Higher Rates Causing Investors to ‘Pull Back Big Time’ on New Deals
John Jordan | August 15, 2022
NEW YORK—The Federal Reserve Board’s campaign to slow down the economy via rate hikes has accomplished its mission in most segments of the real estate market, according to a panel of real estate, finance and economic leaders assembled by the Fordham Real Estate Institute. While they don’t see many investors “hitting the panic button” they are seeing “investor pull back big time” in certain real estate sectors.
The panel discussion entitled “Rising Interest Rates and the Impact on Commercial Real Estate,” was held at the Fordham University School of Law on July 26 and was moderated by Tony Fineman, Senior Managing Director at commercial real estate lending firm ACORE Capital. The panel featured Andrea Balkan, Managing Partner at Brookfield, a global owner and operator of renewable power, infrastructure, real estate, private equity, credit and insurance solutions; Adam Doneger, Vice Chairman, Cushman & Wakefield; and Ryan Severino, Chief Economist at JLL.
The panel’s focus was on how the higher cost of lending in 2022 has caused significant impacts in the commercial real estate markets.
“The indices that we base our loans on, and that the market bases cap (capitalization) rates on, have risen a couple hundred basis points,” Fineman said. “Spreads have risen somewhere between 75 and 150 basis points.”
One major outlier in the real estate industry is the multifamily sector, which continues to attract investor interest, according to C&W’s Doneger, who said, “Multifamily is still on a tear. We all know that if you are looking to rent an apartment in New York City, right now, it is extremely challenging. The fundamentals have never been stronger.” He added that the multifamily lending sector, particularly the agencies, are still lending and are still quoting.” He noted that at the time of the conference, lending rates in the multifamily segment were in the 4% to 4.25% range at roughly 65% LTV ratios.
However, the office segment has slowed considerably. “The office business, which has been the number one seller or asset class du jour over the last 20 odd years in New York City, has slowed down significantly. All of the office trades that were in the market have been put on pause and the debt is fueling the equity,” Doneger related.
He added, “So, obviously, when financing stops, equity is going to stop alongside it.”
JLL’s Severino said that many investors are just trying to come to grips and understand the tremendous change in economic conditions that have taken place over the past six months.
“I don’t see a lot of investors hitting the panic button, but I would say a lot of them are trying to grapple with how fast things have changed and the uncertainty associated with that,” Severino noted. “They are taking a little more time, sharpening their pencils and they are doing more homework. I think they are taking a beat and waiting to see what the next quarter or two looks like because we are in somewhat uncharted waters.”
A number of panelists are seeing “investor pull back” even in the multifamily sector and even in hot markets, such as South Florida. However, all believe that the multifamily sector will benefit as the single-family home purchase market slows down.
Brookfield’s Balkan said there has been a slowdown in most real estate sectors and rising rates have caused Brookfield to change investment strategy. She said that depending on the multifamily asset class, investors are now seeking price reductions in the 5%-20% range.
Balkan said Brookfield’s lending strategy “in an uncertain world” will be focusing on class A assets. “We think there’s still great opportunities and we’re going to continue to lend and invest, but we’re going to be lending on high-quality assets that are going to trade below intrinsic value because other people are sitting on the sidelines,” Balkan said.
She added, “What we’re seeing right now is a market that is very much in flux … in a drastically rising interest rate environment. We are still active, we are still lending, but we’re having to look at every deal with a new lens and say, ‘This deal has to cover its debt service at the forward curve.’ So, it is resulting in our changing terms on deals, which we haven’t done in the 20 years I’ve been there.”
Severino noted that the pandemic and a structural labor shortage are compounding the challenges office building owners and employers are facing in a changing work environment.
“If we’re going to get people back into the office, then employers are increasingly going to look at the office space as part of attracting and retaining talent,” Severino said. “Not just compensation, flexibility, but what is the office space actually like? Is it conducive to being productive, a place you want to come to, especially if you have an onerous commute? That’s very different from prior to the pandemic.”
Doneger did offer one bright spot for the office market going forward, noting the growing demand for spaces to accommodate the life sciences boom. “Most of our clients that are in the office business have pivoted into the life sciences space and they’ve all made a home for themselves. That industry, in particular, has a tremendous amount of room and it all ties into cities that have the medical and educational resources.”