NAIOP Survey Says Sharp Increase in Cap Rates Among Many Headwinds

NAIOP echos what many are seeing ahead for commercial real estate: tougher times ahead.

Its NAIOP CRE Sentiment Index reveals that overall sentiment is down from the spring as respondents expect unfavorable conditions during the coming 12 months due to higher interest rates, higher cap rates, and a decrease in the supply of equity and debt.

Respondents “predict a sharper increase in cap rates and greater contraction in the supply of equity and debt than in any previous survey.

“And their outlook for occupancy rates, face rents and effective rents is also less optimistic, though they still expect rents to grow.”

Construction and labor cost inflation is anticipated to improve, they said, and developers will maintain recent deal volume over the coming year, completing about the same dollar volume of new projects and transactions as in the past 12.

Development Pipelines for 2023 Already Set

Andrew Fallon, executive managing director, SRS Real Estate Partners National Net Lease Group, tells GlobeSt.com that there’s “no question that we face a lot of headwinds going into 2023.

“Project costs and rising rates will put more pressure on developers and tenants as they determine the feasibility of new facilities, but the fact of the matter is that the pipelines for the first half of 2023 are already set with construction projects and deliveries in motion.

“The expectation is that new project starts will decline throughout 2023, and transaction volume will be down due to a shallow buyer pool, while the market absorbs the new interest rate environment. Deal structures may need to be adjusted as rents and exit cap rates change, but demand for space and durable real estate investments will prevail.”

Debt Costs Have Doubled

Drew Dolan, Principal and Fund Manager, DXD Capital, tells GlobeSt.com that his firm will continue to invest in the self-storage sector despite headwinds he is seeing in the current marketplace.

“Debt costs have doubled in the past nine months, and transactions have slowed significantly in the last quarter leading DXD to believe that many projects will be ‘shelved’ or may never happen,” Dolan said.

Institutional self-storage investors are on the sidelines for the time being, this immediately following a two-year period of unsatiable appetite for self-storage investment from the same investors, he said.

“Rental rate increases are expected to continue, but at a slower pace than in the previous two years,” which saw historic rate growth and historic inflation levels, according to Dolan.

“Construction costs, which have been one of the major headwinds for real estate development are beginning to show signs of dampening.

“While most reports are anecdotal to date, subcontractors proactively seeking work indicates excess labor supply in the coming months.

“DXD Capital remains bullish on the self-storage sector and its pipeline remains oriented to markets of high growth and significant barriers to new development.

Bid-Ask Spread Widening

Charles Byerly, CEO, Westport Properties, tells GlobeSt.com, that transaction volume has slowed in all three of its verticals (self-storage, industrial and multifamily).

“There are still opportunities, but the bid-ask spread is widening which may take at least six months to reconcile.

“Obviously, the Fed will have a big say in how this plays out depending on how far they go with rate increases and if/when the increases flatten.

“Debt appears to still be available in the product types we play in, but terms are very conservative and lender spreads have not come in to help offset the increases.”

A Slowing in Top-Line Growth

Byerly said that operationally, he is seeing a slow-down in topline growth in storage assets, “but that is after a very strong couple of years, so it was bound to happen regardless.

“Industrial rents appear to be hanging in there as well, but not seeing the large lease-to-lease increases we previously were seeing over the past couple of years in the markets we’re active in.

“We have several multifamily assets in the Southern California market and those assets continue to perform well.