- Economy. The U.S. economy continues to grow, but with an increasingly fraught outlook. Labor markets are extremely tight, with roughly 1.9 jobs available for every unemployed person. As a result, wages are growing at the fastest pace in decades, especially for lower-skilled jobs in service industries. The result has been high inflation, which has prompted the Federal Reserve to rapidly increase rates. Beginning in mid-November, markets became more optimistic that inflation was falling sharply, supported by data to this effect, and would ultimately enable the Federal Reserve to reduce rates earlier than expected without a recession. Long-term yields came down while corporate bond spreads returned to normal levels, which in turn enabled the stock market to perform strongly in January and for corporate debt issuance to surge. The combination of hawkish statements by the Federal Reserve and recent inflation data that shows a bumpier path to normalization appear to have popped this bubble. While a still-strong labor market and mixed data on consumption suggest a recession is not imminent, in each of the most likely outcomes, the cost of capital will remain elevated for the foreseeable future.
- Debt Markets. CRE debt origination activity has broadly decelerated since May, most clearly in the securitized sectors. Preliminary data suggests that there was a surge of originations in December as both spreads and rates declined; however, it’s far from clear whether this was an exception or an inflection. What is clear is that commercial banks drove an outsized share of lending activity in 2022, particularly in the second half. The banks have overreached and will most likely need to pull back significantly in 2023 and perhaps beyond. The risk of a liquidity squeeze has increased, particularly should securitized markets remain anemic. 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 rates 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 63% year-over-year and 24% quarter-over-quarter in the fourth quarter of 2022. Sales declined year-over-year across property sectors, while hospitality was the only sector to increase quarter-over-quarter. There were small seasonal increases in December deal closings, except for multifamily. Even so, investor allocations remain heavily tilted towards multifamily and industrial assets, though retail and hospitality investment shares were up modestly 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 $237 billion. The capital is concentrated in opportunistic and value-add vehicles, while debt strategies have pulled back. We estimate that 3/4 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 declined sharply in the fourth quarter of 2022. New fundraising in the REIT sector, meanwhile, has slowed to a halt. Even nontraded REITs, which had been vacuuming up capital, are now slowing and indeed being forced to limit redemptions.
- Pricing and Returns. The gap between public and private market pricing remains wide. Transaction cap rates began to increase in the fourth quarter of 2022, albeit modestly. REIT-implied cap rates have been more responsive, though even there, spreads are either historically small (office, retail, multifamily) or outright negative (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. The longer rates remain at or near current levels, the more apparent price adjustments will be. REIT values are down 12% in the last 12 months, with office (-34%) and apartment (-20%) underperforming. NCREIF’s National Property Index returned 9.4% in 2022 but returns continued a rapid deceleration in the fourth quarter of 2022. Total returns, to say nothing of capital returns, were negative for every property sector and every property subsector. Moreover, returns were negative in all the largest 30 markets and in each property sector in those markets.
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Capital Markets Report
Newmark Research presents the Fourth Quarter 2022 Capital Markets Report.
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