Investors Weigh Whether Prices Have Hit Bottom

Depending on the investor type, today is either the time to buy or the time to wait for the market to hit “bottom,” according to John Chang, Senior Vice President, National Research and Investor Relations.

Speaking during his firm’s recent industry trends video, he said institutional investors, those operating major investment funds, have told him that they believe the market still has a ways to go.

“They think prices are still going through a correction process, and they believe pricing could fall another 5% to 10% this year,” Chang said. “Many of them indicated that they plan to sit on the sidelines for a while longer.”

As for private investors, they were generally more optimistic, Chang said and were not trying to time the market and that their focus is on where the market will be in five years.

“They see the current pricing as a discount from where things were, and they believe the underlying commercial real estate fundamentals will improve in the coming years,” he said.

There definitely are challenges and headwinds, according to Chang, but investors are sharpening their pencils and they’re taking lots of swings at deals to land at least a few that will deliver results.

He said that several of them told him that if the deal pencils today or if it’s even close to a break-even right now, it only gets better over time – and they believe they’ll be able to refinance when interest rates go down.

As for investors who are selling properties, one told Chang that even though one of his properties is profitable, it just hasn’t met his expectations.

“So, he’s selling it to free up the capital, then he plans to reinvest that money into a different property with more upside potential,” Chang said.

A few institutions Chang spoke to are choosing to sell properties because they’re not generating the desired results.

“They’re basically clearing off their weakest assets so they can redeploy that capital and bolster their overall yields,” he said.

Chang said it all comes down to one question: Has commercial real estate pricing gotten close enough to its floor to generate buying opportunities?

Depending on the property type, and the market, prices have come down by 5% to 30%. And in some cases, buildings are being sold on a price-per-pound basis.

A notable example of this is the 44-story former AT&T Tower in St. Louis. Back in 2006, that building traded for $205 million, but it just sold for about $3.6 million. That sale’s obviously an outlier, but older urban office towers in many markets do still face significant headwinds.

For other property types, such as apartments, the greatest price softening is occurring in the metros that were priced most aggressively in 2021 and 2022.

Several of those markets have seen cap rates increase by 100bps to 150bps over the last few years. But properly priced assets are still getting strong activity.

Chang said one large apartment community had 43 offers and sold at a 5.5% cap rate, well below the current lending rates – so that’s a negative leverage deal that went through.

Another interesting property type is industrial.

“Although there’s a broad consensus that industrial will likely outperform over the long-term, the significant wave of big-box industrial development has dampened investor enthusiasm,” he said.

On the other hand, small to mid-sized infill logistics space in growing metros has faced a highly competitive bid climate, and that property subtype has seen very little value erosion.

What it adds up to, Chang said, is that prices have bottomed in at least some property types.

Pricing on unanchored retail centers as well as neighborhood and community retail centers appear to be nudging higher, but it’s still too early to tell if this is a bump in the road or an actual transition point, he said.

Likewise, some types of industrial property and some apartment markets appear to be back on the upswing.

“That said, interest rates could still play a significant role in pricing trends,” according to Chang. “If interest rates rise, it could once again stall investor optimism. If interest rates fall, investor competition may heat up.”

But Chang said the real question investors should ask is whether the deal pencils over the hold period and what the deal looks like in five years.