Jeffrey D. Fisher Ph.D

We were pleased to host Dr. Jeffrey Fisher to discuss his commercial real estate market research work at NCREIF and RealNex. With returns off 7.9% at year-end 2023 and 3.0% for the quarter on the NCREIF Property Index (NPI) and 12.1% and 4.6%, respectively for their levered index, Dr. Fisher’s opening begged the question, are we expecting a bottom in 2024 or, borrowing a phrase from the late great Sam Zell, do we need to stay alive until 2025?

W-Shaped Recovery Forming

Dr. Fisher pointed to the solid performance of Farmland, up 5.0% for the year, and Timberland, up 9.5% for the year, together with the 7.9% gain in the S&P REIT Index, including 18.0% in the 4^Th quarter as leading indicators of a market turn. While appraised values of NCREIF properties dropped 14% from the peak and sold property values dropped 21%, there appears to be a bottom forming. Although not a V-shaped recovery as we witnessed in the last two cycles, a tight W appears to be taking shape. The sharp decline in sold property values results from investors’ willingness to part with their worst assets while holding much of their portfolio dear. Indeed, only 90 of the 10,000 properties tracked in the index traded in the past year. That is down from over 200 in a typical year. Dragging the index down the most, office property values dropped by 41%, while industrial values dropped only 6% to buoy the index.

Transaction Volume Drops Precipitously

From a market transaction volume standpoint, Dr. Fisher referenced CBRE data, which indicated a peak volume of $350 billion in Q1 of 2022 has leveled off at a trough of roughly $80 billion per quarter for the past year. The drop in activity is over 75% from peak to trough and approximately 50% off the long-term average of $150 billion. Not surprisingly, the precipitous drop in activity was led by a massive decline in the sale of significant office assets in major urban markets.

Write-Downs Swell

Given the market conditions, private equity funds took writedowns on the majority of the assets in their portfolios. Running at over 50% for the past five quarters, writedowns peaked at 65% after troughing at only 10% in Q1 2021. Although values were off more dramatically, overall returns were less severely impacted as rental growth, and NOI continued to support investment returns. As Cap Rates continue to track Baa bonds, expect them to peak in 2024 and decline as the bond rate follows bank lending rates lower.

Alternative Asset Classes Draw Attention

In their search for returns, institutional real estate investors have broadened their net in recent years to the point that a host of “alternative” asset types are being added to the NPI + index. These alternative assets have enjoyed superior returns and will now be tracked along with the core asset types. Some of the new additions include single-family residential, data centers, life sciences in both office and industrial categories, self-storage, now a category unto itself, medical, entertainment, parking, and operating land. These new categories add over $60 billion in asset value to the index and comprise nearly 7% of the holdings. 

Under Water Properties Increase, Tight Lending Conditions Persist

Of the 10,000 properties in the Index, nearly 0 had a Loan-to-value ratio exceeding 1 in the early 2000s. At the end of 2023, that number ballooned to 115. That number may seem high from nearly 0% to 1.15% of all holdings, but it is hardly alarming. The number spiked to 650 in the Global Financial Crisis(GCF); in 2017, it hit nearly 200. While only a few properties are “Under Water,” many more fail to meet strict current lending criteria. These tight lending policies have resulted in lending activity dropping from a peak of 5.5x 2010 levels to just 2x that level at the end of 2023. And remember, 2010 was on the back-end of the GCF, and lending conditions were still quite constrained.

Investor Appetite Swings

Over time, institutional investor favorites have changed dramatically. At various times, retail and office comprised 40% of portfolios; today, they are down to 25% and 15%, respectively. Industrial, which had been 50%, dropped to 15% and is now back to 33%. Apartments, which were just 3-5% in the 1980s, now account for over 30%.

Market Participants Appear Optimistic…Opportunistic

Before wrapping up, Dr. Fisher conducted a series of polls to gauge audience sentiment. The feedback was rather optimistic, with the expectation that values would stabilize by the end of 2024 and we would again start to see positive returns. Dr. Fisher supported this thesis, indicating occupancy was holding up, NOI and rents continued to improve, and with the expectation that the Fed would start to drop rates in 2024 and 2025, investors would want to get ahead of the move.

Poll I

Where will Values be by the end of 2024?

Poll II

What Property Sector do you think will perform best (highest total return) for all of 2024?

Poll III

What will be the return for investment-grade real estate for the calendar year 2024 (annual return)?

Summary – May be time to get ahead of the curve

We seem to be nearing the end of the downward investment cycle and expect to turn the corner in mid-2024 or early 2025. Nonetheless, the best opportunities may be presented in 2024 as sellers struggle to recapitalize their debt before the market cycle turns.

Key Highlights and Takeaways:

• Returns continue negative for fifth straight quarter
• Market values fall for sixth straight quarter
• Hotels continue to have positive returns
• Office continues to be the biggest drag on returns
• Rent and NOI growth holding up surprisingly well
• Percent leased down a little
• Cap rates continue still rising
• Properties with LTV > 1 are increasing but nowhere like the financial crisis of 2008

Access the video replay here and the presentation deck here.