My Best Guess on When Deal Velocity Will Return

If you can’t figure out the odds, you can’t make the bet. I can’t tell you how many times I have used that phrase in the past several years, as we have seen numerous market dislocations that have frozen deal activity. The pandemic, political events, capital markets anomalies, leaps in technology, tax law changes, and many other things have happened in the recent past that have given market participants reason to pause.  

2023 is different. A perfect storm of rapidly rising interest rates, economic uncertainty, changes in the way we use real estate, a fresh banking crisis and myriad other things have all occurred at the same time.  Assumptions that have been the baseline for decision-making have been totally blown up,  and the cost of capital has changed so rapidly that fundamental return parameters are still moving around. Too many factors are out of an investors’ control and the market to buy and sell properties is essentially locked up.

 Most predictions as to when the markets return to normalcy focus on time frames far enough into the future that they are difficult to argue with. But it’s not that simple. Even before the banking issues of last week, sales volumes are down across the board by as much as 50%, and we have been in what I call an “event-driven” transaction market. The vast majority of transactions in the first quarter of 2023, be they sales, recaps or refinancings, occur because something is forcing them to happen. This is not a new phenomenon and historically when markets freeze up, these event-driven deals provide data points that give investors the confidence to make decisions.  Every other time in my career where I have seen a market freeze, these types of deals are the key to getting things moving. But not this time.

 In every downturn, there are factors that are different than in the past. Today, rising interest rates, an uncertain geopolitical environment, remaining questions on how some real estate will be utilized going forward, population shifts outside certain urban areas, and a host of other factors have combined to totally blow-up the deal-framing assumptions we have relied on for years.

Interestingly enough, one of the positive current market attributes is that there remains a tremendous amount of equity focused on commercial real estate. Memories that are still clear from the last major downtown–where investments made early in the cycle yielded outsized returns–means virtually every investor I have spoken to feels some pressure to invest early in the next cycle. This creates a unique phenomenon that will drive deal flow before the statistics may support it.

I expect this “Fear of Missing Out” will push investors to jump into certain markets more quickly than they otherwise would.  To be clear, FOMO won’t create recklessness, but investors will closely monitor markets and property types they feel strongly about and make deals that they can justify through their personal experience and market knowledge before the statistics may support it. You are going to see institutional and private investors push to get money placed early in the cycle. It may be a price per square foot or cap rate they think is a no brainer, or a specific asset plan they feel uniquely qualified for that drives them, but the first wave of transactions won’t be fueled by big picture market factors and every investor will be looking at deals through a different lens. It will be anything but orderly at first.

 So the question remains, when will the markets come back and what will that look like? My view, based on hundreds of conversations with buyers and equity investors is that once the banking environment settles down and it’s clear there isn’t a systemic issue, we will see the credit window open up for certain deals.

Following that, the market will be dominated by recapitalizations and structured transactions where equity feels a little like debt and is somewhat insulated. Most of that money has been raised for value add and opportunistic deals and will be deployed where the asset level assumptions may have changed, but the fundamental plan is still viable. Multifamily, industrial and hotel in particular are starting to see this and I expect that by the end of the 2Q 2023 that there will be enough datapoints to then drive sales in a meaningful way, especially if the Fed signals a time frame to end interest rate hikes. 

This means that by early 2024 we will see sales velocity in most asset classes return to normal, although certainly some of those transactions will be reactivating deals put on hold in the previous 18 months.

Office however is a different story and will be wildly different across markets. By mid-year 2023, we will likely see more office building sales than recapitalizations, but they will be relatively few in number and largely driven by investors not willing to deploy additional dollars into properties. This will only work if value hasn’t deteriorated to the point where the lender is in control and sadly, I think most office assets won’t fall into this category. We won’t see non-event driven sales of office buildings until there is more clarity on the user market which will take through the end of the year.  As values become clearer, more and more lenders step in and determine the best course of action going forward. I don’t think we see much happening in this regard until early 2024, with sales not occurring in volume for another 6-9 months after that, thus resetting the market for office values.

 In summary, the sheer amount of capital raised will fuel velocity in asset classes outside of office by mid 2023.  It will be choppy, but by the end of the year we will have enough data points to help fuel a more orderly market of buyers and sellers. That generally won’t be the case for office buildings for at least another year after that, well into 2024. I have heard the phrase, “survive to 2025” used more and more often in the past several weeks. Things won’t change quickly, but investors who wait that long to jump in risk missing the most important part of the next cycle. Investors need to be stress testing their theses now with capital and with their partners now, so that when they see the deals they want they can act, the best deals are going to be made early and before the market reaches equilibrium. 

John Kevill is managing principal of the boutique brokerage and investment firm Solitude Cove Capital and a senior advisor to consulting firm Arcturus.