How many quarters will pass before property adjustments?
Despite continuing economic growth, commercial market fundamentals across the US will remain soft in 2024, a state of affairs impacted by a significant bid-ask spread, negative effective leverage and limited price visibility from transactions.
That’s the assessment of Mike Acton (pictured), head of research and strategy at AEW Capital Management – a real estate asset manager/investment firm. Mortgage Professional America reached out to Acton for insights into what might be in store for the CRE market this year amid continued market volatility.
“The big theme is this whole idea of when are we going to finally get to the point where property has fully repriced itself and we can go on to the next cycle,” Acton told MPA during a telephone interview. “Most of our conversations with investors these days sort of end up there. ‘When is the odyssey universe going to be done going through this valuation adjustment? And what should we be thinking about in getting ready for that and going forward?’”
To venture a guess into the unknown is, at best, informed speculation. But certain dynamics already in play can help discern the likely plotline going forward.
Expect continued market softening as the economy slows
Take that softening of the commercial property market, for example. The cause of the softened market is attributable to vacancy/availability rates going flat, or rising, while rent and overall net operation income (NOI) growth slowed, Acton explained.
“It’s very clear job growth is slowing,” Acton said. “The economy is starting to slow. It’s very intentional; the Fed was trying to fight inflation and raised rates really aggressively. That takes quite a while to work its way through the economy. We fully expect this year to have much slower growth. I don’t know if we’ll dip into a recession or not – I don’t have that good of a crystal ball – but definitely slowing.
“And you see it in the property markets,” he continued. “You see it in vacancy rates for apartment properties and certainly office – that’s probably a whole different conversation; it’s not just about slowing job growth but changing how somebody is actually using that space.”
The slowdown is seen in other asset types as well: “We see rising vacancy rates in the warehouse markets,” Acton said. “Some of this is slowing demand, of course, and some of it is a lot of new construction that was done. US values went up a lot in ’21 and at the beginning of ’22, and that triggered a lot of new construction. That’s going to get absorbed as well.”
Bottom line: “Any way you cut it, property markets are going to soften with the broader economy, rents are going to slow down, property income growth is going to slow down.”
The Fed’s presence will continue to be felt
The Fed will continue to loom large in 2024, Acton suggested. While nearly two years of rate hikes since March 2022 have had the desired effect of bringing inflation down from the four-decades highs reached last year, it’s still a little bit over a percentage point higher than the Fed’s desired 2%. The consumer price index (CPI), monitored by the US Department of Labor, is hovering at around 3.4% from 9.1% recorded in June 2022.
“We’re also at this inflection point where the Fed says they’re sort of done raising interest rates and they’ll probably be cutting interest rates,” Acton said. “So, you have to figure out that balance slowing property income, property earnings, and lower interest rates. In other words, lower discount rates and higher multiples – things like that.”
In predicting the future, he suggested, it’s sometimes fruitful to revisit the past. In the present context, think back to the 2007-08 financial crisis.
Looking to the past in presaging the future
“If I had to guess, I’d say that property adjustments – the values in those adjustments – that probably plays itself out by about the middle of the year,” Acton said. “If you look back at the financial crisis period, it took eight quarters for private market real estate to fully adjust. I thought it was probably going to happen faster this time, but we’re five quarters in – and probably fourth quarter data will be negative again – so that’ll be six quarters.”
That’s not such a bad thing, he added. “That’s a good thing for investors to have in their mind: ‘About the middle of the year, I should have a plan for how to deploy capital and what I’m going to do going back up the other side’,” Acton said. “History shows pretty clearly in each cycle as you come out the bottom, that next part is pretty outsized.”
Ah yes! The notion of what’s past is prologue as explored in Shakespeare’s “The Tempest” for reviewing the past for context into the present. But to avoid visions of treachery and vengeance, perhaps “this too shall pass” can serve as gentler reminder of the cyclical.
Want to make your inbox flourish with mortgage-focused news content? Get exclusive interviews, breaking news, industry events in your inbox, and always be the first to know by subscribing to our FREE daily newsletter.
