LPA’s Valuation Experts Look Ahead to 2023. Here’s What They See.

In many ways, the story of commercial real estate in 2022 is a tale of two years.?

Despite the outbreak of war in Europe and yet another COVID-19 surge, almost all asset classes outperformed expectations in Q1 and Q2. The chief reason? The market’s demand generators, such as low unemployment, the high cost of the average single-family home, and robust consumer spending — buoyed in part by another round of?American Rescue Plan ?stimulus checks — continued humming as loudly as they did in 2021. Consider the following statistics:?

• Between April 2021 and April 2022, 551 million square feet of industrial space were sold and/or leased across the United States, setting a new record. (Marcus & Millchap )
• As of June 2022, the national median rent for an apartment crossed the $2,000 threshold. In one Texas market — Austin — rent had risen 48 percent in twelve months. (Redfin )
• In Q2 2022, the average asking rent for shopping centers rose by 1.2 percent. Meanwhile, shopping center vacancy rates fell to their lowest level in 15 years: 6.1 percent. Consumers acting on their pent-up desire for in-person shopping experiences helped this beleaguered sector show such resilience. (Cushman & Wakefield )?

But the script flipped in Q3 and Q4. The market’s strong fundamentals proved to be no match for the rising cost of capital, driven primarily by interest rate hikes intended to curb?inflation . In October, the?Mortgage Bankers Association (MBA ) forecast that multifamily lending would see a 7 percent year-over-year drop by the time the books were closed on 2022. About that same time, the?National Association of Realtors (NAR) ?reported that “about 1.34 million more square feet of office space was vacant and placed on the market than were leased” between July and September.

What does all this mean, if anything, for 2023? What forces and factors are most likely to affect transaction volumes, net absorption rates, and property values in the coming year? For answers to these and other questions of particular concern to CRE stakeholders, we asked some of the most astute observers we know: LPA’s own commercial appraisers. Keep reading to access their insights and expert opinions.

Which 2022 Trends Should Stakeholders Be Paying the Most Attention to in 2023??

“Interest rates are at the top of everyone’s mind, and I’m no different,” says Jake Allen, Director of?LPA Lubbock . “The cost of financing affects activity levels across the entire real estate market.”

On December 14th, 2022, the Federal Reserve raised its benchmark interest rate by another 50 basis points. The bad news: the federal funds rate is now the highest it’s been since before the global financial crisis of 2008 – 2009. The good news: this increase was lower than expected. In fact, it broke a streak of four straight three-quarter point hikes dating back to June 2022. Most market experts believe the federal funds rate will top out at around 5 percent sometime in 2023.

Drew McFarland, Senior Managing Director,?LPA Dallas , is closely monitoring both inflation and interest rates. But he’s looking at both through a slightly different lens. “Stakeholders should be on the lookout for rising construction costs as well,” he advises.

Adds Mark Lowery, Principal and CEO, “2023 is?a potential wake-up call on cap rates.” How so? “Most in valuation theory agree that cap rates move in tandem with interest rates. While it’s not always a direct or instant correlation, the two clearly impact one another,” Mark explains. “Most CRE is leveraged, and when market participants are making decisions, their cost of capital is always a consideration. Right now, deal flow has slowed. Many are sitting on the sidelines, holding onto their capital and waiting to see what happens.”

Jake concurs. He also places the current slowdown in a broader context — one that gives him cause for optimism. “The current slowdown hasn’t come close to what we saw at the height of the pandemic in 2020,” he observes. “I believe most market participants share this sentiment and are confident that conditions will soon improve.”

What Other Factors Are Likely to Influence Commercial Real Estate Markets in the Coming Year?

Mark expects that consumer behaviors will continue to shape commercial real estate markets nationwide. But the buying habits he’s talking about are not specific to real property transactions. Citing the seemingly insatiable demand for industrial, Mark predicts that “the last-mile demand generated by the continued expansion of online commerce will continue to prop up that asset class.”

Drew, whose office serves the fourth-largest metropolitan area and?the hottest commercial real estate market in the United States , believes the shifting employer-employee power dynamic will continue to be impactful. “The way work is carried out is still evolving following the pandemic,” he says. “This continual change can directly influence the need for commercial real estate. Office will likely remain soft due to the work-from-anywhere trend.”

For Jake Allen, however, the cost of energy — a significant contributor to the summer 2022 spike in inflation — is always top of mind. “Oil and gas prices directly affect the West Texas markets in which I specialize,” he notes. “Those prices don’t just affect the transportation industry. They affect just about every part of Texas’ infrastructure.”

Which Asset Classes Will Perform Better in 2023 Than in 2022? Which Will Perform Worse?

Both Mark and Jake are bullish on multifamily. “With the high cost of financing, I believe multifamily properties will see the biggest growth,” Jake says. He adds that he’s “keeping a close eye” on the single-family rental market. Although the housing market has cooled considerably since then, as of August 2022,?single-family built-for-rent construction starts were up 60 percent YOY . What remains to be seen is whether institutional investors continue to bet big on this asset class. Some indicators point to?several key players looking to cut their losses if not leave the space entirely .

Meanwhile, Mark points out that “multifamily has remained frothy for a number of years.” But he also sees reason for cautious optimism. “Cap rates have compressed low enough that increased interest rates will undoubtedly soften this asset class,” he says. “There will be heavily leveraged investors who will undoubtedly get stuck with their hand in the proverbial cookie jar.”

How Can Appraisers Keep Current with Emerging Commercial Real Estate Trends in 2023?

Jake says that keeping in front of emerging trends starts with continually honing his analytical skills. He is on track to earn his?MAI designation ?in 2023 and plans to continue his studies and classwork even after achieving the profession’s “gold standard.”

Drew emphasizes the more informal education that comes from being a good colleague and active citizen. “Staying connected and active in local industry groups furthers my understanding of the field and the dynamic market we serve,” he says. Jake agrees, sharing that “the day-to-day of appraisal requires conversations with a wide variety of market participants. I believe speaking with them is incredibly educational.”

As Principal and CEO, Mark has already created a growth plan to ensure that LPA can maintain a front-edge understanding of trends as they emerge. “We’re doubling our research efforts to provide our clients the most up-to-date, accurate, and ethical opinions of value possible, and we’re significantly expanding our Market Research Team,” he reveals. But, for Mark, research entails much more than crunching numbers. Like Drew and Jake, he believes it involves building lasting relationships with trusted partners. “There’s no substitute for the human factor,” he explains. “There’s just no foolproof substitute for calling and emailing market participants.”?

LPA operates multiple offices in Texas, and our professional network extends far and wide. We’ve likely appraised a commercial property in almost every city and town in the Lone Star State — and we’re proud to say so. We also provide commercial real estate appraisals outside Texas, and our market footprint continues to grow rapidly.?

Whether you’re located in?Dallas ,?Fort Worth ,?Houston ,?Austin ,?San Antonio ,?Corpus Christi ,?Lubbock ,?El Paso , New Mexico, Oklahoma, Arkansas, Louisiana, or somewhere in between, we look forward to providing you with an exceptional customer service experience featuring best-in-class research, principled expertise, open communication, and 100% on-time delivery. To learn how you can put our Team’s market knowledge, geographic competencies, and property-type expertise to work for you,?contact any of our 8 locations today .

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