Analyst: The Road Back to Break Even Could Take a While

​CRE is amidst a rare moment in recent history when the national average prices of assets are down, according to John Chang, National Director of Research and Advisory Services, Marcus & Millichap.

Other periods were the early nineties and then during ​the Global Financial Crisis.

Chang cited Real Capital Analytics’ report that for May, industrial prices were down 2.3% on a year-over-year basis, retail prices were down 7.4%, apartment prices were down 12.5%, suburban offices were down 8.1%, and CBD offices were down 6.9%.

“These numbers seem a bit overly positive to me, especially office,” Chang said.

“But whether prices are down 2%, or 5%, or 10%, or 20%, one thing that generally holds true is when prices fall, they tend to go down faster than they go up.”

Currently, there are a lot of forces in play, recession risk, flagging consumer sentiment, and overdevelopment risks in some markets for some property types, according to Marcus & Millichap.

“But the big issue the industry is grappling with is the rapid surge of interest rates,” Chang said. “So basically, the cost of debt is higher. Banks are running scared, and have pulled back on their lending, and many investors are seeking much higher yields today as the risk-free rate on the 6-month treasury is in the mid 5% range.”

Therefore, prices have begun to fall, and yields are on the rise, he said.

“It’s hard to precisely measure price movement because all the hard data is backward-looking,” Chang said. “They’re based on closed deals put under contract months ago. And, of course, no two buildings are exactly the same.”

Not trying to offer a doom and gloom story, Chang said this current cycle will not be anything like the global financial crisis, “but the commercial real estate market is tied pretty closely to the lending market, and the lending market is getting squeezed pretty hard right now, except for apartments.”

Fortunately, financing for apartments is backstopped by Fannie Mae and Freddie Mac, so debt capital for apartments is holding up comparatively well. But debt availability for other property types is becoming more challenging, he said.

“For property owners who were thinking about selling, but decided to hold off until prices recover, you’re basically committing to standing still for a year, or two years, or maybe even three to six years,” Chang said. “We may already be at the bottom of this cycle, but maybe not. Much will depend on the Federal Reserve, and it will vary by property type and location. But the road back to break even could take a while.”

Chang said that many investors think the Fed will drop rates this year, “and that will fix everything.”

But Chairman Powell has been pretty adamant that they will not reduce rates this year. And a rate cut in 2024 is not guaranteed, according to the video.

“So, if you plan to hold through the cycle, make sure you like your property, and that you’re okay holding onto the asset for a few years,” Chang said. “That could mean you’ll have a very weak return on capital. Consider whether that capital would be better deployed in other property types or locations, or maybe in other financial instruments.

“For buyers, make sure you have your loan dialed in, like in triplicate. Even if you have a bulletproof relationship with your bank, make sure you have a backup plan.”

According to some investors Chang has spoken with, “Even banks where they have significant deposits and long-term relationships, those banks are dropping out of deals.”

Chang suggests buyers consult a mortgage broker who has hundreds of lender relationships, to make sure a backup lender is in place.

All is not lost, he said.

“There are some unique investment opportunities that have come to market in recent weeks,” according to Chang. “Yes, the market is choppy, but when you look at the long-term value trends the levered yield on commercial real estate is hard to beat.”