Private Real Estate: From Peak to Trough – Where Are We Now?
Executive Summary:
The Current State of Commercial Real Estate
- Transaction activity has meaningfully slowed, exacerbating uncertainty around asset valuations.
- Despite valuation volatility, real estate fundamentals remain healthy across most property types.
- Compelling opportunities will emerge in 2024; however, the capital markets environment will be a large determining factor of performance.
Is Private Real Estate Recovering from 2023’s Lows?
2023 presented unprecedented challenges for commercial real estate, with higher-than-expected costs of capital, limited transaction activity and widespread uncertainty. Rising interest rates, combined with limited financing sources, put pressure on asset values. As cap rates expanded across property types, investors waited on the sidelines, aiming to predict when valuations were presumably “bottoming out.” And, as many sellers were unwilling to mark down their assets, a wide bid-to-ask spread was observed between buyers and sellers. As a result, many transactions in 2023 fell through, and a significant amount of dry powder remained on the sidelines. As seen in the charts below, 2023 marked the lowest transaction volume observed in commercial real estate across the 10-year period.
Transaction Volume
Cap Rate Spreads vs. 10-Year Treasury Yield1
Effective Rent Growth
Indexed to $100
Cap rate expansion was widespread across all property types, albeit in different magnitudes, with the office sector experiencing the most negative impact. Rent growth, though dampened, generally remained positive across favorable sectors. We saw this translate to NCREIF Property Index (“NPI”) performance, as appreciation returns were negative every quarter of 2023; however, income returns remained positive during the same periods, proving generally strong real estate fundamentals.
NPI Quarterly Returns
Finding Opportunity Amidst Challenges in Private Real Estate
Turning to the million-dollar question we are all contemplating now: Have real estate valuations indeed bottomed out, or should investors continue to be cautious of catching a falling knife? Given healthy property-level fundamentals, we believe that the answer lies in the capital markets arena – namely the U.S. Federal Reserve’s rate moves for the remainder of the year. If the U.S. remains in a higher-for-longer interest rate environment, buyer discipline will be tested. If cap rates continue to expand or begin to stabilize, we will see an attractive entry pricing environment, especially for investors in search of value plays. Now, more than ever, asset quality, market fundamentals, manager selection and expertise matter most.
We provide further insights and observations across real estate in our 2024 Real Assets Market Overview. Please complete the form below to receive an emailed copy of the report.
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As of June 5, 2024