U.S. Real Estate

The third quarter of 2021 benefited from favorable year-over-year comparisons given the severity of the pandemic’s impact during 2020. As such, commercial property transactions surged—up 151% year-over-year—and are on pace to set an annual record. While the return of entity-level deals is contributing to overall volumes, individual asset sales are driving the expansion, suggesting a very healthy transaction market. Property sales activity continues to be bifurcated, though laggards like office are seeing increased activity, albeit skewed to suburban locations, central business districts, and markets specific to tech, life sciences, and education. Lodging continues to experience an outsized recovery in transaction volumes, posting the highest growth rate year-over-year of any property type. The geographic mix of transaction volumes year-to-date has shifted meaningfully; Manhattan was the fifth most active market in 2019 and is now ranked fourteenth, while Phoenix went from seventh to fourth and Dallas rose from third to first. Foreign investment activity rose 48% year-over-year in the second quarter, but foreign investors’ share of transaction volume has declined, as domestic capital has been more active in currently favored property types.

The Trepp CMBS delinquency rate stood at 5.25% in September, a little over half the level seen at the peak of the pandemic last year. Maturity-related defaults remain likely to persist for certain sectors, but lenders are still generally accommodating defaults by providing forbearance measures. Meanwhile, credit markets are robust, with CMBS issuance surpassing $100 billion year-to-date through September and on track to eclipse the current full-year record.

Real estate markets remain bifurcated. Apartments, industrial, and most niche property types have more than fully recovered, while retail, office, and some lodging lag behind with more questionable prospects for a complete recovery. The rise of the Delta variant challenged some reopening and normalization progress, including return to office plans, but economic activity is largely still heading in the right direction. The Federal Reserve Board is signaling a near-term start to tapering, as employment markets are strong enough despite some recent slippage in growth. Meanwhile, the Fed has shifted its posture to acknowledge transitory inflation is likely to linger and will maintain its low-rate stance, although pressure from inflation could cause rates to be raised sooner than anticipated.

On the valuation front, the Green Street Commercial Property Price Index has increased 18% year-to-date and is now 8% above pre-pandemic levels. U.S. REIT shares have continued to rally alongside ongoing liquidity, market rent growth, and recovering occupancy. Company valuations vary by property type, but on average, core property types imply a leveling off in private market property valuations. Attractive pricing in the private market has translated into larger-than-average premiums for non-core sectors. 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 22% undervalued.

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Private real estate pricing has surged ahead of pre-pandemic levels, but with significant variation by property type. Note, the Moody’s CPPI Index reflects an upward bias due to capturing executed transactions as opposed to contemplated and attempted transactions.

U.S. REIT valuations vary by property type, with premiums for favored sectors and discounts for those facing greater uncertainty. Strong private markets have translated into larger-than-average premiums for non-core sectors.

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.

Following the 2020 demand shock, multifamily, industrial, and several niche sectors have surpassed pre-pandemic levels, while office, retail, and lodging remain in a slower recovery.

New deliveries are generally peaking for property types with more questionable outlooks, but apartments, industrial, and several niche property types are experiencing surging supply alongside elevated levels of demand.

Angelo Gordon’s Capital Markets Perspectives

AG Capital Markets Perspectives (“CMP”) provides our portfolio managers’ views on the credit, real estate, and private equity markets. To access this quarter’s CMP and past quarterly reports, please complete the form below.

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