How FED Rate Hike Impacts the Commercial real estate outlook

Takeaways From September Fed Meeting

• The Fed reiterated its commitment to preserving stable prices and moving inflation back to 2.0%
• They raised interest rates 75 basis points, projected another 125-basis point rise before the end of 2022
• Indicated a 4.4% unemployment rate may be needed to balance the labor market and control inflation

Why Rising Rates Matter For Investors

• Rising capital costs are squeezing levered yields; buyer underwriting becoming increasingly conservative
• As market recalibrates sellers must review market pricing to align with buyer expectations

How This Impacts Commercial Real Estate Transactions

• Expectation gap emerging between buyers and sellers
• Recalibration of the transaction market is needed for buyers and sellers to reach market clearing sales prices

*Through September 22
Includes apartment, retail, office, and industrial sales $1 million and greater
Sources: Marcus & Millichap Research Services, CoStar Group, Inc., Real Capital Analytics, Federal Reserve

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Smaller Metros Increase their Share of CRE Sales Activity

CRE Sales Activity Shifting Across Market Types

• Transaction activity was previously concentrated in primary markets
• The share of transactions in primary markets fell from 60% in the early 2000’s, to 34% by 2022
• Tertiary markets now house most transactions, accounting for almost half of deals

What is Driving Activity in Tertiary Markets?

• Properties often trade for a lower price and provide higher average yields
• Population growth rate has been faster in smaller metros

Will Sales Activity Remain Elevated in Tertiary Markets?

• Current demographic trends favor tertiary markets
• Primary markets would benefit from a return to the office
• Sales activity has increased across all property types

*Through 1Q
Trailing 12-month average; includes apartment, retail, office and industrial sales $1 million and greater
Sources: Marcus & Millichap Research Services, Real Capital Analytics, CoStar Group, Inc.

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Three Ways CRE Investors Can Create Value

Repositioning an Existing Property

• Renovations and capital improvements can help make a building more appealing
• Repurpose one property type into another; More intensive, but may greatly alter value

Altering Building Management

• Make operational adjustments or leverage a professional management team
• Restructuring and re-tenanting a building can help bolster occupancy

Utilizing Knowledge to Exploit Opportunities

• Understand the market, economic, demographic and policy trends that influence property outlook
• Find unique areas of growth not already baked into an asset’s price
• Align property to capitalize on long-term trends

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Is Inflation Pressure Starting to Subside?

Inflation Shows Signs of Easing

• CPI Inflation rose by 8.5% in July over last year, down from 41-year high in June
• Reflects recent drop in oil and gas prices
• Supply chains appear to be improving, should further help lower prices for goods

Will the Fed Change Course?

• Fed likely to raise rates by 50-75 bps on September 21
• Also expected to double monthly balance sheet reduction to $95B/month (Quantitative Tightening)

Considerations for CRE Investors

• Inflation resistant properties remain in favor
• Underlying demand drivers sustaining strong fundamentals for most property types
• Investors recalibrating strategies to higher interest rate climate; CRE market remains liquid

*Through July; 10-Year Treasury through August 10
Sources: Marcus & Millichap Research Services, BLS, Federal Reserve

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Interstate CRE Investment on The Rise

Capital Movement Between States On the Rise

• Increased out-of-state buyer activity
• Secondary and tertiary markets claiming larger share of total CRE sales volume

Advantages of Out-of-State Investing

• Geographic diversification may mitigate risk
• Wider range of assets and yields available
• Unique market forces may create opportunities

Considerations for CRE Investors

• Influx of out-of-state capital has contributed to yield compressions across market types
• Out-of-state buyers may have different decision drivers and objectives, could pay premium
• Marcus & Millichap provides:
  • Buyers with access to nationwide inventory
  • Sellers with a national pool of buyers

*As of trailing 12 months through 2Q 2022
Sources: Marcus & Millichap Research Services, MNet

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