The term “mind the gap” had its start in England as a reminder that subway patrons should step over the space between the train door and platform.
Today in commercial real estate, the gap is a bid-ask transaction one, where buyers and sellers are separated by a space between their respective valuations of a deal. Unfortunately, this price gap is having significant impacts on deal volumes, as MSCI noted in its Q2 2023 capital trends report.
Deal transaction volumes have been down significantly, with “potential buyers and current owners are still too far apart on price expectations for higher levels of deal volume to close across most property sectors.” The observation is in keeping with what many in CRE have related as anecdotal to GlobeSt.com since September 2022.
Most in balance is the industrial sector, perhaps because evidence suggests that rents are strong and help support perceived value of buyers. “Industrial is seeing slight price declines, but the price expectations gap shows that little movement is needed to bring buyers and sellers together, as volume is still elevated relative to history,” MSCI wrote.
In office, retail, and multifamily, though, gaps are significant and volume falling, which creates a vicious circle dynamic. The fewer transactions, the more price discovery is necessary because it is harder to find evidence to back valuations.
“The office sector is the worst of these, with a 7.4% gap between buyer and seller expectations,” MSCI wrote. “That modeled gap would imply that about a 17.6% YOY decline in a liquidity-adjusted version of the RCA CPPI for offices would have been needed to get volume to a more normal level for the quarter.”
The firm acknowledges that an “outside shock” for offices, like heavy distress sales, could lure buyers back in while helping to establish new mutually agreed upon pricing. MSCI treats this as an unlikely optimistic take with a low probability. “Less optimistically, this price expectations gap may continue to grow in the coming quarters,” they wrote.
The evidence suggests that price adjustments have settled into cap rates, which have risen. The RCA Hedonic Series of cap rates are up for all majority property types, including that least affected industrial.
“Relative to the levels seen before the low interest rates from 2021 to 2022 however, some sectors are still priced dearly,” they wrote. “Industrial cap rates were 60 bps lower than the 2015-19 average in the second quarter. CBD office cap rates, by contrast, stood 40 bps higher than the pre-pandemic average.”