Deal Volume To Likely Remain Tepid As Rates Increase

In the wake of yet another 75 basis point hike by the Federal Reserve, expect commercial real estate transaction volume – already down year-over-year – to continue to slump.

Trading activity is recent months is short of but close to same-quarter figures in 2019, according to recent research from Marcus & Millichap. But “the compounding effects of multiple interest rate hikes has made it more challenging to complete commercial real estate transactions,” the firm’s analysts say. “Once interest rates stabilize at a new, higher plane, this consistency will help investors come to agreement and close deals more readily.”

Where rates will ultimately land is another story: the Fed will likely want strong evidence inflation is moving back toward the 2 percent target before hitting the brakes on increases, “which leaves the door open in 2023 as to where rates will ultimately land,” Marcus & Millichap researchers say.

Properties with higher cap rates like hotels, which traded over the last four quarters with first-year returns in the low-8 percent zone, are faring better than others in this new environment. Financing premiums are often higher for hotels, but improvements in performance are softening risk perceptions, the firm says. National occupancy for the year ending in September was 62.2 percent, a mere 30 basis points below the long-term mean, and average daily rates in September were up 17 percent from the same period in 2019.

Last month, the American Hotel & Lodging Association and Kalibri Labs projected overall US hotel industry revenue will exceed 2019 levels by 14%, translating to nearly $12B in positive results.

Senior housing also offers comparatively high yields, with cap rates recently falling in the mid-7 percent range. And the deals are popping:  Walker & Dunlop reported in September that it sold $1.3 billion of senior housing and long-term care facilities in the first seven months of 2022, its highest recorded sales for such a period. But the sector will likely remain challenged by labor issues and rising operating costs, experts say.

“The ownership and capital structure of a company [may determine] whether they’re able to manage through a decrease in operating margin,” Julie Ferguson, executive vice president, senior living at Ryan Companies, told GlobeSt in October. “There will be owners who are unable to provide additional working capital to projects if their lease-up is not on track or their expenses are higher than budgeted. It’s hard to say whether there will be more or less these in [2023] because there are a lot of variables that factor into these decisions.”