As originally covered in The Business Journal
The world of commercial real estate has been a rollercoaster of trends and shifts, with 2023 proving to be no exception. After a robust 2022 marked by strong investment sales, the current year has brought about a significant deceleration. Investors find themselves grappling with heightened uncertainty in the economic landscape, rising interest rates and tighter debt markets. These factors have led to a decline in sales, leasing, and financing, impacting prominent brokerages’ profitability by staggering margins of 50% to 100%.
A notable barometer of the commercial real estate market’s health is the RCA Commercial Property Price Index, which reveals a dip of 8% in the value of commercial real estate over the past year. The situation is even more pronounced in the multi-family sector, where values have shrunk by 10%. This decline shows the market’s current fragility, prompting investors to ponder a central question: How much longer will this trend continue?
In contrast to the strong apartment investment sales in 2022, 2023 activity in Q1 and Q2 has cooled down considerably. A significant change in the investment landscape has manifested through an increase in capitalization rates (cap rates), which now average 5.61%. This marks the fourth consecutive quarter of cap rate escalation. Alongside this, there has been a remarkable 62% year-over-year decrease in sales volume, plummeting from $353,960,818 in 2022 to $133,484,774 in 2023. The number of transactions has also decreased, with just 25 transactions recorded in the first two quarters of 2023 compared to 61 in the previous year. Multi-family was the darling of the dance after COVID but the music seems to be fading. The significant decline in sales raises questions about the impact of the new normal and higher interest rates on the once-thriving multi-family market.
Similar to the multi-family sector, the retail market has witnessed a substantial reduction in sales volume, affecting both single and multi-tenant properties. Multi-tenant properties, in particular, have experienced a significant drop of 66% in sales volume year-over-year, while single tenant properties have seen a 43% reduction over the same period. The average cap rate for multi-tenant properties, 6.86%, is the highest average cap rate since the early stages of COVID recovery in Q1 2021. Further, transactions have decreased by a staggering 58% year-over-year. The data illustrates that sellers can expect a reduced buyer pool, prompting pricing adjustments aligned with the debt market, given buyers’ inability to match the previous year’s prices; consequently, the coming months are likely to reveal a notable shift in pricing expectations.
The recent extension granted by the Internal Revenue Service (IRS) for 1031 exchanges in regions affected by severe storms might hold promise for increased market activity. The extension is until October 16th for the 45-day identification period and 180-day closing term for 1031 exchanges. Investors who were awaiting this extension could potentially unleash pent-up demand, leading to an upswing in transactions. This scenario has historical precedent, as a similar IRS extension during the summer of COVID prompted a surge in activity as the deadline approached.
The combination of rising interest rates and divergent seller-buyer perspectives on property values has left investors hesitant to commit to new investments. This will likely curtail sales activity as the year progresses, extending into 2024. Apart from the anticipated effects of year-end exchanges, investors are adopting a patient stance, observing how the economy and interest rates unfold before committing to major investment decisions.
Market volatility can create complexities in commercial real estate investing. Consult with an experienced advisor who understands your financial goals and can provide market expertise, with an understanding of elements that impact value.
Brett Visintainer, CCIM is a Commercial Investment Advisor and the Principal of Visintainer Group in Fresno, CA. Formed in 2018 and built on a foundation of investment real estate, the Visintainer Group is a client-first commercial real estate firm. The Group has executed over $715 million in transactions across the United States. Brett specializes in commercial property acquisitions and dispositions and 1031 exchanges for owners in the Central Valley, Sacramento, and Central Coast markets. He can be reached at 559.890.0320 or [email protected].
The commercial real estate investment market in 2022 experienced a record year, particularly in the retail and multi-family sectors, as investors capitalized on the recovering economy and increased consumer spending. On the heels of Q1 wrapping up, it’s time to examine the performance of the market and explore how factors such as interest rates could impact the remainder of 2023 and beyond.
In Q1 2023, the real estate market started the correction from the record-breaking year in 2022, attributed to raising rates, not seeing pricing adjustments, and buyer sentiment in the market. Here’s a breakdown of Q1 for each of the major sectors in the Central Valley:
Interest rates play a crucial role in the market, influencing both borrowing costs and investment decisions. In Q1 2023, the Federal Reserve began implementing gradual rate hikes to curb inflation and stabilize the economy. These rate hikes are expected to have the following impact:
Considering the current economic climate, interest rate trends, and increasing competition from alternative investment options, the commercial real estate investment market is expected to face some moderate headwinds moving forward:
The industrial sector is anticipated to continue thriving, fueled by e-commerce and supply chain optimization.
As the market navigates the challenges of rising interest rates, investors need to adopt suitable strategies to ensure continued success. Here are some tips to consider:
There continue to be opportunities for buyers, but they need to focus on the fundamentals when investing in commercial real estate in 2023. By focusing on quality assets, diversifying their portfolios, and exploring value-add opportunities, investors can navigate these challenges and continue to find success in the commercial real estate market. As we move through the remainder of 2023 and into 2024, keeping a close eye on market trends and adjusting investment strategies accordingly will be key to thriving in this ever-evolving landscape.
Market volatility can create complexities in commercial real estate investing. Consult with an experienced advisor who understands your financial goals and can provide market expertise, with an understanding of elements that impact value.