Falling Valuations, Less Capital Worry CRE Execs

Experts in commercial real estate overwhelmingly share a gloomy outlook on the current state of the market, the Real Estate Roundtable’s Q4 2023 Sentiment Survey reveals.

The survey, intended to serve as a comprehensive measure of senior executives’ confidence and expectations for the market, suggests that both are low. The corresponding index of sentiment registered an overall score of 44 – two points below that recorded in Q3, highlighting “the persistent challenges faced by participants in the market.”

The vast majority of respondents – 92% — believed asset values have decreased compared to 2022 and they worried about the difficulty of finding capital. Some 70% thought there was less equity capital on tap than a year ago, and 80% thought that was equally true of debt capital.

“We’re experiencing a cost of capital crisis, not a demand-driven boom-bust,” one respondent commented.

There were bright spots in certain segments of the market like data centers, outlet malls and hotels. Multifamily and industrial continued to attract interest, along with top-of-the-line Class A office properties. But in general, investors and CRE executives were weighed down by uncertainty about liquidity, capital availability, interest rates, and remote work.

The survey also indicated that participants generally have a more optimistic view of this year’s conditions than those of a year ago, but a more pessimistic view than they held in the third quarter of this year. Compared to 2022, sentiments about current conditions are up 3 points, perceptions of future conditions are up 9 points, and overall conditions are up by five points. However, compared to 3Q 2023, the view of current conditions is down 1 point, and the views of future and overall conditions are each down 2 points.

Somewhat confusingly, when asked about general market conditions, responses suggested the opposite. By comparison with one year ago, 68% said today’s environment is less favorable and just 15% say things are better. Asked what they expect one year from now, 49% look forward to improvement, 24% said things would be worse, and 27% do not expect much change.

“For those organizations with low leveraged assets, this is the best buying opportunity in over a decade. But for firms with lots of floating rate debt or office properties, it’s a bit trickier right now,” one respondent noted.

Declining asset values remain a key concern. Some noted prices have fallen 20% because of rising cap rates and unpredictable interest rates. One respondent predicted continuing downward pressure on valuations for the next two or three quarters, with some asset classes experiencing it more harshly than others, and the possibility of some stabilization afterward.

As for capital, there was broad agreement that the markets for both equity and debt capital have worsened. However, some saw opportunities in less usual places. “Pension funds are allocating more dollars to credit strategies and it is much easier to raise credit than equity capital,” one respondent said. Another cited family offices and high net worth individuals. Others noted “a monumental capital raising trend for distressed funds” with more to come. “It may be a contrarian view, but I predict there will be more money than distressed properties to buy,” said another.

Commenters also described adopting different approaches to the way they operate. One pointed to opportunities in second-tier markets outside the big cities that present opportunities because of population growth – the “new Nashvilles.” Another said his company was focusing on its existing portfolio. One respondent questioned the value-added approach to deals, asking, “Who is going to buy these newly renovated core buildings? In the end, everything is going to need repricing.”

“There will be a great revaluation cycle with more real estate assets priced lower,” another agreed. “Hopefully, we will see more movement in 2024.”

Other executives saw a teachable moment. One saw the rise in insurance costs as “a moment for managers to incorporate ESG considerations into deals.” In another case, a respondent described how senior-level executives are helping newbies who have never been through market downturns.