Investment Real Estate: Don’t Expect Tight Credit to Trigger A Sell-Off
May 23, 2023
Whether or not the tenth and latest (May 2023) rate hike marks the peak of the US Federal Reserve’s anti-inflation crusade, the past year’s soaring borrowing costs have already cooled real estate markets. In just over a year, mortgage rates have doubled from the mid-threes to the mid-sixes and lenders have moved to mitigate default risk by tightening credit. As a result, deal volume for investment real estate is a trickle compared to a year ago.
For real estate investors who, until last year, basked in a long run of cheap capital, tighter credit reduces leveraged returns and makes it difficult to peg reliable NAVs.
Fund managers are divided. Some acknowledge that the high cost of borrowing has merited a recalibration of asset values. Other cite a lack of transaction data to justify more of a wait-and-see approach.
The truth lies somewhere in between. CRE investment strategies require context. Higher borrowing costs do not in themselves call for knee-jerk revaluations. For one thing, rate changes happen within a much shorter cycle than a typical investment holding period. For another, the impact of a credit crunch must take account of other market forces.
In today’s work-from-home era, for example, vacant space is the ‘big elephant’ for the office sector. With the notable exception of grocery-anchored centers, Main Street retailers continue to face strong headwinds from on-line outlets. Industrial properties continue to experience income growth making them probably the least impacted by expensive capital. Meanwhile, the resilient multi-family and lodging sectors continue to perform in the mid-risk category. Alternatives such as student housing, retirement living, and self-storage remain popular when paired with expert management.
So while the high cost of capital is bad news for property values, previous cycles have shown us that, just because there is a keen appetite for bargains among cash-rich buyers, tight credit doesn’t mean a fire sale. Typically, owners hang tight; no-one sells.
Will this current inflationary period be any different? Only if the cost of capital remains high for an extended period and over-leveraged owners find themselves tempted by the dry powder of waiting equity investors.
Article written by: Steve Williams FRICS, Non-Executive Director