CEO on class repricing and prospect of expanding cap rates
A prolonged shift in the commercial space is likely to see continued repricing across a variety of asset classes, cap rate expansion and fresh opportunities for commercial investors, according to a leading executive in the sector.
Greg Friedman (pictured), chief executive officer at real estate investment firm Peachtree Group, told Mortgage Professional America that while rate declines were almost certainly on the horizon this year, market observers shouldn’t expect a dramatic drop anytime soon.
“I think it’s becoming clearer that interest rates are not going to reduce back to the… environment we saw over the last decade where the 10-year treasury, on average, was around 2%,” he said. “Today, the 10-year treasury is around 4%, and we expect over the next five years for [that] rate to stay around 4%, which would be double what it was over the last decade.”
That’s a trend that would have a significant knock-on effect in the commercial space, where high rates have already impacted the market in recent years.
“What that means to us is that [with] the repricing across a lot of these lower-cap rate assets like multifamily and industrial – even self-storage and so forth – you’re going to continue to see the cap rate expand out,” Friedman said.
“So you’ll see further pricing deterioration across those property types, just as the market continues to recalibrate to this new interest rate environment.”
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Which asset classes are getting most attention from investors?
Multifamily and industrial remain the sectors with the most appeal for investors at present, with interest in those areas currently outstripping their share of the commercial real estate ecosystem.
About 80% of the “dry powder” on the sidelines is allocated to those two asset classes despite their constituting slightly over 50% of the market, according to Friedman – compared with the hotel space, which makes up around 7% of the ecosystem but has only roughly 4% of that dry powder.
Opportunities have emerged as a result on the hotel side. “It’s less crowded. Fewer investors are chasing hotels versus some of the other property types like multifamily and industrial, just as interest rates have continued to stay higher for longer,” Friedman said.
Over $1 trillion of loans are slated to mature between now and the end of 2025 on the commercial real estate side – and in the hotel space, capital expenditure spend has been whittled steadily down over the last three years, close to 70% since the beginning of the pandemic.
Deferred maintenance has emerged as a major trend as a result of that increasing lack of capex, which Friedman said has also resulted in many hotel owners needed a complete property improvement plan.
“That’s another catalyst that’s creating opportunities for us to make new investments and to be able to go and buy hotels opportunistically as well as for us to make loans to existing hotel owners and operators that are either refinancing assets in their portfolio or looking to acquire assets,” he said.
“The loan maturities and the lack of capex spend within hotels are the two big catalysts that we’ve noticed this year across commercial real estate that are creating new opportunities for us.”
Challenges continue for the beleaguered US office market
Unsurprisingly, the outlook for the US office market – which has been pummeled since the onset of the COVID-19 pandemic amid a transition to hybrid and home-working arrangements across the country – remains murky at best.
“For the most part, we’re just observing what’s happening across office. It’s going through so much distress,” Friedman said. “There’s no question – there’s a huge opportunity to buy distressed debt across office. The challenge in the office sector is just the capex spend needed to go in and try to reconnect these buildings.
“And candidly, across the US, office is just way oversaturated. There’s way too much office space relative to demand, and we expect that to continue to be an issue over the next several years – especially with the challenges on return to office within the US.”
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