Economic forces at play across the globe, including the rising cost of capital and the threat of a U.S. recession have caused investors to think twice about how and where to place their money, with several leading indicators of deal volume slipping heading into the second half of the year.
But the slowdown might merely be a cooling from the frenetic pace of investment of 2021, as the economy bounced back and certain property types — industrial and apartments — were in unprecedented high demand.
Major investors are still in the game because fundamentals are still strong, MSCI Real Assets Chief Economist Jim Costello said.
“The high investment volumes in 2021 and early 2022 aren’t sustainable, and would have cooled off some even without higher interest rates,” Costello said.
With any luck, higher rates will eliminate some of the froth that the investment market has seen lately, he said.
“The smaller, high-leverage buyers are pulling back — the fund manager from Tupelo, Mississippi, say, who wanted to syndicate a bunch of buildings in a crowdfunded platform, he’s having second thoughts.”
That is the point of higher interest rates, Costello said.
“There’s been a frenzy of certain types of buyers coming into the market who were arguably being a little too aggressive, and higher interest rates ought to slow that down,” Costello said. “Of course, that’s just in our little real estate world, but that’s what the Fed is trying to do across the whole economy.”
The question now is whether a slowdown induced by higher interest rates will slow the CRE investment volume down too much. Costello says he is optimistic that major investors will not be overly deterred during the rest of 2022 from their quest for real estate assets.
“There are still deals getting done, just not quite as many,” he said. “And certainly there is concern about the next shoe to drop on prices. No one wants to buy at the top.”
Second-quarter investment tallies haven’t been reported yet, but there is some evidence of a cooling off.
For instance, price growth for commercial properties, an indicator of continued demand among investors, was still on the rise as of May, according to RCA data — but not as much. That month, the RCA CPPI National All-Property Index was up 18.6% from a year earlier, a little down from the record annual growth of 19.3% seen in January.
The last few years have been a wild ride for U.S. commercial property investment sales. After slumping in the second quarter of 2020, sales volume had bounced back by the fourth quarter of that year to roughly where it had been in 2019, according to CBRE data.
The first quarter of 2021 saw another slump, though not as pronounced as in 2020. Each quarter of 2021 after the first saw investors ever more eager to buy properties, and by the fourth quarter of 2021, sales nearly reached $340B, well above the 2015-19 average of $132.5B per quarter.
The Q4 pace proved unsustainable, and Q1 2022 saw sales of about $150B, CBRE reports. That was above the pre-pandemic Q1 2020, when sales were about $130B, and also above Q1 2019, when sales barely topped $100B.
The two darling property types of the pandemic — multifamily and industrial — continued to be so in Q1 2022, with investors ponying up $57B for apartments in Q1, followed by industrial with $32.2B in sales for the quarter, according to CBRE, both records.
Another factor that might keep investment volume from collapsing is the few alternatives that other investments offer. As of the end of June, global equities were down 20% since the beginning of 2022, the worst six-month start to a year since 1975.
So far there is little evidence that major investors are backing away from real estate in a major way.
“Most [pension] funds are increasing their allocations towards real assets,” Eli Randel, chief strategy officer at CREXi, told Wealth Management. For example, CalPERS and CalSTRS both recently increased their allocations to real assets from about 13% to 15%.
That may seem small, but in those dollar amounts it is actually very large, Randel said.
“The extent to which the real estate market has not only survived, but thrived, in the aftermath of Covid is nothing short of remarkable,” said Herrick Feinstein partner Morris DeFeo, who is chair of the firm’s corporate department.
There is a significant amount of capital available for investment in real estate, and inflation and rising interest rates could actually drive REIT growth by attracting investors, DeFeo said.
“In my view, REITs focusing on industrial and multifamily assets will continue to look for acquisition opportunities,” DeFeo said. “This may slow depending on whether and to what extent the U.S. is affected by a recession, but REITs in these sectors are likely to remain significant purchasers.”
On the other hand, in the net-lease realm, a popular investment product for smaller investors, The Boulder Group reports that in the second quarter of 2021, transaction volume was down about 15% year-over-year.
“Some sellers may choose to hold assets versus a sale given a decline in value,” Boulder Group partner Jimmy Goodman said, noting that cap rates have been inching upward from record lows last year. The recent interest rate increases are also making some investors rethink deals.
Major overseas investors are still quite active in U.S. real estate. For example, last year German real estate investor Commerz Real spent $850M on Manhattan office building 100 Pearl St., and the company is planning more acquisitions in the U.S., opening an office in New York this year to up its exposure to U.S. real estate, which currently stands at about $2.5B.
On the whole, foreign investor outlook for the U.S. real estate remains positive, with 75% of respondents expecting their volume of investment activity and revenue growth to increase this year, according to AFIRE’s survey of 175 investors earlier this year. About 80% of investors estimate allocating as much as $5B for US investment in 2022.
Still, in the short run, inbound cross-border investment fell by 19% year-over-year to $6B in Q1 2022, which CBRE chalked up to the relative strength of the U.S. dollar.
For the four quarters ending in Q1 2022, the largest country of origin for cross-border investment in U.S. real estate was Canada, with nearly 23% of the total, the company reports. Singapore was second, with 14.4%, and other important investment sources included South Korea, Germany and Bahrain.
Once a formidable investor in U.S. real estate, China has seen its investments shrivel to practically nil.
“Cash flows and capital chains are broken,” Colin Lau, the founder of Hong Kong-based Bei Capital and the former head of real estate at China Investment Corp., the Chinese sovereign wealth fund, told Bisnow.
“Right now, if you are not able to do well domestically and you can’t find liquidity or refinance debt, then overseas assets are the last priority,” Lau said.
Though historically a relatively small source of real estate investment in the U.S., the EB-5 program has been a steady source of capital over nearly 30 years. Now that Congress has revived the program, and the rules have been clarified by a judge, investment is flowing again, according to Saul Ewing Arnstein & Lehr partner and EB-5 specialist Ronnie Fieldstone.
“The judge’s order clarified a lot of issues with the program, and opened the gates again,” Fieldstone said, with investors from Asia and the Middle East particularly eager to participate.
Even China is relevant again as a source for EB-5 investment, Saul Ewing partner Rohit Kapuria said, because a new emphasis on the program is spurring investment in rural areas in the United States.
“With the new program, there is a visa set-aside for investing in rural areas — and those investors will be first in line for visas,” Kapuria said. “So we’re already seeing a huge demand from brokers in mainland China looking for projects in rural areas.”
Written by: Dee Stribling