High-level commercial real estate executives have expressed concern about the office and retail sectors due to continued market uncertainty, which has minimized investors’ risk tolerance, GlobeSt.com reports.
The execs’ concerns were displayed through the Q3 2022 Real Estate Roundtable Sentiment Index, a quarterly survey that measures CRE senior executives’ confidence and expectations about the CRE market environment. The survey measures the views of CEOs, presidents and other to CRE executives regarding today’s conditions and tghe future outlook on overall real estate conditions, access to capital markets and real estate asset values.
The quarter’s index posted an overall score of 44—a seven-point decline from the prior quarter and a 34-point drop year-over-year. One survey respondent said retail was “a big unknown” and that “we don’t know which tenants are going to stay in a brick-and-mortar store. The Internet and COVID-19 have just accelerated this uncertainty. There is not a lot of appetite for it.”
Increased interest rates, supply chain issues and higher inflation were among the main reasons survey respondents have been proceeding with caution, GlobeSt.com reports. However, they remain optimistic about CRE’s underlying fundamentals. Meanwhile, a little more than half (53 percent) of respondents said they felt market conditions are somewhat worse than a year ago, while 23 percent said conditions were about the same. Additionally, 34 percent forecasted that these conditions will be somewhat worse in 2023 and 26 percent predicted they’d stay about the same.
“(The Q3 Sentiment Index) reflects many of the challenges our economy and industry have faced since early 2022,” said Roundtable President and CEO Jeffrey DeBoer. Those challenges “will continue to be bottlenecks in the near term.
“Industrial and multifamily continue to be a source of strength, but office and retail still struggle to regain momentum following the pandemic. These are uncertain times, but quality assets and owners will persevere as they continue to meet fundamental demand.”
Modern buildings, interest rates could impact CRE’s future
Tenant experience has been a top factor in CRE owners’ ability to attract, and retain, people in their buildings. Survey respondents said they believe demand will continue for buildings that provide flexibility by way of offering more amenities and better accommodations. The same could be said about what employers are striving to do to get workers to return to the office following the pandemic.
“New stock, with light and airy atmospheres, and efficient buildings are coveted,” one respondent said. “The older and vintage buildings have dwindling occupancy and declining rental rates. The pandemic accelerated flexibility and disinterest in going into some of those older spaces.”
“Hospitality properties that are designed to allow consumers to live, work, and play in different ways are in demand,” another said.
Even if demand increases, higher interest rates remain a concern, GlobeSt.com reports. Rising interest rates negatively impact asset pricing as well as trades, which are currently happening at a discount.
“The office sector continues to see an erosion in asset valuation due to poor lease ups,” a survey respondent said. “The high interest rates and lack of availability of debt capital are creating additional challenges, meaning office values have come in 15- to 30-percent below where they were over the past few quarters.”
Another respondent said that rising interest rates is the biggest concern. “There should be a direct correlation where valuations will decrease because the cost of capital is more expensive.” Meanwhile, another noted that many in the industry are “sitting on their hands” until things become clearer when it comes to supply chain issues and how the Federal Reserve handles rising inflation.
When it comes to asset pricing, one respondent said values have decreased for every asset class and it will be harder to finance six months from now because of the widened spread. Underwriting has become more conservative, according to another respondent and the cautious approach has impacted availability and pricing. Assets are trading between 10- to 20-percent less for a well-leased office building, GlobeSt.com reports.
“With industrial, the darling asset class, there’s some chatter that valuations are topping,” a respondent told Roundtable. “The fundamental demand drivers of e-commerce may be slowing, heightening rates, supply chain issues, etc., are all percolating to more conservative underwriting but the long-term runway for the asset class isn’t changing.”
Download the full Q3 2022 Real Estate Roundtable Sentiment Index here.