2023 Will Be a Year for CRE Investor Caution

The question isn’t whether the economy in 2023 will be bad, according to the 2023 CRE outlook from Aegon Asset Management. That, they argue, is largely a given. The question is how weak. The results of expert forecaster votes aren’t encouraging.

“The Blue Chip Economic Indicators survey of 50 forecasters, published November 11, 2022, reported that only 22% of forecasters expected a ‘soft landing’ while 78% expected recession in 2023,” and with a 0.2% consensus GDP growth, Aegon wrote.

So far, the impact on commercial real estate hasn’t been on cap rates — which one might expect with higher interest rates that reduce NOI — but on transaction volume.

“For US CRE performance in 2023, the important point is the degree of weakening in the demand for space,” Aegon wrote. “In 2022, CRE pricing is already showing the impact from higher interest rates though the response so far is muted. Through October, cap rates on completed transactions have widened very little but the pace of transactions has slowed sharply, according to MSCI Real Capital Analytics.”

The reason for the transaction pace, according to a number of experts who spoke to GlobeSt.com earlier in the fall, was that uncertainty had already begun to undermine price discovery. Investors began to pull back because trying to determine the true value of properties and, so, what to pay for them became extremely difficult. No one knew what values should be.

“Higher interest rates and a pronounced environment of uncertainty with respect to the longevity of the current inflationary period and the severity of a potential recession are adding risk to the system that requires higher returns,” said Joseph Rubin, a consultant at Eisner Advisory Group. “There is upward pressure on capitalization rates in many markets and therefore property valuations have begun to decline. Real estate price discovery is just beginning what will likely be a long journey.”

The uncertainty extends to fundamentals, such as absorption, vacancy rates, rent increases (and questions of whether they are sustainable), and new supply (and if there is the financing, labor, and ready demand to finish it). Things depend on geographic location, property type, and, of course, on the economy.

“If the consensus of forecasters is correct in predicting a mild recession, prospects for CRE performance will be generally positive reflecting the relative absence of excessive new supply with some exceptions,” Aegon said. “All sectors will confront the challenge of catching cap rates up to the reality of higher interest rates and weaker growth. Our preferences for investment focus on Class B apartments where supply remains more constrained and grocery-anchored neighborhood retail.”