Deal Activity Shrank 56% in Q1 as Cap Rates Rose 30 Basis Points

Too many services of adult beverages can land a person in a hangover the next morning. In a way, that is the U.S. capital trend that MSCI sees in its 2023 Q1 report. Except that the overdoing for the CRE industry was a “period of excess liquidity” that is requiring a downward adjustment.

It reports that deal activity shrank by 56% in the first three months of the year compared to a year ago. At the same time, cap rates rose across all major property types by 30 basis points to 60 basis points.

“Deal volume is down at double-digit rates from a year earlier, prices are in retreat and cap rates are ticking upward,” the firm wrote. “Uncertainty abounds amid ongoing questions about the status of financing with the turmoil at regional/local banks and the viability of certain office and retail properties. Combine that uncertainty with the high levels of construction for the apartment and industrial sectors in recent years, and it is understandable that some would take the view that calamity is ahead.”

However, conditions aren’t necessarily bad. Even the drop in transaction volume was a comparison to a raucously busy base. MSCI says that deal volume is “still at healthy levels.”

“Investment sales averaged $87.8b across every first quarter period from 2005 to 2019, putting the $85.0b in sales for the first quarter of this year broadly in line with historical averages,” they said. “Granted, there is a difference in what is transacting in the first quarter of this year versus the asset classes that investors sought over the last 15 years or so.” And the first quarter in 2022 was still hot because the Federal Reserve hadn’t started on inflation-fighting interest rate hikes.

For example, multifamily transactions were at $25.4 billion, but that was down 64% from more than $45.3 billion in the same period of 2022. Nevertheless, the amount was still 9% ahead of average activity for first quarters between 2005 and 2019. Prices are down 10.3% year over year, or 23.1% on an annualized basis.

Industrial, which was the other big winner during the pandemic, hit $18.5 billion in the first quarter, which was 54% lower from the year.

But office sales were down 68% year over year to $10.7 billion and last 12 months lower by 43%. Hotels were off by 55% at $5.9 billion and for a 25% 12-month drop.

“Commercial real estate prices are falling, with the industry expecting this decline for months,” the firm wrote. “The price components of the MSCI USA IMI Core RE indexes that measure performance in the REIT markets are generally down at high double-digit rates since the end of 2021. That scale of decline has not yet hit the pricing seen for asset sales, but the declines are accelerating.”

However, according to MSCI, prices have a way to go before investors decide to start buying.