Capital Markets Report

3Q 2023
Newmark Research presents the Third Quarter 2023 Capital Markets Report.

Economy. The U.S. economy continues to prove surprisingly resilient to rising rates. Real gross domestic product grew at a 4.9% annual rate in the third quarter, a strong showing. Employment continues to grow robustly with some possible slowing on the margin. Labor markets are extremely tight, with 1.5 jobs still available for every unemployed person. Wage growth has moderated but remains at the highest levels since the late 1990s. A broad range of metrics show inflation remains above target but continues to moderate apace. This combined with the continued strength of the economy provides the Federal Reserve with justification to maintain rates their current level. The Federal Reserve has been clear that it does not anticipate any rapid reduction in rates. Belatedly, the market began pricing this in over the last several months, spurred on by treasury issuance as well, resulting in a bear steepening of the treasury curve. The steepening seems to have overshot and rates are retracing while remaining solidly above levels seen earlier this year.
Debt Markets. CRE debt origination activity has remained constrained year-to-date, down 48% year-over-year and 32% compared to pre-pandemic. It’s not just dollar volumes – there are 26% fewer active lenders in the market today compared to the peak. Originations are down sharply across property types and lending sectors, though office, debt funds and CMBS/CRE CLO are negative outliers. The bigger issue remains the small and regional bank lending engine that has driven the CRE market is rapidly slowing with no clear replacement. All this is occurring at the same time as the market is set to absorb $1.9 trillion in debt maturities in the 2023 to 2025 period—debt that will mature with significantly higher debt costs than when loans were originated. Additionally, many loans are underwater or nearly so, especially recent loan vintages of most property sector and broad swaths of office debt. We estimate that $792 billion in debt maturing between 2023 and 2025 is potentially troubled.
Equity Markets. Investment sales declined 56% year-over-year in first three quarters of 2023 and 30% compared to the 2017 to 2019 average. Sales declined year-over-year across property sectors in the third quarter of 2023 and in the year to date. Sale declined quarter-over-quarter except for retail. Investment allocations continue to evolve. Multifamily has returned to its pre-pandemic share while office and industrial allocations have risen year-to-date. The office share continued to contract in the first three quarters of 2023. Investment has declined across capital groups year-to-date, but institutional investors have declined most dramatically – likely due to higher sensitivity to cost of capital.
Supply of Capital. Dry powder at closed-end funds currently sits at $257 billion, down 9% since December. The capital remains concentrated in opportunistic and value-add vehicles, while debt strategies have pulled back. We estimate that 79% of this capital is targeting residential and industrial assets. Much of this dry powder was raised from prior vintages. More recently, new fundraising increased sharply in the second quarter but does not seem to have been maintained into the third. Meanwhile, contributions to ODCE funds declined to a new post-GFC low in the third quarter of 2023 with many funds facing redemption queues. Similarly, new fundraising in the REIT sector is anemic. Nontraded REITs have been forced to limit redemptions, even as they’ve had success in bringing in new institutional partners and post surprisingly high returns.
Pricing and Returns. Transaction markets now show clear increases in transaction cap rates, belatedly following the public markets. Even so, both in the private and public markets, cap rates appear distinctly unattractive relative to the cost of debt capital, possibly excepting office REITs. This is not surprising in the private markets where transaction volumes are muted and reflect selection bias and appraisal-based valuations lag market conditions. Extremely narrow cap rate spreads in the REIT markets are harder to justify and seem to require a rapid decline in debt costs, historically abnormal NOI growth or a combination of the two. Notwithstanding the structural deficiencies in NCRIEF valuations during periods of rapid change like today, NCREIF NPI total returns were broadly negative in the third quarter of 2023. Hotel and retail continued to outperformed on the margin. Returns were negative in 60% of metro markets, including 83% of multifamily markets.