U.S. Real Estate
The second quarter of 2021 benefited from favorable year-over-year comparisons given the severity of the pandemic’s impact during the second quarter of 2020. As such, commercial property transactions surged, up 176% year-over-year, and are ahead of pre-pandemic levels. The return of entity-level deals has also been contributing to overall volumes, with several M&A transactions announced year-to-date. Property sales activity continues to be bifurcated, with property types that have been buoyed by pandemic behaviors—such as industrial and multifamily—generally running above pre-pandemic levels, while office and retail are trailing. Lodging has experienced an outsized recovery in transaction volumes, posting the second-highest quarterly deal volume since 2016. In the trailing 12 months ended March 31st, foreign investors’ 9% share of transactions was meaningfully below their mid-teens share seen during the particularly active 2015-2019 period but only modestly behind their longer-term average. However, like their domestic counterparts, these investors have shifted their purchases to property types that proved resilient during the pandemic. In particular, this poses a risk to gateway office markets where foreign buyers have historically had a meaningful presence. Despite some continuing green shoots, investors remain tentative about the outlook for urban areas, especially when it comes to office, as physical occupancy and leasing have been slow to recover.
The Trepp CMBS delinquency rate stood at 6.15% in June, down modestly from 6.58% in March and a peak of 10.3% in June 2020. The rate of improvement has begun to wane, as most rent abatements and loan modifications have been worked through. Maturity-related defaults remain likely to persist—particularly for lodging, which maintains 18.7% of loans in special servicing—but lenders are still generally accommodating defaults by providing forbearance measures. Nevertheless, recapitalizations and forced sales have picked up.
Real estate markets are generally on their way to a full recovery, with some lodging and office being the notable exceptions. Markets continue to be excited by the gradual reopening and normalization on most fronts, and investors have taken advantage of significantly reduced borrowing costs to refinance. The Federal Reserve Board continues to maintain its low-rate stance and willingness to tolerate what it believes is transient inflation.
On the valuation front, the Green Street Commercial Property Price Index has increased 11% in the past 12 months and is only 1% below pre-pandemic levels, but variation by property type is at all-time extremes. U.S. REIT shares have continued to rally alongside ongoing liquidity, positive guidance revisions and earnings, and the general benefits of the economic reopening. Company valuations continue to imply improvement in private market property valuations. Listed REITs in core sectors ended the quarter at a premium to NAV of 8%. Green Street Advisors’ model, which tracks the relative value relationship between private real estate and fixed income (investment grade and high yield), pegged real estate at 20% undervalued.
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Private real estate pricing has recovered overall, but with significant variation by property type. Note, the Moody’s CPPI Index reflects an upwards bias due to activity in property types that have been less impacted or have flourished (e.g., industrial and multifamily).
Core property type valuations for U.S. REITs imply that growth is expected in private market valuations as a whole, but with variation by property type. However, the public markets are also signaling that U.S. REIT balance sheets are in good shape and well positioned for offense.
Unlevered real estate has historically offered a return between investment grade and high yield bonds. Real estate currently appears undervalued on a relative basis compared to debt.
The combination of development deliveries and a demand shock drove rent and occupancy declines; however, a recovery is underway for most property types.
New deliveries are generally peaking for property types with more questionable outlooks, but apartments, industrial, and several niche property types are expected to experience supply alongside elevated levels of demand.