$205B of Dry Powder Ready to Pounce on Distressed CRE Assets

Real estate investors sitting on a mountain of dry powder may have to wait another six to 12 months for the lowest valuations to arrive before they pounce on a growing pool of distressed CRE assets.

Data analytics firm Preqin estimates there is a more than $205B currently earmarked for investment in CRE in the US. Meanwhile, CRE prices are heading for bargain basement prices as valuations drop: across all sectors, prices have dropped an average of 16% since their peaks in March 2022, according to Green Street data.

However, the nadir in valuations is not expected to arrive for another six to 12 months, according to the Wall Street Journal—and the opportunities for heavily discounted prices are not spread evenly across sectors, as they were after the GFC in 2008.

Investors waiting for fire sales before they spend the wad of the cash they’re sitting on will most likely find them in the beleaguered office sector. With office occupancy levels hovering around 48%, according to Kastle Systems 10-city average, offices have lost 31% of their value since the March 2022 peak.

Multifamily values fell 14% for the year ended in June after rising 25% the previous year, according to CoStar data.

MSCI’s bid-ask spread on US multifamily transactions indicates that sellers are holding out for prices that aren’t supported by current market conditions. According to July data, the gap was 11%, the widest since 2012.

Still going strong is the sector that reigned supreme during the pandemic, industrial. According to MSCI data, asking prices of sellers of industrial properties were only about 2% higher than what buyers are willing to pay in July.

Investors waiting for a cresting tide of distressed properties and foreclosures to ignite widespread fire sales received a strong indicator last week from Newmark, which projected that $626B of an estimated $1.4T in CRE loans coming due between 2023 and 2024 is “potentially troubled.”

But while a tsunami of CMBS debt will be coming due in the next three years, the level of distress is not likely to equal the tidal wave that swamped CRE markets during the Great Recession that followed the global financial collapse, when the combined total of distressed and foreclosed CMBS loans approached $200B in 2010.

In Q2 2023, an additional $8B in assets became distressed, bringing the total to $71.8B, according to MSCI.

Rising 10-year Treasury yields are being watched closely as a key indicator of falling CRE valuations. The 10-year Treasury rate hit 4.35% on August 21, its highest level since 2007, and nearly double the 2,24% average over the past 10 years.

According to Richard Barkham, global chief economist for CBRE, econometric evidence suggests that every 100 bps rise in long-term interest rates results in a 60 bps rise in CRE cap rates.

“So, a predicted rise in the 10 -year rate to 4.75% from 2.2% would cause a 150-basis-point increase in the average cap rate. Under this scenario, a prime asset trading at a 4.5% cap rate would now trade at a 6% cap rate, equivalent to an approximate 25% fall in capital values,” Barkham said.