Different segments have seen values drop
Commercial real estate values may be on the decline, but not all commercial real estate is created equal.
“Commercial real estate prices are down, but they’re down by different percentages depending on the asset class,” Ian Formigle (pictured), chief investment officer at CRE investing platform CrowdStreet, told Mortgage Professional America during a recent telephone interview. An ardent follower of insights from research and advisory firm Green Street, he checks on real estate values as regularly as investors check their stock performance: “Prices across the entire spectrum characterize as down by 15% from the March ’22 high,” he said.
And here’s where asset classes differ: “Within that, multifamily is down at around 20% from peak. You have industrial that’s down 15%, then you have retail and hospitality which are down less – about 9% and hospitality about flat. But it’s fair to say retail and hospitality are sitting in their own cycles because they got completely demolished during the depths of the pandemic. So they were actually rebounding, and were recovering in 2021 really strongly. Office is down definitely more, but we characterize it as a complete outlier because it’s obviously going through its own transformation. It’s struggling coming out of the pandemic. Offices are still 50% utilized. You have office almost sitting in its own bear market.”
On the road to recovery
The ongoing recovery is key to the post-COVID matrix, he suggested: “That recovery at a base, fundamental level, continues on,” he said. “This actually draws into an interesting point overall: When we look across the spectrum of commercial real estate – when we get to the sources of pricing – there’s a difference between operating distress and financial distress. In real estate, when you go back to the GFC [Great Financial Crisis] period, we had both. Today, you have absolute distress in the form of everything that’s going on. Is the banking system going to collapse again? Lenders are just tight – they’re not lending. The spreads are high, interest rates are high to borrow for commercial real estate. This is all inserting financial distress on the market, absolutely. And that’s what’s leading to a lot of the price declines you’re seeing – specifically in multifamily and industrial, and also some drag in retail and hospitality.”
And now, for the good news: “But for the most part, the operating fundamentals are mostly in place,” Formigle said. “Industrial fundamentals are still strong – 96% occupied nationwide, rent growth that was 9% last year. Those are strong numbers. You look at the state of the market, if you didn’t know there was financial stress going on, you would say it looks like a great market. Buildings are occupied, they’re getting leased, people are showing up, they’re paying rent, rents are increasing.”
Multifamily isn’t faring as well, he noted, but still fundamentally strong: “Multifamily is slowing down. It had an insane year in 2021 – rents up 12% to 13% nationwide, rents up 25% to 30% in some fixed markets like Miami and Orlando. So it had this boom coming out of the depths of the pandemic. It’s definitely come back down to Earth, but we still see roughly 3% to 4% rent growth nationwide. Occupancies are starting to tick down a little bit but we are still in the 94% or so occupied range. And what I would say about multifamily is yes, there’s some supply coming to the market. We’re delivering at a rate we haven’t done since the 1980s. But overall, the market is still functioning; it feels well. When we look at the pricing, the pricing we’re seeing is definitely a function more of financing stress than operation stress. So that’s why we see the potential for relative value in stepping back and taking a long-term perspective.”
Investor sentiment is mixed
So how does all this square with investor appetite?
“I would say it’s fair to characterize that investors are looking for deals, they’re looking for bargains,” Formigle explained. “They want to see that stress in the market creating mispriced opportunities that could be capitalized on today to then potentially realize gain in the future if everything more or less goes back to a more normal state of operations in the out years. And because real estate is something you invest in for multiple years – you are typically buying into business plans anywhere from three to 10 years, it’s a multi-year investment – you step back and look at it from the perspective of if this asset feels like a good deal today, with all things known.
“If the answer is ‘yes’, some investors are stepping in. It’s also fair to say that many investors are still sitting on the fence waiting on some signs of if we are really reaching peak interest rates before they want to come in because this period of financials stress is correlated to interest rates. We saw what happened in 2022 as rates spiked up every quarter - readjusting borrowing rates and so forth. So I think investors are blending some trepidation but also understanding that when real estate goes on sale, you tend to want to buy it. But you have to be willing to ride through some short-term volatility.”
In the final analysis, it might be the dizzying pace of interest fluctuations that has everyone bewildered and confused: “Five-hundred (500) basis points in a year is a lot to digest,” Formigle said. “Banks can’t figure it out. Similarly, the commercial real estate market is struggling to digest that rate of change, hence why we’re seeing some of these prices go down as quickly as they have. It also seems to suggest that with amount of stress so fast the probability of that creating a buying window is decent, if nothing else.”
