MacKenzie Capital’s President John Black was featured in the following article published in NAIOP Maryland’s newsletterSeptember 14, 2022
The combination of a steadily rising interest rate environment, escalating asset pricing, typical summer doldrums and renewed investor caution has pumped the brakes on the volume of investment sales transacted in recent months across all asset classes. However, experts participating in a recent roundtable discussion believe this situation will be short-lived in the Maryland and Mid-Atlantic marketplace. The continued existence of readily-available capital, the shift towards real estate investing as a hedge against inflation and the hope for a short-lived and “V-shaped” recession is providing optimism for Christopher Burnham, Principal, Retail Investments; KLNB; John Black, President, MacKenzie Capital, LLC and Lisa Goodwin, Senior Vice President, MRP Industrial.
Christopher Burnham (CB): While I focus solely on retail investment sales, the highest volume of transactions post COVID has occurred within the multifamily and industrial asset classes. Retail has performed well with the strongest transaction activity amongst grocery-anchored retail centers, neighborhood strips in strong locations with a high caliber tenant mix and credit, long-term net-leased assets. In general, the market continues to experience a limited amount of inventory across the retail sector with a high amount of demand. Retailers, both grocery and non-grocery, have performed exceptionally well post-pandemic due to consumers pent up demand and disposable income. However, the market is carefully observing the changing economic tide to see how retailers’ performance may be affected in the short to medium term.
Lisa Goodwin (LG): The performance of warehouse/industrial product has historically been equal to the national GDP but, over the past eight years, the sector has actually out-performed this metric. The dramatic increase in online shopping driven by COVID placed industrial fundamentals on steroids, as many end-users adjusted their supply chain from just-in-time to just-in-case inventory. Add in the increased need for manufacturing space, and we now have the lowest vacancy rates, strongest absorption figures and highest rent growth that many of us have experienced in our careers. As a result, it has seemed as if there are a slew of new entrants into the space on both the development and investor front. In recent months, we have experienced a slight slowdown in both demand and investor appetite, and underwriting standards have been tightened, but it is too soon to say if this is attributed to the typical summer slowdown, rising interest rates or a combination of the two, which is likely. There has been some reporting about Amazon giving back some industrial space, but we do not see any substantial impact on vacancy. In fact, this trend could open up opportunities for others.
John Black (JB): Multifamily has been the darling among institutional and private investors and will remain so in the foreseeable future, especially as rents continue to increase. We believe conditions may become a bit choppy in the near-term, although fractionalized, with markets in the south and southeast – including Austin, Charlotte, Nashville and Raleigh – outperforming others based on the job and population growth in those markets. Many investors were waiting for distressed commercial office product to hit the market after COVID, but that scenario never really materialized. Particularly in urban areas, office buildings are being converted to multifamily uses and we are presently working with the owner of a hotel that is transforming the asset to workforce housing.
JB: We predict a growing disconnect between buyers and sellers about appropriate cap rates and value which, in turn, will serve to depress investment sales activity in the near term. The unknown about the future direction of cap rates will also produce uncertainty in the marketplace. The refinancing binge is over due to rising interest rates. Over the second half of 2022, we see investors increasingly attracted to the value-add and adaptive re-use sectors, hospitality developments, and troubled commercial real estate assets that have not completely recovered from the pandemic.
LG: Investment sales activity has really cooled both among existing assets and land trades. I am hearing assets, that previously were generating 15-20 offers, are now getting four or five, including new construction Class “A” projects in the Baltimore-Washington Corridor. In addition, underwriting standards have tightened and many investors remain on the sidelines as they watch how the interest rate environment plays out. The general consensus is that groups will likely begin looking again in the fall, with the remainder of the year being slow and steady. From our perspective on the industrial side, all important fundamentals are still in place and we are not yet concerned about overbuilding or discussing lowering rents.
CB: A slight slowdown has occurred of retail investment sales, prompted by volatile and higher interest rates and lower loan to values. While the volatility had somewhat subsided, we do envision a slower second half of 2022. Transactions have become more challenging and both marketing periods and closing timeframes have been pushed out. There remains a hesitancy among sellers to market an asset and then not obtain pricing. The good news is that capital remains plentiful with most deals in the market continuing to receive multiple offers but the buyer pool has shrunk. Lastly there is a segment of the market that is on the sidelines waiting to see where the interest rates and pricing end up.
Real estate opportunities
JB: There is talk about an upcoming recession, and recessions come in different shapes and lengths. Some are predicting a V-shaped or short-lived downturn reminiscent of the late 1980s to early 90s, with a rapid correction. There are certainly changes coming our way over the next 12-18 months but the difference this time around is the availability of liquidity.
LG: Depending on the depth of the recession, some developers may be inclined to put a pause on land that has not traveled through the entitlement phase. For others that have already broke ground and have debt in place, they are moving forward with their original plans.
CB: We do envision scenarios for opportunities borne out of a potential downturn. Asset values have been elevated, and cap rates compressed, for an extended period which has made some transactions challenging for investors. A potential downturn could lead to more attractive acquisition opportunities for all buyers, so long as the debt and equity markets continue to remain healthy.
What is old is new again
JB: Investors need to be reminded that the current interest rate environment remains extremely attractive, despite the prospect for further increases throughout the year. With current long-term fixed rates trending in the low 4% to 5.5% range, we are reverting to a more normalized world and investors need to adjust their mentality and expectations, and possibly take a glimpse back to the 1990s for perspective. What’s old is now new again and, if investors would simply take the time to step back and reflect on the current conditions, they would realize how much opportunity awaits them.
LG: Over the past 18 months, investors have been especially aggressive on pricing if the assets had near term lease expirations with below market rents. The continued rise in achieved rents across the Mid-Atlantic has allowed some investors to achieve upwards of 40% above in place rents. In some cases, these investors were willing to take on negative leverage for a year or two. This is not occurring at all now as underwriting has significantly tightened due to the change in debt markets. In our case, we are currently underwriting to 2019 standards.
CB: The spread between interest rates and cap rates have been relatively healthy in the retail sector, versus industrial and multifamily where, in some instances, investors are beginning to see negative leverage. Overall, interest rates remain relatively low compared to historical levels, but this spread is narrowing between all asset classes, including retail, which in some instances has affected pricing, specifically in core/core plus offerings where going in cap rates were in the 4% to 5% range. Interest rates are now hovering around 5%. Another component that is affecting both pricing and interest in overall deals is the requirement for more upfront equity, or lower loan to values (LTVs).