Commercial real estate deal activity slowed considerably across the industry’s sectors in the first half of 2023, sliding to a dollar volume even lower than what was posted at the onset of the Covid-19 pandemic.
For the first six months of this year, $181.77 billion of commercial real estate sales occurred, a sharp drop from the $424.51 billion in transactions a year prior, according to MSCI Real Assets data requested by The Business Journals.
When comparing the first halves of the past five years — 2019 to 2023 — the first six months of this year had the lowest total deal volume, with the next lowest being $187.91 billion from the first half of 2020, when Covid-19 was declared a pandemic and businesses shuttered worldwide.
The count of transactions was the lowest in the first half of 2020, at 10,637, compared to 11,560 in the first half of 2023, the second-lowest total over the five-year span.
The MSCI data includes deals in office, industrial, retail, hotel, apartments, senior housing, development sites and self-storage.
Newport Beach, California-based commercial real estate firm Green Street recently found first-quarter sales volume dropped 70% year-over-year across the four core commercial real estate sectors — office, industrial, apartments and retail — when looking at U.S. sales comp data on transactions of $5 million and higher.
Daniel Ismail, managing director and co-head of strategic research for Green Street, said in a statement accompanying the data that total commercial real estate transaction volume this year is set to be well below the most relevant historical time frames if trends continue.
The Federal Reserve increasing interest rates 11 times since March 2022 is considered the primary culprit behind deal slowdown. Higher interest rates in a compressed period compared to investments that were funded by cheap capital before and during the pandemic have made deals less attractive and, in some cases, not even viable, including within relatively stable sectors.
Banks also have been pulling back on new commercial real estate lending activity as red flags about the future of certain property types — namely, dated office towers — continue to emerge.
Matt Riccio, senior real estate analyst at RSM U.S., said everyone in commercial real estate investment sales is cautious right now. Deals that are able to cross the finish line are typically being sourced with alternative financing, such as general partnership co-investment structures connected to high net-worth individuals or family offices.
“That’s something unique we’re seeing,” he said. “People are having a hard time getting capital at favorable terms.”
Commercial real estate lending slowed in the second quarter of 2023, according to CBRE Group Inc.’s (NYSE: CBRE) Lending Momentum Index, which tracks CBRE-originated commercial loan closings in the U.S. The index declined 5.4% from Q1 2023 and fell 52.2% when compared to a year prior.
While banks have pulled back their commercial real estate lending activity — comprising 43.4% of deal volume in Q2 — they’re still providing the majority of lending to the sector compared to life insurance companies, alternative lenders and commercial mortgage-backed securities.
About 43% of the bank loans in Q2 were refinancings, with the rest acquisition loans.
“Despite ample available debt, commercial lending has been hampered by choppy markets,” said Rachel Vinson, president of U.S. debt and structured finance for capital markets at CBRE, in a statement. “Borrowers who have to transact in the current environment are turning to shorter-term fixed loans until stability returns. Costlier credit with tighter terms continues to encourage many to sit on the sidelines.”
An executive with CBRE was not available by deadline to discuss investment deal volume.
What’s on the horizon?
The major lever that’ll influence when commercial real estate acquisition activity comes back is, of course, interest rates.
Riccio said investors are waiting for more predictability and stability with inflation and interest rates rather than any sort of major decline.
“Real estate is a long-term game, and this isn’t the highest rates have ever been — it’s just the highest they’ve been in a really long time,” he said, adding investors are still adjusting to what a new normal will be.
Even if interest-rate hikes begin to level off in the coming months, the run-up to the 2024 presidential election is also having an impact on commercial real estate sales volume — and will continue to do so, Riccio said, as any potential change in office could determine policies, such as tax abatements, that would directly affect real estate investments.
The office sector is undergoing a dramatic shift as the role of the workplace continues to evolve in a post-pandemic world and tenants of all sizes and industries downsize, exit leases or relocate to higher-quality buildings. For outdated office buildings that are getting left behind, conversions have been touted as a potential strategy, but pricing on those buildings would have to fall significantly in most scenarios for those deals to make sense.
Riccio said lenders are working with office-building owners to refinance and restructure loans, as they don’t want to take control of those assets. There will be more transactions in the distressed office space, he said, but those deals likely will take place over the long term.