RealNex was pleased to host another quarterly Commercial Real Estate Market Update with Dr. Jeffrey Fisher. During the session Dr. Fisher presented his perspective based on year-end 2022 data as reported by members of the National Council of Commercial Real Estate Investment Fiduciaries (NCREIF) with additional analysis from a host of market experts. In addition to his perspective the audience provided real time market insights through a series of polls.
Based on the NCREIF data, Q4 2022 was the first quarter of negative returns since the Great Financial Crisis save for the quick covid blip in the first half of 2020. Returns spiked down from positive 6% at the end of 2021 to nearly negative 4% by year-end 2022. During the Great Financial Crisis returns fell to negative 8% before quickly rebounding in a sharp V-shaped recovery. Taking the impact of current levels of inflation into consideration, the current downturn is actually closer the GFC than the headline number would imply.
While the Office sector was the worst performer, even long-term darlings Industrial and Apartments had negative returns, while Retail fared somewhat better, and Hotel actually bucked the trend remaining positive. The Office Sector had led the downturn moving into negative territory in Q3.
Interestingly, market fundamentals continued to be positive even as values declined. Both Rent and NOI increased across all property sectors, yet values were drawn down by the sharp move up in Cap Rates. The dramatic move in interest rates during 2022 finally was reflected in Cap Rates with a move up from an historic low of 3.6% to nearly 4.0%. While the change was small in nominal terms, it reflects an increase of over 10% in just one quarter. Further impacting prices, the spread between the Going-In Cap Rates and Terminal Cap Rates used to value properties reached nearly 120 basis points after many years sub 100 bp. As a result, during the quarter institutional investors marked down values on over 70% of their portfolio, more than doubling the percentage of properties marked down in the prior quarter.
Leading the performance pack, Retail saw rent grow by approximately 3.25%, with NOI up nearly 5%. Apartments had rent growth of 1.5% and NOI growth of 3.0%, whereas both Office and Industrial had roughly 2.5% rent growth but only 1.5% NOI growth. Occupancy levels remained steady with the exception of older lower quality Office.
From an investment demand stand-point, Multi-Family is the most favored by investors followed by Industrial, while there is very little desire for Office and Retail. The numbers are even more pronounced from a lender perspective with Industrial remaining the most desirable followed closely by Multi-Family. Lenders have no appetite for Office and very little for Retail or Hotels.
The webinar audience had a somewhat different view. When polled they 46% agreed that Industrial would be the top performing asset class in 2023, but 29% thought Retail would outperform and 13% were most bullish on Hotels. Only 8% thought Apartments would be the top performer, with 4% holding hope for the Office sector.
From a geographic stand-point the sun-belt continues to shine, with markets like San Diego, Charlotte, Orlando and Raleigh/Durham outperforming across the board. Southern Florida also demonstrated broad strength, and Riverside was the overall top performing market. Worst performers were gateway cities, New York, Washington DC, Chicago and San Francisco.
With values down, transaction velocity also plummeted with less than 1% of institutional properties changing hands. This is far below the peak of 6% in 2004 and the norm of 2% over the past decade. When surveyed, 45% of institutional investors expect to sell even less in 2023, 25% about the same and 15% said that won’t be selling at all.
The audience perceived values would continue to drift lower. 60% indicated values would be Somewhat Lower by year-end 2023, 25% believed we be stable at current levels and only 5% were optimistic about value gains by year-end. 10% were uncertain.
Concluding, Dr. Fisher reiterated:
- Q4 2022 saw the largest negative return since the Great Financial Crisis.
- Hotels were the loan bright spot with positive returns.
- Fundamentals remain healthy with rents and NOI improving.
- Values severely impacted by a rise in Cap Rates (Going In and Terminal) driven by a spike in interest rates.