CRE Execs Proceed with Caution as Inflation, Market Uncertainty Persists

Senior commercial real estate executives are concerned about office and retail fundamentals as market uncertainty continues to curtail investors’ appetites for risk.

The Q3 2022 Real Estate Roundtable Sentiment Index registered an overall score of 44, a decline of seven points from the previous quarter’s overall score and 34 points down year-over-year. One survey respondent called retail in particular “a big unknown,” saying “we don’t know which tenants are going to stay in a brick-and-mortar store. The internet and Covid-19 have just accelerated this uncertainty. There is not a lot of appetite for it.”  Another investor said office was “nuanced,” with COVID-19 accelerated disinterest into older or more vintage buildings.

Overall, respondents to the survey said they were cautious of rising interest rates, increased inflation, and supply chain disruptions, but are optimistic about the underlying fundamentals for commercial real estate. About 53% said general market conditions are somewhat worse than a year ago, while 23% said conditions were about the same. And 34% predict conditions will be somewhat worse in a year, while 26% say they’ll be about the same.

In a statement, Roundtable President and CEO Jeffrey DeBoer said the Q3 Sentiment Index “reflects many of the challenges our economy and industry have faced since early 2022,” saying those challenges “will continue to be bottlenecks in the near term.”  

“Industrial and multifamily continue to be a source of strength, but office and retail still struggle to regain momentum following the pandemic,” DeBoer said. “These are uncertain times, but quality assets and owners will persevere as they continue to meet fundamental demand.”

Respondents say they expect long-term demand to persist for assets that allow flexibility by giving tenants more amenities and higher-quality accommodations. But as interest rates continue to rise, asset pricing is taking a hit, with trades happening at a discount relative to recent highs.

“We are still seeing strong rental rate growth and record high tenant retention, but something is going to have to give with rising rates,” one respondent told Real Estate Roundtable. “People are trying to remain debt neutral but there were a lot of deals that were underwritten aggressively the last few years with low cap rates that may not work anymore.” 

Another noted that “the biggest concern right now is the rise in interest rates. There should be a direct correlation where valuations will decrease because the cost of capital is more expensive,” the anonymous respondent said. And yet another respondent said “a lot of people are sitting on their hands until things become clearer” with respect to supply chain disruptions, geopolitical conflict, and the Fed’s reaction to rising inflation. 

As for the impact on asset pricing, one respondent said values are down across the board in every asset class, saying that it will be even more difficult to finance in six months than today due to widened spreads. Another said underwriting has gotten more conservative, which is “rippling through” availability and pricing with assets trading at 5% less for multifamily and between 10-20% less for a well-leased office asset.

“Investors are turning into vultures overnight, but there aren’t a ton of bargains out there yet. Everyone is afraid to buy something because they’re fearing it’s too high,” another told Roundtable. “Investors are trying to steal assets, not trying to look if it’s a good deal. There is not a whole lot of movement right now.”