The investment sales market finds itself in a precarious position. Year-over-year volume continues to fall, with Q1 volumes mirroring levels not seen since 2013. Treasury yields, which started the year around 4%, have risen steadily, touching 4.7% by late April, further pressuring deal volume. Inflation concerns and a Q1 GDP miss have pundits discussing the specter of stagflation. Consequently, expectations for Fed rate cuts have been deferred further into the year. The market is anticipated to find a pricing floor when cap rates exceed borrowing costs.
Despite these challenges, there are glimmers of recovery. The pace of sales declines has slowed, and the typical drop-off from Q4 to Q1 was less severe than historically observed. Office volume, particularly driven by medical office transactions, posted quarter-over-quarter and year-over-year increases. Retail volume also saw an uptick compared to Q4. Notably, the market is witnessing significant development loans and a growing focus on data centers, with numerous multi-billion-dollar partnerships, developments, and dedicated business lines being announced.
Signs of Recovery and Investor Sentiment
BOV (Broker Opinion of Value) activity is on the rise, indicating a potential surge in volume in the coming months. This may be the moment investors have been waiting for. Blackstone’s acquisition of AIR Communities has bolstered market sentiment in the multifamily space. Many investors look to major players like Blackstone for guidance, and the company's substantial investment has encouraged others to re-enter the market. Loan sales are beginning to increase, short sales are appearing, and while not overwhelming, distress is present. The considerable stockpiles of capital waiting on the sidelines reflect optimism and may soon be deployed to recapitalize deals and acquire properties at attractive prices. Investors are seeking mid-to-high-teen IRRs, and the market adjustment has broadened their options.
Economic Indicators and Market Dynamics
Recoveries take time, and recent economic and inflation data suggest potential bumps in the road. The Fed faces a delicate balancing act, with higher interest rates appearing to rein in consumer spending. However, the Fed's preferred inflation metric, the personal consumption expenditures (PCE) index rose quarter-over-quarter and remains above the 2% target. A divergence in payroll employment and the household survey indicates a slackening labor market, supporting the need for rate cuts. Investors have been eagerly awaiting a clear indicator to re-enter the market, and based on client sentiment, this could be it. The cap rate on Blackstone’s deal has been reported as sub-5%, though other estimates suggest it’s closer to 6%. Regardless, this $10 billion investment is a significant vote of confidence that will likely boost volume once the deal closes. Institutional investors are reappearing on buyer lists, providing increased liquidity, while private buyers have sustained the market in their absence.
Market Fundamentals and Opportunities
Market fundamentals have softened, with development impacting some markets significantly. However, forecasters expect occupancies to be near or at their lowest point, suggesting better days ahead. Rising insurance costs, higher operational expenses, and falling effective rents are putting pressure on net operating income (NOI). Consequently, deals are shaking out from weaker operators, creating opportunities for rescue capital, while broken development deals need to be recapitalized.
Offerings with assumable debt have been met with enthusiasm. With their below-market loan terms, these deals are attractive to buyers, sparking vigorous bidding activity and enabling pricing and cap rates that otherwise wouldn’t be achievable.
Sector-Specific Trends
Multifamily: The multifamily sector remains dynamic, with notable transactions and strategic investments indicating confidence in long-term fundamentals.
Office: Office sales rose to start the year, bucking a six-quarter trend of declining year-over-year volume. Volume increased compared to Q1 2023 and year-end. Approximately 30% of this activity was driven by medical office transactions, such as Healthpeak Properties' acquisition of Physician’s Realty Trust for $4.7 billion. Additionally, Boston Properties sold a partial interest in a two-property life sciences portfolio in Cambridge to Norges Bank Investment Management. These assets were valued at $2,049 per square foot. Distressed sales also contributed to volume numbers. Office fundamentals continue to weaken, with vacancies reaching new highs in Q1. There is a clear divide within the market due to a general shortage of new, modern products. This scenario explains why major new developments from Oklahoma City to Beverly Hills are being financed despite the sector's challenges.
Industrial: Sales volume remains down year-over-year, but declines are easing, and signs of recovery are emerging. Rexford acquired a 3 million square foot portfolio of infill assets in Los Angeles from Link for $844 million. Prologis is strategically selling properties, and institutional investors are returning to the bidding process. Many groups that had been on the sidelines for several quarters are now actively seeking acquisitions. Despite a brief pause caused by the rise in the 10-year Treasury yield, most major players are underwriting and pricing through the volatility. Core plus and value-add strategies are currently the most popular, with competitive bidding between those groups.
Hospitality: Trading activity in the hospitality sector remains below historic levels. While year-over-year comparisons show signs of improvement, with volume declines less severe than in the previous quarter, it is taking longer for this asset class to recover than others. Q1 volume was the weakest since Q1 2012, excluding the immediate aftermath of the pandemic. Despite the soft transaction market, values remain more stable than other asset classes. Signs of a thaw are apparent, with lending volume picking up and securitized loans increasing significantly compared to the previous year. Cash-out refinancing is once again possible for select assets and portfolios. Construction activity remains strong, suggesting a need for additional financing and creating new investment opportunities for those seeking acquisitions. Demand trends show a continued preference for luxury products, while economy-class products are experiencing the most significant declines in RevPAR.
Nationally, occupancy has decreased over the past year, though differences in the holiday schedule and increasing international travel could help offset some of this.
The investment sales market is navigating through a period of uncertainty and adjustment. However, signs of recovery are emerging across various sectors. With strategic investments, increasing BOV activity, and the re-entry of institutional investors, the market shows potential for growth and stability in the coming months. Investors are cautiously optimistic, seeking opportunities to capitalize on market adjustments and position themselves for the anticipated recovery.
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