With signs pointing to a surge of capital poised to enter the commercial real estate (CRE) market, forward-thinking investors are proactively pursuing opportunities ahead of the curve. In this article, we’ll explore the factors that have kept investors on the sidelines and how to capitalize on emerging trends.
According to an October 2023 report by Marcus & Millichap, large institutional investors have kept their powder dry, with an estimated $200-$300 billion capital currently waiting on the sidelines, amidst the market uncertainty of the past year. At a 60% LTV, total capital is projected to amount to $750 billion of CRE sales volume.1
Why are CRE transaction volumes so low?
The current market environment has left many property owners hesitant to sell, expecting lower valuations than in previous years. Buyers have been equally cautious, attributing their reluctance to market uncertainty, perceived overpricing, and low cap rates. The Marcus & Millichap report challenges these notions, emphasizing that a property’s future rent increases or anticipated decreases in mortgage rates can justify new investments even when current metrics “appear” to be less favorable.
“If you knew a property’s rent was going to surge by 20% next year, you’d probably buy it, even if the cap rate today is 50 or 75 basis points below the prevailing mortgage rates, or if you knew that mortgage rates will drop by 100 basis points next year, you’d probably buy as much property as you could get because you could refinance when the rates go down.” – John Chang, Senior Vice President, National Director Research and Advisory Services, Marcus & Millichap.
High interest rates are also seen as a barrier for buyers, however the consensus is that these rates may decline over the coming year. The most recent Federal Open Market Committee dot plot indicates that the overnight rate at the end of 2024 could be 25 to 100 basis points below the rate at the end of 2023.1
Investors who recognize opportunities in assets with potential future upside may thrive in this environment of buyer hesitation and uncertainty.
The importance of being proactive
One of the potential effects of a surge in investor activity in the future is a spike in demand for assets, creating increased competition. In a competitive market, which investors are likely to start facing in the coming year, thinking more long-term is a key to success. Thorough research and analysis are also critical when aiming to stay ahead of an increasingly competitive landscape.
Heightened demand may translate into price appreciation and bidding wars, making it more difficult to participate in quality deals. Furthermore, finding undervalued assets or those with substantial growth potential therefore becomes increasingly difficult, as does the ability to diversify successfully. As investors come into competition for the same opportunities, portfolios get over-weighted in specific sectors or asset classes.
How to find opportunities now
So for those investors seeking to stay ahead, where are the opportunities currently presenting themselves?
CRE as an asset class has long been considered a tool to hedge against inflation, with sound underwriting and reasonable leverage. With the correlation between commercial real estate returns and inflation being very low relative to other asset classes,2 multifamily investments can be a good option.
Multifamily investments can provide resilient income, and average effective rents in the US are up 5.9% YoY highlighting the continued strength of this asset type.3 Median home prices are on the rise again, up 3% in Q3 2023 as compared to the previous quarter.4 These rising prices create a financial barrier to home-ownership for many, fueling demand for more affordable, rental accommodation.
Opportunities to be seized in the distressed sector
The rising rates and inflationary pressures currently impacting the market are also creating opportunities in the debt sector, with the offloading of distressed CRE loans by banks of particular note.
Banks are less willing to retain non-performing loans than they previously were, creating opportunities for savvy investors to buy discounted senior debt at a healthy loan to value based on mark to market pricing, and see potential returns after a refinancing by the borrower or a foreclosure and sale.
Responding to this trend, nearly two thirds of investors are intending to increase their allocation to the asset class, according to a 2023 Preqin survey, and experts predict significant opportunity to be found in the sector in the years to come.5 Further evidence of this shift came earlier this year, when PacWest sold its CRE loan portfolio to Kennedy Wilson, with the real estate company indicating that it could double its portfolio of commercial real estate loans in the coming years, such is their commitment to the sector.6
While the landscape continues to shift, proactive investors can stay ahead by adapting, embracing diversification, and identifying potential upside opportunities. iintoo continues to seek attractive opportunities for our investors, by leveraging existing relationships with sponsors and institutions to source deals, utilizing our dedicated team of real estate experts and financial analysts. Hundreds of opportunities are vetted each year, and our uncompromising requirements result in fewer than 1% of these deals being approved. Log in to our platform to see detailed information on our current offerings.
- Marcus & Millichap: What’s holding sidelined capital back?
- Martha S. Peyton, CRE: Is Commercial Real Estate an Inflation Hedge?
- Arbor: Top U.S. Multifamily Rent Growth Markets — Q1 2023
- Motley Fool: Average House Price by State 2023
- CAIA/Preqin: A Case for Distressed Hedge Fund Strategies and How to Enhance Returns
- Globe St: Banks Increase Their CRE Loan Charge-Offs