Headline Figures on Deal Volume Mask CRE Weakness in Q2 2022

All commercial property is not the same. Investing in this asset class is not like buying a bushel of soybeans on the Chicago Board of Trade. There are differences in quality, location, age, and size among other factors that can drive variation in performance. These unique features of every property can also drive differences in the target investor groups and investment activity over time. Signals from the smaller end of the U.S. market in the second quarter of 2022, however, suggest trouble may be ahead for the rest of the market.

Interest rates spiked in Q2 2022, with the 10-year US Treasury yield up nearly 100 basis points in the quarter. This change in the interest rate environment has driven up mortgage rates and led to much discussion of “negative leverage” situations where current mortgage rates are often higher than the cap rates set just a few months back. These changes did not impact U.S. deal volume in total for the quarter, with sales up 17% from a year earlier.

Activity at the smaller end of the market did pull back from a year earlier. For deals priced below $20 million, sales fell 11% from Q2 2021. This smaller portion of the market is sizeable and represented just over one-fifth of all investment activity in Q2 2022. All the growth in the quarter was in the larger deals that are dominated by institutional players.

There was some variation by property sector, but the smaller deals were generally down from last year. Apartment and industrial represented the two largest sectors for commercial property investment in the first half of 2022 – 61% of all new investment. For the deals priced under $20 million, these two sectors were down roughly 22% from a year earlier in the second quarter. Such deals were down 5% from a year earlier for the office sector, but the pattern of bigger deals doing well is not the case in this sector due to idiosyncratic drivers of performance. The hotel sector is in the same boat, with more of an investor focus on smaller hotels.

In good times and bad, deals at the smaller price points are dominated by private capital sources. Institutional investors can be less nimble than smaller investors when it comes to shocks in the market, owing to negatives like a more bureaucratic investment process. They also may not feel shocks as acutely in the short term because of deeper capital sources and because more complex deals would likely have started weeks before the interest rate changes hit the market. The way deal activity fell for these smaller deals in Q2 2022 is a signal that the more institutional investors should take to heart when setting expectations for the rest of 2022.

This article is an update of a version published for clients of MSCI at https://www.msci.com/ with subscribers getting this information earlier. Data analysis for this article conducted by Alexis Maltin whose contributions are always top notch. Any opinions expressed are mine and not those of MSCI and should not be construed as investment advice.