Archives for April 2023

What Supply and Demand Trends Mean for CRE Investors

Office and Retail Pipelines are Thin This Year

• Both office and retail inventories are expected to grow by no more than 1% in 2023, but differing demand environments are propelling divergent outcomes
• Office space demand has been low since 2019, while retail demand has surged, helping the segment record two years of downward moving vacancy and solid rent growth

Multifamily and Industrial Developers are More Active

• Multifamily and industrial developers are forecasted to increase inventory by greater than 2% this year
• There is good reason to believe the loan environment and construction shortages will delay some projects, diminishing the impact of 2023 construction on existing properties

Construction Pipelines Appear to be Tapering

• With the interest rate on construction loans around 8%, new CRE construction starts are declining
• The supply and demand outlook for apartments, retail, industrial and most niche property types remains promising

*Forecast for 2023
Sources: Marcus & Millichap Research Services, CoStar Group, Inc, RealPage, Inc.

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Where Is The Risk In Today’s CRE Market?

Some Investors Face Greater Headwinds Than Others

• Some CRE segments could see heightened distress this year, but risks are not broad-based
• Aggressive investors strategies, underwriting and debt profiles will face challenges; urban office properties also face outsized risk

Some Financing Strategies Have Compounded Risk

• Investors that maximized floating rate leverage, going as high as 80% face substantial risk
• Investors with floating rate debt who did not get a rate cap or hedge may need to sell or recapitalize assets

Systemic Behavioral and Societal Changes Pressure Office

• The hybrid work schedule could drive a significant office vacancy increase that snowballs into a broader problem for the market
• Office properties make up roughly 26% of the loans maturing this year, and distress in these assets could create ripples that impact other urban property types

*Sources: Marcus & Millichap Research Services, Mortgage Bankers Association

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What The Latest’s Labor Market Data Means For CRE Investors

Data Release Shows Sharp Pullback in Job Openings

• February’s JOLTS report shows that the number of open positions fell below 10 million for the first time in 2 years
• Hiring remained steady, suggesting some firms closed open listing without filling the roles, bringing the ongoing labor shortage to its lowest level since September 2021

Cracks in The Labor Market Starting to Form

• The unemployment rate has held around 3.5%, but a substantial 1.3 million fewer job openings existed after the first 2 months of 2023
• This is the most significant sign of stress on labor markets since the Fed started raising rates last year and will help control wage growth, a major focus of The Fed

Labor Market Stress Could Help Deter a Fed Rate Hike in May

• This shift in the labor market could be enough to convince The Fed to pause rate increases at the May meeting, but further hikes present heightened recession risk
• If the Fed Funds Rate stays flat, CRE lenders and investors will have time to lock in lending rates and strategies, facilitating heightened deal flow

*Through February
Sources: Marcus & Millichap Research Services, BLS

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Will CRE Spark a wave of Bank Failures?

News Headlines Suggest CRE Loans Will Be Next Shoe to Drop

• Broad-based media coverage suggests regional and local banks are overexposed to CRE loans – they could present a significant risk for the banking sector in 2023
• Many of these reports have misinterpreted the data, misrepresented the findings or relied on loose estimates that overrepresent the CRE risk

Some CRE Loans Will Default, but The Risks Are Overstated

• Most of the default risk is in two segments: office properties with elevated vacancy rates and properties purchased between 2H2020 – 1H2022 using aggressive underwriting and variable rate debt with no cap on it
• Because of strong underwriting since the Global Financial Crisis, the vast majority of the debt coming due has significant investor equity

What Investors Should Consider

• The FDIC and the Federal Reserve have backstopped the banking sector reducing the risk of a broad banking crisis
• Banks represent a relatively small segment of the total CRE lender stack and only a small portion of their CRE portfolio comes due in 2023

*As of 2022
Sources: Marcus & Millichap Research Services, Mortgage Bankers Association, Trepp Inc., MSCI

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