Two things can make a big dent in commercial real estate sales: prices and financing costs. Markets have faced a double whammy. Not only have prices continued to rise, albeit at a slower rate than before, but Federal Reserve attempts to stem an incoming inflation tide have meant higher interest rates.
And now, commercial property sales are slowing, according to a Wall Street Journal report. “Property sales were $39.4 billion in April, which was down 16% compared with the same month a year ago, according to MSCI Real Assets,” the paper noted. “The decline followed 13 consecutive months of increases.”
Sales in multiple categories had been growing since the onset of the pandemic. Multifamily and industrial have been particularly hot for two reasons. One, each was needed. The move to online shopping during the heavy days of the pandemic boosted the need for warehouse and logistics space. A shift of people from some major cities to the West and South, as the Census Bureau documented, along with companies either abandoning old headquarters or expanding regional presence means a need for more housing.
The second reason was that CRE money goes where the people are and demands are hottest. Cap rates followed because investors bid against each other for a smaller pool of deals, driving up prices. The motivation was the expectation of rising rents that, even with higher prices, would keep more cash coming in and act as a hedge against inflation and an uncertain future.
But markets can quickly change. In March, CRE sales were up 57% year over year, a huge change from the 16% drop that April saw. MSCI Real Assets Jim Costello told the WSJ that the “speed of that transition is shocking.”
Companies and investors are worried about the future. If there is a recession, that would mean reduced economic activity on the part of many companies and a good chance of reduced demand, or the inability of many businesses and consumers to afford the vertiginous climb of rents.
And then there’s been the looming problem of debt. Many developers and investors have entered deals because of low interest rates. Cheap debt enables many plans that might otherwise be marginal.
The warnings have been up in other industries, particularly high tech, with an abundance of so-called zombie companies that have needed to refinance to keep themselves solvent. As rates climb, their ability to maintain enough cash flow for debt service can disappear. In the same sense, CRE likely has a significant number of zombie projects, animated only through regular infusions of low-cost cash. Many of these are starting to come up for five-year renewals, with more on the way. As financing gets tighter and more expensive, seeing fewer buyers and, thus, a reduced number of transactions.
All that said, a sudden reduction in sales and competition for properties could usher in something not seen for a while: lower prices and perhaps even a healthy distressed market.