Commentary
TLDR - Higher for longer lengthens CRE recovery as tease of lower rates offered a lifeline to make capital decisions for current owners feels further and further away. Preference for safer lower beta plays while the rates market finds its footing.
Ah the shifting sands of public opinion. November pivot with rate cuts and CRE stability to now higher for longer is here to stay ("for now" but could be like inflation is "transient"). ZPIR feels very very very out of the question, but what will the data ultimately say in 6-12 months? Is this restrictive range going to have the impact desired and give us our soft landing/target inflation or like everything in life create unintended consequences that will potentially roil the market?
Lots of questions, I honestly can't answer, BUT higher for longer is decidedly bad for CRE. While I do agree that at some point this year we will bottom in terms of CRE valuations. Sure some NOI's might hit their peaks like MF/Industrial/Hospitality, but with capital markets becoming more defined you can value your leveraged returns. But this bottom is on light volumes given if you don't have to sell you won't. CRE investors can have patience unless of course Newtons law of motion kicks in. What are the acting forces? Well floating rate debt that is annoyingly high and choking off returns, withdrawals (I am sure we all read the WSJ article), and frankly no light at the end of the tunnel. If you think you will be able to refi in 6-12 months at materially better rates then you can hang on to your equity option, but if that light becomes more dim you have to start making harder decisions.
The draconian scenarios priced into assets pre pivot, still feel like in the rear view mirror and debt basis on the margin still has a decent chance of refi or there is ample term left on the loans to wait and see, but if funding rates even for Agency Debt is around 6%, the leveraged returns will require higher cap rates. And the credit curve has to steepen out as well. From Class A to C and MSA to MSA vs the massive compression seen post covid. This is all healthy, BUT it means a longer road to recovery and a lot more noise with fat tails and tape bombs.
All of this points me to waiting and watching, which isn't exciting or fun for me, but with most of the obvious trades squeezed, market bifurcation of troubled vs presumed gold trading at eye watering levels with nominal total return left, and 1740 Broadway, which was a known entity in the market, echoing through internal risk meetings, more conservative profiles make a lot of sense.
Curious to know your thoughts
- Wilson
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