"Silence can be the most powerful scream." Transaction activity is down by about 60% from last year. If this pace holds, CRE trades will run 33% below the normal level of activity over the last 20 years. Big problem: The industry is geared to run at the pace set over the last five years, which is 60-70% above the normalized level. CRE executives are calling for a rebound in transaction activity in late 2023/early 2024. Let's hope they are right (or wrong if you're betting on distress). We don't know when transaction activity will rebound but because we can follow the dollars, we know what a rebound needs to look like. Nearly all buyers are currently on the sidelines. Here's why... 1. Prohibitive capitalization challenges Despite the headlines, capital challenges vary by profile... -- Perpetual income funds are struggling with exit queues, and until those outflows reverse, they won't be in "buy mode." -- Public REITs have more flexibility than others, but they trade at meaningful discounts to asset values, which means acquiring assets would translate to equity dilution (and less executive compensation). -- Value-oriented investors can't leverage assets to hit their minimum returns. 2. No "green shoots" Since we know what pushed buyers to the sidelines, we can make some educated guesses about what would solve those challenges... -- What would motivate investors in core and core plus vehicles to stop running for the exits? Value stability. As long as investors think actual values are below their carrying values, they'll try to exit at their carrying/appraised values. What is needed for value stability? Economic certainty. -- Similarly, what would motivate REIT investors? Value stability. Once values stabilize, REIT prices will stabilize, closing the gap between share prices and underlying property values and putting REITs back in a position to buy. -- Value-oriented buyers are different. They actually prefer distress, market fractures, and discounted opportunities, but they are not able to move on them right now. Unleveraged IRRs typically top out at 10-11%, then they use debt to juice targeted IRRs to 15%+. ...an impossible standard when debt is currently unavailable for risky deals and/or priced at around 9-10%. As long as lenders remain cautious and don't have to compete by lowering spreads, these buyers will stay on the sidelines. We're rooting for a rebound, but we think the only path to more transactions requires the remedies outlined above. Do you see these remedies forming? #realestatecapitalmarkets #creanalyst #acquisitions
I think a path to more transactions will be more owners being forced to sell as the wave of debt maturities begins to crest the end of this year into next. There is a ton of debt that has become unserviceable and unrefinanceable, and many owners don't have the desire or ability to do a ton of cash-in refinances. Those who don't have debt issues and can hold probably will though, so I'm not sure if this gets us back to "normal" or not.
Excellent point on the public REITs and (artificial) value dilution discouraging acquisitions.
Value / Opportunistic groups are probably the first to move. Yes, debt is tough for everyone, BUT for the value groups opportunities to seize distressed assets at a really attractive basis means they're more likely to move on the deal, even with the limited debt options. A great basis allows a reset, and probably a better outcome when values stabilize and the other groups re-enter the market. I've heard many distressed assets (from Owner & Lender) have just kicked the proverbial can to Q1 2024 because there was an optimistic consensus that rates would be stabilized by then and the industry as a whole would be looking at rate reductions by April / May. It would appear that rate decreases are NOT going to happen that soon. I think distressed assets kick off 2024 early, and a reset basis for opportunistic buyers is the first shift from the RED appetite, despite the cost of borrowing. And let's be honest, opportunistic buyers will underwrite (their eyes) levered IRRs well over 20% even at 9/10% debt costs. The election is looming large on top of all this.
Clarify “appraisal lag”. Are you saying the lag from a previous valuation point to current market dynamics?
Very much benefitted from our discussion about this in class last night!
“ buyers are on the sidelines…” Well, maybe. Either that, or they are nursing wounds.
Agreed. First, though, we need relativel interest rate outlook certainty. Only then will we get value stability.
Funds that will thrive in this market will be "distressed focused" with access to dry powder (cash/equity) and low LTV. However, the redemption issue due to 3-month appraisal lag is something that can't be solved until the market stabilizes.
Tailwind Investment Group
1 年Well, the most sophisticated buyer/operators have been thru this before and know that now is the time to focus on operations and relationships with your investors. You can’t be successful “if your backyard is on fire”.?Communication is key, every line item on the financials needs scrutiny and they are searching for ways to reduce costs with inflationary headwinds. Shopping for more competitive insurance quotes, looking at ways to use technology to reduce payroll, ways to lower their utilities. Acquisition guys are now moved to asset management while the CEO’s are meeting with their equity partners to keep them up to date on how their money is being protected. Action is happening, just not as much on the transaction side of the hallway.?The few who are still doing deals already prepared and had their house in order as soon as Powell started hiking rates. The rest are bailing out the water that is pouring in.