Published on Wednesday, November 23, 2022
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Q3 report from JLL shows economic-driven caution dampens interest for first time since pandemic.
Global direct investment in real estate fell for the first time on a quarterly, annual basis since the onset of the pandemic, according to a report this week from JLL.
It dropped 24% to $234 billion due to uncertain economy, monetary policy and geopolitics, JLL said.
Retail and hotel investment bucked the trend, rising 19% and 7%, respectively, according to the report.
Investment in the living sector – which includes multi-family housing, build-to-rent and student housing assets – was up 9% year-to-date, despite declines during the quarter, JLL said.
Imminent Recession is ‘Highly Likely’
David Bitner, whose official title at Newmark is Executive Managing Director of Global Research, tells GlobeSt.com that the US economy is continuing to grow, but market-based indicators and expert commentary alike suggest that an imminent recession is highly likely.
Labor markets are tight with around 1.7 jobs available for every unemployed person, “a dynamic that has initiated a chain reaction in which wages are growing at their fastest pace in decades causing a subsequent spike in inflation and, ultimately, a rapid increase in rates from the Federal Reserve,” Bitner said.
“The combination of tightening global liquidity conditions, the strengthening dollar and rising hedging costs has conspired against inbound investment, despite weaker economic outlooks in many investors’ home countries. As such, foreign investment in commercial real estate is declining overall, though the activity that is occurring remains focused on the residential and industrial sectors.”
Bitner said that “dry powder” at closed-end funds currently sits at $257 billion — a record figure – and “this capital is concentrated in opportunistic and value-add vehicles while debt strategies have pulled back.”
Newmark estimates that roughly two-thirds of this capital is targeting residential and industrial assets.
Not ‘Out of the Woods’
Jared Gils, Senior Associate at Green Street, tells GlobeSt.com, “Uncertainty has more capital waiting on the sidelines. Real estate private equity is sitting on a mountain of dry powder, but little has been put to work this year. Many investors are waiting to see where the dust settles. It will take time for buyer and seller expectations to adjust. Once they do, we would expect investment activity to pick up.”
Peter Rothemund, Co-Head of Strategic Research, Green Street, tells GlobeSt.com that rising interest rates have caused property prices to decline by 13% this year, according to Green Street’s November Commercial Property Price Index.
“It’s a simple story: Higher yields on Treasury bonds equals higher cap rates,” Rothemund said. “And as large as the decline in pricing has been, I don’t think we’re out of the woods. If the 10-year note stays above 4%, property prices are likely to keep falling.”
Repricing of Transactions Now ‘Common’
Sean Coghlan, global head of capital markets research and strategy at JLL, said in prepared remarks, that many investors remain cautious and are delaying decision-making.
“In most markets across the globe, repricing of transactions is now common, and a prolonged period of price discovery is impacting investment conditions,” Coghlan said.
In a sign of caution, JLL reported that bidding dynamics weakened across all real estate sectors during the third quarter. The average winning bid-ask spread declined, as well as the variability of bids on transactions.
“This is having an impact on market efficiency and muting transaction markets,” Coghlan adds. “The outlook is now more uncertain.
“Having lagged the U.S. market, pressure on underwriting has grown in Europe and Asia in the latter half of 2022. Volatility is not uniform across lenders, with lender appetites shifting with market conditions.”
Values Continue to Be ‘Put into Question’
Vincent DiSalvo, chief investment officer for Kingbird Investment Management, tells GlobeSt.com, “Real estate values, like valuations across all asset classes, continue to be put into question as the Fed determines its policy guidance going forward. While investors are wise to remain cautious, real estate is special because it is both a cash flow series and a hard asset.
“The underlying cost inputs to new construction are not currently seeing much softness. This implies that stable CRE sectors like multifamily, may have a softer landing ahead because even at bottom they’re theoretically at least as valuable as their replacement cost.”
Opportunities on the Horizon
Neil Schimmel, CEO of Investors Management Group, tells GlobeSt.com that “the disconnect that real estate sponsors are currently experiencing is putting us in a position of being very watchful for strong market signals indicating how the next months will look like.
“We've been proactively addressing immediate risks and opportunities all year, and we're constantly adjusting our predictions. As our anticipated timeline plays out, we'll have even more confidence moving forward.
“Watching for things like the labor market loosening and construction costs deflating, I can see opportunities on the horizon with other facets of our business. As of today, investors are holding onto real estate value, so interest in the multifamily sector is gaining momentum. I expect to see more movement in the first and second quarters of 2023.”
Digging Beyond the Headline Statistics
Bonnie Murray, CEO, New York-based Raccord, tells GlobeSt.com, “Certainly some investors are sitting on their hands until the landscape becomes clearer, and that’s had an obvious impact on investment volumes.
“However, if you do a bit of digging beyond the headline statistics, there’s still activity across some sub-sectors within real estate. We’re seeing a de-risking of portfolios as assets are revalued based on the current market dynamics.
“The flight to quality is typical during market dislocations. The key for proactive investors will be to focus on data integrity which informs strategic investment decisions as we head into 2023.”
Flashback to the 1990s
Geoffrey West, Senior Vice President, MDL Group/CORFAC International in Las Vegas, tells GlobeSt.com that since 1990, the 10-year treasury has not seen as significant of an increase in this short of a time as has occurred in the past 26 months.
In that time, it went from a low of 52 bps in Aug 2020 to a recent high of 4.24% on Oct. 20 - an increase of 3.72%.
West pointed to 1990 as the beginning of the downward trend of the 10-year Treasury, decreasing from an average of 8.5% in 1990 to 89bps in 2020.
“The beginning of this decline also coincided with the evolution of a new world order with the fall of the Berlin Wall, the dissolution of the USSR, the strengthening of NATO, and a general stability among the world powers,” he said.
Most-Active Investors: Late-Boomers, Early Gen-Xers
Investors currently most active in the market include late-Boomers and early Gen-X, both generations who came of age in a time of world instability and the nuclear arms race which created a general environment of uncertainty, West said.
“We now find ourselves in a similar geopolitical situation of increasing instability with Russia, China, North Korea, and Iran and as learned in the Great Recession as the world economy goes so goes the United States economy on a macro basis,” West said.
“While this geopolitical situation may not directly impact the average investor’s behavior, it is reasonable to expect this uncertainty to have some impact and when coupled with the uncertainty being exhibited in the capital markets environment and the significant existing bid-ask spread being exhibited the current market pause is understandable.
“Investors appear to be ready to be patient and avoid catching a falling knife as the necessary market correction of 20% to 30% value decreases occurs to bring risk adjusted real estate yields in line with underlying index rates and debt costs.”
Investors Don’t Want to ‘Jump in too Early’
Constantine “Tino” Korologos, CRE, member of the Counselors of Real Estate, NYU clinical assistant professor and founding principal of Leonidas Partners LLC, tells GlobeSt.com that geopolitical risk may be less visible in the press, and not as pressing as it was at the start of the Ukraine-Russia war, but it still can trigger further ‘risk-off’ and investment uncertainty if anything else escalates globally.
“Investment transaction activity is impacted by cost of capital, the availability of mortgage debt, the expectations of future returns and a bid-ask spread that has not tightened enough to stimulate deal flow,” Korologos said.
“There is no clarity on the settling mortgage rates and cap rates, and values adjustments have not materialized enough to point to a measurable correction.
“The impact on assets that have debt maturities approaching, could increase distress that will affect the market. Investors don’t want to jump in too early, but recognize that if they wait too long, they may miss opportunities.”