- Economy. The U.S. economy continues to grow—but with an increasingly fraught outlook. Labor markets are extremely tight with around 1.7 jobs available for every unemployed person. As a result, wages are growing at their fastest pace in decades, especially for lower-skilled jobs in services industries. The result is high inflation, which has prompted the Federal Reserve to rapidly increase rates. Tightening financial conditions and still-high inflation have pummeled consumer confidence, which is now weighing on consumer spending, the primary engine of the U.S. economy. A recession is widely expected across surveys of business managers, economists and the populace at large. Additionally, market-based indicators, such as the yield curve, suggest an imminent recession is highly likely.
- Debt Markets. CRE debt origination activity has declined sharply since May. Originations declined 46% year-over-year in the third quarter of 2022 as opportunistic refinancing has disappeared and acquisition financing has decelerated. Activity is declining across property sectors and lender groups. There is little wonder as to the cause—rising rates. There is very little distress in the market today, but with over $1 trillion in loans coming due over the next two years and rates expected to be significantly higher than in-place on maturing debt, expect conditions to become more challenged. Recent bridge finance loans and a wide range of office and retail loans are most at risk.
- Equity Markets. Investment sales declined 23% year-over-year and 27% quarter-over-quarter in the third quarter of 2022. Even so, it was the second best third quarter on record. Sales declined quarter-over-quarter across property sectors while retail was the only sector to increase year-over-year. Activity was lower in September than in July, speaking to decelerating transaction momentum into the fourth quarter of 2022. Investor allocations remain heavily tilted towards multifamily and industrial assets, though retail and hospitality investment shares are up modestly in the year-to-date. Acquisitions have been declining month-over-month across investor groups, but most strikingly among institutional investors.
- Supply of Capital. Dry powder at closed-end funds currently sits at $257 billion, a record. The capital is concentrated in opportunistic and value-add vehicles while debt strategies have pulled back. We estimate that 2/3 of this capital is targeting residential and industrial assets. This is mostly a reflection of fundraising from an earlier environment. New fundraising has slowed sharply due to increased uncertainty and negative denominator effects in LP portfolios. Contributions to ODCE funds have declined since their peak in the first quarter of 2022, though they remain in line with 2019 levels. New fundraising in the REIT sector meanwhile has slowed to a halt. Even non-traded REITs, which had been vacuuming up capital, are now slowing.
- Pricing and Returns. The gap between public and private market pricing continues to widen. Transaction cap rates continued to decline across major property sectors even as the cost of debt rose sharply, resulting in negative spreads. REIT-implied cap rates meanwhile have adjusted upwards, though even there, spreads are either historically small (office, retail) or outright negative (apartment, industrial). REIT cap rates are likely to rise further. Reduced and more selective liquidity will continue to obfuscate the price adjustments in the transaction market and still more appraised values. The longer rates remain at or near current levels, the more apparent price adjustments will be. REIT values are down 29% year-to-date with office (-35%) and residential (-33%) underperforming. NCREIF’s National Property Index meanwhile has returned 9% year-to-date, but even there, returns rapidly decelerated in the third quarter of 2022 as capital returns slowed or, in some cases, turned negative (CBD office). As with cap rates, the longer that the public markets remain depressed, the more likely there will be a similar adjustment to private markets.
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Capital Markets Report
3Q 2022
Newmark Research presents the Third Quarter 2022 Capital Markets Report.