The following is a response post from Adam Shultz, Broker — Coldwell Banker Commercial McGuire Mears & Associates August 2, 2022
The southern Wisconsin market is still seeing robust activity as the recently completed I-90 interstate project has brought distribution and warehousing to the forefront of local development in the Janesville/Beloit MSA.
Demand remains strong for industrial buildings as multiple developers are working to bring buildings as large as 500,000 square feet to the market built on spec. While we are seeing overall transaction counts are slowing down, the quality and size of deals we see coming into our market is really impressive given the national headlines and recession calls.
Thus far in 2022, we are encouraged with what we are seeing in the local market and are cautiously optimistic moving forward.
By Peter Grant and Rebecca Picciotto - July 26, 2022
Wall Street is tightening the loan spigot on the commercial real-estate industry, which is putting a squeeze on deal making and values.
Banks are lending less and charging higher interest rates for the loans they make to owners and buyers of office buildings, shopping centers and other commercial real estate. The tightening is a response to the sharp increase in interest rates this year triggered by high inflation as well as concerns of a possible recession that would lead to an increase in defaults.
“Banks are exceedingly cautious right now,” said Manus Clancy, senior managing director of data firm Trepp Inc. “They don’t want to get caught with their pants down.”
In this year’s second quarter, banks issued $20.6 billion of securities backed by real-estate loans, down from $29 billion in the first quarter, according to Trepp. Market sentiment turned especially negative in June after the Labor Department reported a big increase in the consumer-price index, indicating that “inflation wasn’t going to be easily wrestled to the ground,” Mr. Clancy said.
In June, banks issued only $3.6 billion in commercial-property securities known as collateralized-loan obligations, which are backed by short-term loans made to developers with business plans involving major upgrades or conversions of properties from, say, an office building to a hotel. That was less than half of the February volume, when there were $8.9 billion of such issues in this higher-risk category, Trepp said.
Commercial real estate is highly dependent on debt because most properties are highly leveraged. Last year, when interest rates were near historic lows, property sales volume hit a record level.
This year, the sales-volume growth rate has been falling as rising inflation has pushed interest rates higher. In the second quarter, investors purchased $190.3 billion of commercial property, an increase of 17% over the same period in 2021, according to data firm MSCI. That is down from a 150% sales-volume increase in the second quarter of 2021, MSCI said.
‘It’s the smaller buildings in Toledo or Poughkeepsie. Those deals have fallen off first in response to this financial shock.’
— Jim Costello of MSCI
Meanwhile, the number of transactions in the second quarter of this year fell to about 8,500, down 22% from the same quarter in 2021. That is a sign that higher interest rates are putting more of a crimp on smaller transactions, which are more voluminous than deals with big price tags, according to Jim Costello, chief economist at MSCI’s real assets team.
“It’s the smaller buildings in Toledo or Poughkeepsie,” Mr. Costello said. “Those deals have fallen off first in response to this financial shock.”
Higher rates are putting a squeeze on values as well as deal volume. Real-estate analytics firm Green Street says that commercial-property prices have fallen an average of 5% from the peak they hit in March.
Meanwhile, shares of real-estate investment trusts are trading at an average 11% discount to the value of the properties they own, a sign that stock-market investors think values will fall further, according to Dave Bragg, a Green Street managing director.
“Going forward, we see risk of continued downside in pricing,” he said. “If investors agree with us, maybe it’s contributing to their reluctance to buy right now.”
Many deal makers remain active. For example, Regent Properties, which closed on the purchase of the Trammell Crow Center in Dallas in March, is looking to buy other Sunbelt office buildings, says Eric Fleiss, the firm’s chief executive.
Mr. Fleiss said that lenders “are focusing more than ever” on higher-quality properties and operators. “If a loan costs more, we have to factor that in,” he said.
But he added: “When we buy buildings, the debt almost never makes or breaks the decision as to what we’re buying. It influences the price.”
Rapidly falling property values historically have put a pall on commercial-property deal making as buyers have stepped to the sidelines and sellers have resisted cutting prices. In past downturns, sales activity has taken one year or even longer to normalize.
This time the market may be adjusting faster than usual, according to Jeff Scott, a managing director of Eastdil Secured. He said one sign of this is “widespread” repricing. That is when sellers who signed contracts with buyers before the sharp increase in interest rates agree to renegotiate prices lower.
“Think about it: Before, you were borrowing in the low 2% [range.] Now you’re borrowing in the low 5% range,” he said. “It’s just math. It’s not someone trying to take advantage.”
Some big players are beginning to amass a war chest to take advantage of future market dislocations. For example, Blackstone Inc. is in the final stages of raising a new real-estate fund that will likely set a record as the biggest vehicle of its kind.
On an earnings call last week, Blackstone executives said the fund already has closed on $24.4 billion in commitments. Combined with other firm capital, the new fund will give Blackstone $50 billion to deploy in global real-estate deals, said Jonathan Gray, Blackstone’s president. “This is a very advantageous position given the current environment.”
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