Real Estate State of the Market - Life after ZIRP
By Austin Milliken
What is going on in the private markets? Well, given the state of the public market, it is much as you would expect. There is a major Federal Reserve forced repricing at work (chart below).
I thought that I would share some observations and feedback of what this repricing has done to the real estate market and private investor appetite. While this is real estate focused, the sentiment mostly carries across asset classes.
Valuation is driven by capitalization rates (cap rates) and net operating income (NOI). Currently, Cap rates are adjusting as the risk free rate and lending rates increase. NOI is largely determined by property type and local market conditions. Rents generally have increased, but associated costs have also increased. There is identifiable regional market dispersion in the sector for expected NOI adjustments right now.
Transaction volumes are falling as new valuation levels are established. Institutional owners have deployed capital underwritten with high return expectations and are hesitant to sell into a weak lower valuation market.
Buyers are only transacting when they feel they are getting exceptional value. Fresh money is looking to be rewarded for stepping into this market given the greater uncertainty. As rates continue to rise, sentiment shifts. Increasingly investors are seeking to hit return targets through cash flow yield rather than capital appreciation. It is unclear if the market has found a bottom and investors are hesitant to catch a falling knife.
The refinancing cash flow is not a given in this market. Many assets today do not qualify for refinancing as some lending ratios don’t work with much higher rates. Unfortunately, the numbers don’t pencil in many cases. This could force asset selling, hopefully lenders in the short-term will look to modify and extend loans instead. This creates a pricing differential between assets with older vintage debt and assets with newer vintage higher cost debt. This makes turning around assets with short-term debt that need to be refinanced much more challenging.
Clearly, we are in the middle of an exceptional market. Managers have told us during Q3 and Q4 of this year that they looked to Q1 2023 to allocate which is welcome news. Although, every manager is expecting discounted deals and that will be tough for operators to face. For some managers, this valuation reset is the payoff for patience. For most it is a time to lick wounds, reflect on our lives, and be grateful for what we still have.