10% to 15% decline in values through the first three quarters of 2022. CBRE forecasts cap rates may expand by another 25 to 50 bps next year, which translates to roughly another 5% to 7% decrease in values.

Figure 5: Historical Cap Rates & Forecast

Sources: CBRE Econometric Advisors, CBRE Research.

Due to their relatively strong fundamentals and positive long-term demand outlook, multifamily and industrial properties will remain the most favored by investors. Grocery-anchored retail centers will also remain attractive following a decade of restrained development that bolstered fundamentals and has left the sector well positioned to weather a downturn. Investors will remain more discerning between high-end Class A office assets, which continue to have relatively strong fundamentals, and Class B and C office assets, which are showing signs of distress.

While higher capital costs will deter some buyers, there will be opportunities for large equity players who can deploy capital quickly. However, these investors will likely have a short window: Following the Great Recession, the trough in pricing only lasted around six to nine months before cap rates began to compress. Given expectations for a relatively moderate recession, the window of opportunity may be even shorter this time.

Figure 6: New York Commercial Real Estate Investment, Pre- & Post-GFC

Note: Bubbles are scatter plot indicating year and cap rate, size of bubble corresponds to magnitude partial investment volume.
Sources: CBRE Research, Real Capital Analytics, Q3 2022.

Investment activity will bottom out in early 2023

CBRE forecasts a 15% year-over-year drop in U.S. commercial real estate investment volume in 2023, although it will exceed the pre-pandemic record annual total in 2019. Investment activity likely will bottom out in the first quarter and then gradually improve. This timing assumes a moderate recession, lower inflation, a drop in long-term U.S. Treasury yields and the end of rapid-fire interest rate hikes. All of this will result in a less-uncertain environment, bolstering investor sentiment and facilitating sound underwriting.

Figure 7: Historical U.S. Commercial Real Estate Investment Volume & Forecast

Sources: CBRE Research, Real Capital Analytics , Q3 2022.

Trends to Watch

Discerning Buyers

Multifamily and industrial will continue to enjoy structural tailwinds, which will underpin investor preference for those property types. Grocery-anchored retail will also fare well as investors gravitate toward relative strength in the market. Office investors will continue to prefer high-end Class A buildings.

Waning Uncertainty

By Q2 2023, a clearer picture should emerge about the terminal (max) federal funds rate and the overall economic outlook. Long-term yields and spreads should help reduce capital cost and allow for more sound underwriting. As a result, we expect quarter-over-quarter improvements in capital markets activity starting in Q2.

Investment activity, asset values expected to drop

The slowdown in commercial real estate investment activity that began in the second half of 2022 will continue in the first half of 2023. Financing may be difficult to obtain as the cost of capital increases and lender appetite diminishes amid volatility in financial markets. However, capital is available for the right deals, such as high-quality multifamily, industrial and grocery-anchored retail, or with established, creditworthy borrowers. CBRE expects lenders will become more active as the macro-economic environment improves and interest rates stabilize.

The market will also benefit from the near-record amounts of equity capital that continue to target real estate investment despite the prospect of a moderate recession next year.

Figure 4: Global Dry Powder by Sector

Sources: Preqin, CBRE Research, October 2022.

Rising interest rates to impact values

Rents tend to keep pace with inflation over the long term, making commercial real estate relatively attractive in times of high inflation. However, real estate asset values fall when interest rates rise, as tighter financial conditions inhibit economic activity and real estate demand. Since bottoming in early 2022, cap rates are up by approximately 100 basis points (bps) across all property types, translating to a 10% to 15% decline in values through the first three quarters of 2022. CBRE forecasts cap rates may expand by another 25 to 50 bps next year, which translates to roughly another 5% to 7% decrease in values.

Figure 5: Historical Cap Rates & Forecast

Sources: CBRE Econometric Advisors, CBRE Research.

Due to their relatively strong fundamentals and positive long-term demand outlook, multifamily and industrial properties will remain the most favored by investors. Grocery-anchored retail centers will also remain attractive following a decade of restrained development that bolstered fundamentals and has left the sector well positioned to weather a downturn. Investors will remain more discerning between high-end Class A office assets, which continue to have relatively strong fundamentals, and Class B and C office assets, which are showing signs of distress.

While higher capital costs will deter some buyers, there will be opportunities for large equity players who can deploy capital quickly. However, these investors will likely have a short window: Following the Great Recession, the trough in pricing only lasted around six to nine months before cap rates began to compress. Given expectations for a relatively moderate recession, the window of opportunity may be even shorter this time.

Figure 6: New York Commercial Real Estate Investment, Pre- & Post-GFC

Note: Bubbles are scatter plot indicating year and cap rate, size of bubble corresponds to magnitude partial investment volume.
Sources: CBRE Research, Real Capital Analytics, Q3 2022.

Investment activity will bottom out in early 2023

CBRE forecasts a 15% year-over-year drop in U.S. commercial real estate investment volume in 2023, although it will exceed the pre-pandemic record annual total in 2019. Investment activity likely will bottom out in the first quarter and then gradually improve. This timing assumes a moderate recession, lower inflation, a drop in long-term U.S. Treasury yields and the end of rapid-fire interest rate hikes. All of this will result in a less-uncertain environment, bolstering investor sentiment and facilitating sound underwriting.

Figure 7: Historical U.S. Commercial Real Estate Investment Volume & Forecast

Sources: CBRE Research, Real Capital Analytics , Q3 2022.

Trends to Watch

Discerning Buyers

Multifamily and industrial will continue to enjoy structural tailwinds, which will underpin investor preference for those property types. Grocery-anchored retail will also fare well as investors gravitate toward relative strength in the market. Office investors will continue to prefer high-end Class A buildings.

Waning Uncertainty

By Q2 2023, a clearer picture should emerge about the terminal (max) federal funds rate and the overall economic outlook. Long-term yields and spreads should help reduce capital cost and allow for more sound underwriting. As a result, we expect quarter-over-quarter improvements in capital markets activity starting in Q2.

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