Smooth Sailing for Net Lease Cap Rates Until 2024. Then, Watch Out

Spencer Levy, CBRE’s Global Chief Client Officer, delivered a bullish outlook of two more years of strong CRE growth in his keynote at GlobeSt’s Net Lease Spring conference, held in New York on Tuesday, dismissing inflation concerns and rising interest rates as “a two-year-blip” during his presentation.

Levy predicted a “surprising upside” to a retail market he says is “undervalued overall by 200 basis points,” surging industrial and multifamily markets “on cruise control” and an “evolving” office market that will see footprints shrink by less than 10 percent.

The CBRE exec underlined the euphoria of a seemingly endless tide of capital flooding asset classes by displaying a slide that instructed the in-person audience to “Don’t Worry, Be Happy.”

Then he delivered a buzz-kill with the illustration for his 2024 forecast: two ancient sailing vessels about to plunge off the precipice of what appeared to be a flat earth where no one thought cap rates would expand or spreads would blow out anytime soon.

After the keynote, Levy’s interpretation of his long-term prognosis sounded like a much softer landing than sailing over the edge of a cliff—with a caveat that labor shortages have the potential to set off an “out of control” inflationary spiral.

Levy said CBRE doesn’t expect cap rates to expand for most industrial and multifamily assets that are recording record rent growth right now, but it does see cap rates expanding for long-term net lease deals that do not have significant annual rent increases, a.k.a. bumps, built into them.

“We do see cap rates for long-term net leases expanding, but how much they’ll rise is the topic of the day,” Levy told GlobeSt.com.

“Long-term, you’re going to see some cap rate expansion and small bumps (in net lease deals), but in the short term you’re going to see a thinning of the market for some disfavored asset classes,” he added.

Levy identified value-add office as an asset that will be pressured by expanding cap rates. “The debt capital market for value-add office that is not stabilized is thin, and the buyer market for that is thin as well,” he said. “That’s the kind of asset that will be most negatively pressured by a rising rate curve because these assets already were under pressure prior to a rate expansion.”

Levy also tempered his “two-year blip” description regarding inflation and interest rates, noting that CBRE recently upped its projection of 2022 interest rate hikes by the Fed from 4 to 7.  He also said the severity of the inflationary cycle will be determined by whether the labor shortage can be alleviated.

“Labor is the whole story as far as I’m concerned,” he told us. “If we don’t figure out a way to solve the labor shortage, that’s where inflationary pressure is going to spiral out of control.”

With a slide he titled “The Scariest Thing You’ll See Today,” Levy told the audience at the Westin Times Square that e-commerce’s penetration of retail, which rose to a 26 percent share in 2020, actually declined last year and appears to be plateauing in recent months at about 22 percent.

“I’m not saying e-commerce has peaked, but there’s a risk factor that e-commerce will peak a lot sooner than people think,” he told us. “Last year, e-commerce penetration dropped. Is it a temporary drop or a permanent drop? Nobody knows the answer to that question.”

Regarding workers returning to offices, Levy said workers and employers are in the midst of “a classic labor-management dispute” over how many days per week employees are needed in the office. He projected that this will shake out to 3-4 days per week, depending on job functions.

“What we’re seeing in offices is not a real estate story, it’s a labor story,”he said. “What we have right now is such a tight labor market that labor is asserting its rights.”