When you’ve hit the peak, the only way forward is down, which seems to be where CRE transactions are going at the moment. MSCI’s Capital Trends report for February makes it clear.
“The markets are moving faster than a monthly review of deal trends can realistically capture,” they said. “When we started this report, which provides a review of the commercial mortgage market in 2022, Silicon Valley Bank had not even failed yet. That said, the trends in deal activity, pricing, and credit availability were already pointing downward before the recent challenges in the banking world. The events in recent weeks might be viewed as a force accelerating changes that were already underway.”
By underway, they meant that February deal volume was down 51% year over year. If it hadn’t been for the take-private STORE Capital REIT deal—a hefty transaction—the 2023/2022 February comparison would have been off by 59% instead.
The 12-month fall of all categories were office, -37%; retail, -1%; industrial, -24%; hotel, -15%; and multifamily, -28%.
“Prices fell in February alongside falling deal volume,” said the report. “The RCA CPPI National All-Property Index dropped 6.9% from a year earlier, but the annual change underplays recent movements. Looking at a higher-frequency measure, the annualized rate of decline in February from January came in at -23.6%. The apartment and retail sectors posted the largest annualized declines for February.”
Cap rates are significantly higher than during the buying rush of not long ago: office, 6.4%; retail, 6.4%; industrial, 5.3%; hotel, 8.5%; and multifamily, 4.7%.
Another gloomy fact is a nearly $900 billion wave of maturing loans. “CMBS, CLO, and investor-driven lenders are behind more than half of the approximately $400b in loans coming due in 2023,” says MSCI. “CMBS lenders have the single largest exposure to loans maturing this year, accounting for more than one-third of the outstanding balance. Bank loans maturing in 2023 —including those provided by international, national and regional/local banks —account for a smaller share of loans coming due than CMBS alone.”
Financing is likely to get tougher as well given the banking crisis as a sudden flood of MBS or CMBS onto the market could undercut current values. Many in CRE are already facing problems getting projects refinanced. More pressure in these areas could ultimately mean more distress.
“Newly distressed assets did climb in the second half of the year, with $13.7b of such assets running into trouble,” MSCI notes. “Around 65% of these newly distressed assets were in the retail and office sectors. As opposed to the opportunities seen in the aftermath of the GFC however, these are not situations where otherwise cash-flowing properties simply had problems in the debt portion of the capital stack. The office and retail sectors have faced fundamental challenges tied to property obsolescence.”
Three years after the global financial crash, distressed sales were 20.3% of all property sales. So far, in 2022 Q4, distressed was 1.2% of sales.
But it’s far too early to feel comfortable. As MSCI repeats, the challenges currently are more fundamental than they were in the past. “Would a further curtailment in the debt portion of the capital stack throw more assets with fundamental challenges out to the market?” they ask. “Or would lenders and current owners be pushing cash-flowing assets out to the market as they did in the aftermath of the GFC?”
Too early to tell, but maybe just soon enough to be concerned.