U.S. Real Estate
Commercial property transactions in the third quarter continued the trend from the second quarter, dropping 57% year-over-year, as illiquidity continues to challenge the transaction market. Once again, entity-level deals were non-existent, and sales of individual properties were down 49% year-over-year. A hazy picture on future income trends is suppressing investor appetite, though activity is picking up for property types that are less impacted on a relative basis, such as industrial and multifamily. Although investors are captivated by the industrial sector and individual industrial asset sales—excluding the challenging year-over-year comparable, which includes GLP’s sale of two massive portfolios of industrial properties—posted the lowest decline across all property types, deal volume still dropped 25%. Major gateway markets and central business districts are typically a driver of transaction volumes; however, investors are questioning the outlook of urban areas and the magnitude at which households and companies might abandon the large coastal markets for more affordable secondary and tertiary markets. Refinancing activity accounted for 50% of all capital flows to commercial real estate in the first half of 2020, yet financing markets are bifurcated by the haves and have-nots, with lenders hesitant to finance asset classes with less certain recovery profiles, including retail, hotel, and office.
The Trepp CMBS delinquency rate declined to 8.92% in September from 10.32% in June; though with relief nearing an end for some loans, an uptick in delinquencies in the future is likely. Loans with a special servicer rose to 10.48%, while loans on servicer watchlists rose from 19.9% in August to 20.7% at quarter-end. During the global financial crisis (GFC), the peak for newly troubled loans was seen in the fourth quarter of 2009, while distressed sales peaked a year later.
The decline in transaction volume is occurring against a backdrop of investor concern over rent collections, rental rates, and growth prospects in the intermediate and long term, compounded by the potential for waning fiscal stimulus as well as multiple domestic and geopolitical uncertainties. The Federal Reserve Board has firmly anchored expectations for low interest rates, which will continue to be generally supportive for commercial real estate pricing, but the shock to demand has moved buyers and sellers far apart on pricing.
On the valuation front, the Green Street Commercial Property Price Index is 10% below pre-pandemic levels, but with significant variation by property type. Meanwhile, the REIT market oscillated between gains and losses in the third quarter, though company valuations still imply significant corrections in private market property valuations are to come. Listed REITs in core sectors ended the quarter at a discount to NAV of 19%. Green Street Advisor’s model, which tracks the relative value relationship between private real estate and fixed income (investment grade and high yield), pegged real estate at about 9% undervalued.
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Private commercial real estate pricing has begun to correct, but with significant variation by property type.
U.S. REIT valuations imply significant corrections to come in private market valuations as a whole, with significant variation by property types.
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 is driving rent and occupancy declines.
New deliveries are generally at cycle peak and are expected to decline.
New deliveries for the major property types are generally at cycle peak, but apartment and industrial completions are expected to remain elevated.