Looking for green shoots? Watch the credit cycle

Just as velocity of money (nominal GDP/money supply) is an important driver of monetary inflation, a greater influx of cash flow into commercial real estate (CRE) is a fundamental driver of property value appreciation. Figure 1 highlights the four-quarter rolling average transaction volume divided by the market cap for all property types.

Velocity normalizes volumes across cycles by controlling for the natural growth in the U.S. economy or the CRE market. Each CRE sector peaked in Q2 2022 at a level well below the high point of office’s velocity in 2007. This cycle the multifamily sector stands out with 1.5% of the market trading hands—well above past cycles and highlighting increased capital allocation to multifamily. The investment market’s peak reflects the fact that the cost of capital now exceeds the NOI prospects for most assets.

CRE velocity is fundamentally driven by the availability of capital and credit. Figure 1 illustrates how tightening lending standards have historically led to changes in velocity. Velocity will decline further in coming quarters as the Fed’s aggressive rate hikes and a broad pullback in lending activity will restrict capital flows into CRE. Eventually, price discovery will emerge once it becomes clear that the Fed’s rate-hike cycle is ending and/or if maturing loans force distress sales, particularly in the office sector. At that point, bid-ask spreads will narrow and banks would begin to expand their loan book again. CBRE EA believes green shoots such as these will begin to emerge by late 2023.

Figure 1: Real Estate Sales Velocity and Changes In Bank Lending Standards

Source: Costar, Federal Reserve