Rising inflation, higher mortgage rates, and geopolitical headwinds slowed the commercial real estate market during the third quarter of 2022, but as uncertainty about the economy begins to ease, CRE markets are expected to stabilize.
“The potential for a recession, inflation, increasing interest rates and the war in Ukraine naturally contribute to uncertainty, so we saw a pause in transaction volume during the third quarter of 2022,” said Richard Martinez, Head of Production, Agency lending for Greystone. “Acquisitions and financing for those deals are slowing down. The fourth quarter of 2022 won’t bounce back to where we were in the third quarter of 2021, but the market should stabilize.”
Overall commercial transaction volume was down 22% in the third quarter of 2022 compared to the third quarter of 2021, according to Real Capital Analytics, with multifamily transactions down 19.5% year over year.
“Financing should start to come back as uncertainty eases, particularly from Fannie Mae & Freddie Mac (GSEs),” said Martinez. “It’s very clear that the banks are receiving advice from the regulators to be a little more cautious, so they’re pulling back. Debt funds, which are a primary source of capital, have pulled back. The market should turn to stabilized financing, which is GSE financing. The agencies are countercyclical. They have solid underwriting parameters and good pricing, so they will be there to lend as a stabilizing force.”
Greystone is well positioned to take advantage of any rate drops and quickly implemented rate locks on deals that were on the sidelines when there was a 50-basis point drop in Treasuries, said Martinez. He anticipates investment sales to pick up during the first quarter of 2023.
Valuations and Transactions
Valuations are clearly in flux and, depending on the market, assets are down anywhere from 5% to 25%, Martinez noted. Overall, values are down about 15%, but not in all locations and property types.
“There’s less capital available for purchases and lenders are charging more for financing, so buyers are adjusting their valuations accordingly,” he added.
“Sellers are waiting on the sidelines to see how the market normalizes in the coming months,” he said.
Capital will be available for multifamily investors on both the debt and equity side, Martinez asserted, although cap rates are not likely to be at the historic lows they reached in 2021.
“Cap rates should be up, but it depends on the depth and breadth of the recession,” Martinez said. “If we get a soft landing and a mild recession, people will have the capital sitting on the sidelines to move into multifamily investments. If it’s a deeper recession, it may take a little longer, but there’s still a tremendous amount of capital that needs somewhere to go.”
However, increased lending costs impact developers in all markets.
“A year ago, the difference in cap rates and valuations between primary, secondary and tertiary markets was fairly flat,” Martinez said. “Now we’re seeing that tertiary markets have higher cap rates, with cap rates a little bit higher in the secondary markets compared to primary markets. We’re likely to get back to the point where there’s more of a differentiation in valuations between these markets.”
Institutional Investors and Real Estate
Institutional investors have made long-term strategic allocations into CRE for the past decade.
“I think we’ll see moderate growth among institutional investors,” Martinez said. “Throughout history, commercial real estate tends to be profitable, steady and, typically has limited downside over the long term.”
However, he anticipates that allocations may change within the portfolios of institutional investors.
“With office and retail values falling, multifamily investments may be a larger percentage of some portfolios, so there may be some rebalancing,” he said.
Capital Availability
In the short term, Martinez expects the pullback of capital for CRE to continue, especially among bankers. That should continue for at least the next 90 days.
“However, Greystone is one of the largest GSE lenders, so this situation plays into our strengths,” Martinez said. “The agencies have capital available even if it may look a little different than what the banks offer.”
In the medium term, Martinez anticipates capital to come back, with banks coming back last because of regulatory pressure.
“In the long-term there should be multiple robust sources of capital and I don’t see that as fundamentally changing,” Martinez said.
Opportunities for Investors
A significant number of loans will be maturing in the next few years after aggressive buying and lending in 2021, so some owners and lenders are forming opportunity funds in anticipation of troubled assets becoming available, Martinez noted.
“Greystone is well positioned to take advantage of potential opportunities to work with owners if they’re experiencing lackluster leasing or pressure from banks,” Martinez said. “We have lending capacity throughout our platform.”
More opportunities can be found in attempts to solve workforce housing and affordable housing issues, he believes.
“The FHFA took steps to reward borrowers who put self-imposed restrictions in place such as to keep 25% of units affordable for the term of the mortgage to renters who earn 80% of area median income,” Martinez said. “Borrowers who are willing to do that should get better pricing.”