For more than a year, commercial real estate buyers and sellers have been in a standoff over asset pricing. Conventional wisdom dictates that cap rates will rise alongside interest rates, with a typical six-month lag; however, in the last year, pricing has not followed this model. Although interest rates have doubled since the beginning of 2022, cap rates have remained steadfast with current owners holding tight to last-cycle pricing.
For retail assets, some relief is finally here. In the last three months, retail owners began to adapt to new market fundamentals, according to Connor Olandt, VP of net lease retail at Matthews Real Estate Investment Services. The pricing gap has started to narrow, and it is helping to bolster investment appetite.
Pricing Gap Begins to Tighten
In the last few months, triple-net retail cap rates have increased 100 to 150 basis points, according to Olandt, a sign that buyers and sellers are starting to become more aligned to new market conditions. This is a change from the first quarter, when there remained a standoff on pricing. "I've personally seen the pricing disconnect decrease over the last one or two months, even compared to what I experienced earlier this year," he says.
The pricing correction has highlighted the importance of strong real estate fundamentals. According to Olandt, B and C class properties in tertiary markets without a national tenant or strong credit tenancy have lost value at the highest rate. While class-A properties are retaining the most value—or declining at a lower rate—with cap rates increasing roughly 50 to 75 basis points.
The Fed has expressed plans to stall or slow interest rate increases for the remainder of the year, so pricing adjustments are also likely to slow. "We've already seen the shift in pricing, and cap rates are starting to stabilize," says Olandt. While he expects the pricing disconnect to become smaller for the remainder of the year, there aren't likely to be any other major changes in retail cap rates, as a result of interest rates. However, the recent tightening of lending from banks and credit unions could cause serious market disruption.
Investment Appetite Heats Up
Despite the disconnect on pricing, Olandt has seen very little change in transaction volume for his business, even compared to the last few robust years. With a smaller pricing gap, he is optimistic about investment activity in the second half of the year. "The deals are much harder to get done, but they are still getting done," says Olandt.
He has been working with sellers to exchange out of assets that don't align with their long-term goals, and helping buyers find opportunistic deals. Typically, passive investors are looking for a coupon clipper with strong national tenancy, while value-add buyers are looking for assets with operational challenges where there is an opportunity to raise rents or improve the tenancy to create value. "We have been relentless in the pursuit of adding value to our clients," says Olandt.
There are opportunities for both buyers and sellers to pursue deals and find value in this market. As the Matthews net lease retail VP says, "a difficult market is certainly not a time to take your foot off the gas."
For more stories in the Matthews Real Estate Investment Services thought leadership series, click here.
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Kelsi Maree Borland
