Property Investment Returns Primed For Reset

The so-called “sugar rush” is over, as property investment returns — long buoyed by intense investor demand, cheap debt and strong fundamentals — are primed for a reset, according to a new report from ULI and PwC.

Whileotal returns for the institutional-quality real estate in the NCREIF Property Index (NPI) ticked up to more than 20% in the four quarters ending in mid-2022, nearly three times the 20-year average, those returns are predicted to come down.  According to the 47 economists and analysts surveyed in April by ULI’s Center for Real Estate Economics and Capital Markets, total returns will moderate to 8 percent in 2023 and 7 percent in 2024. And more than half the respondents to this year’s ULI/PwC Emerging Trends survey say they think capitalization rates will come up next year while returns tick down, primarily due to rising interest rates and capital costs. As rates drive up debt costs and in turn the costs to acquire and develop property, tick up, leveraged returns are reduced. reducing leveraged returns. What’s. more, the government is also turning off the spigots of monetary and fiscal policies designed to stimulate the economy during the pandemic.

“Property investors and managers are learning anew that whopping growth and profits eventually fall back to earth—a ‘reversion to the mean,’ to use finance jargon, or simply ‘normalizing,’ as numerous industry experts we interviewed put it,” the report notes. “Some looming market adjustments will be cyclical due to the weakening economic conditions that most economists and real estate professionals expect, while others represent more of a return to normalcy after all the pandemic-fueled market distortions.”

The head of a development company told ULI and PwC: “I feel like we’ve been on a little bit of a sugar high with this stimulus and cheap debt. There’s going to be a slowdown. There’s got to be this normalization. So, what does that mean? I think it’s going to be a little bouncy; it’s going to be a little bit turbulent. But then we bottom out, and we start back into growth.” 

Analysts say the reversions will take the form of declining prices as cap rates rise and deal volumes fall from historic highs, while rent gains will moderate for other property types as demand resumes more normal levels. And while “perhaps the biggest surprise is that these reversals of fortune are hitting favored property sectors like multifamily and industrial, that does not necessarily mean the market corrections will be painful,” ULI analysts say. “In many cases, recent losses in property value will only trim already healthy gains. But many indicators suggest that the (really) good times may be over, at least for a while.” 

The housing sector has already seen virtually all aspects of the market decelerate, both in for-sale and rental homes. New home prices peaked in April 2022, while the pace of apartment rents growth has been moderating in recent months and construction starts also have slowed.  The industrial market has also paused somewhat already this year as e-commerce growth slows and Amazon, the largest warehouse user in the US, delays occupying completed projects and attempts to sublet many in what some are calling the “Amazon pause.” But while ”investors are not ready to abandon industrial or multifamily, both of which still reign at the top of the heap in the Emerging Trends survey…the ratings are a bit less exuberant than last year, and these high-riding sectors do not look quite as invulnerable as they had in recent years,” the ULI report notes.

Reversion will also take the form of returning up to more normal levels, particularly for the hotel and retail sectors.