Chicago, Illinois, May 1, 2023 – Real estate capital markets remained calm for the past month as investors continued absorbing rising debt costs and watching for improving economic conditions. In summary, the five and ten-year about 40 basis points landed about ten basis points higher than at the beginning of the month.
But, investors remain on edge. To control stubborn inflation in the face of tight labor markets, the Fed raised interest rates nine times during the past year. Nevertheless, the markets expect the Fed to raise interest rates a quarter point in the next meeting for the third conservative time this year.
In addition to dealing with rising mortgage rates leading to tougher realty underwriting standards (especially much lower loan-to-value ratios), investors face a challenging lending environment based on financial institution stability issues. Smaller and more medium-sized banks lose depositors, creating a lending vacuum due to the Silicon Valley Bank debacle and, more recently, the First Republic seizure. As a result, many banks are retreating or scaling back from real estate lending. The more active banks focus on existing customer relationship lending instead of pursuing new funding opportunities.
Despite the difficult realty capital market conditions, transaction flow continues at much lower levels than in previous years. Higher-grade properties selectively trade at premium prices as buyers justify paying more based on limited supplies, high construction costs, and cashflow inflation protection. For example, ten-year treasuries fall in the mid-three-percent range, while multifamily capitalization rates average in the five-percent range – a very tight spread of about 150 basis points reflecting yield compression. In contrast, this spread was more than doubled during the Covid crisis. In other words, many investors now accept lower yields via the commercial real estate sector as an important component of a diverse investment portfolio. And compared to Baa bonds, the benchmarks for institutional realty investments, buyers will accept 50 basis points tighter yield as an inflation premium.
The Real Estate Capital Institute’s® director, Mr. John Oharenko, notes, “A wait-and-see attitude prevails among most investors. Sellers hope for lower rates and better pricing conditions within a supply-constrained environment. Meanwhile, buyers expect prices to fall resulting from challenging capital market conditions.”