'So Far, Nobody's Panicking': CRE Evaluating Strategies As Stocks Dive With Rest Of Market
Real estate equities are now suffering as fallout from the threat of inflation and higher interest rates nudge the U.S. economy closer to the brink of recession.
Although some areas of commercial real estate have fared well in recent years, inflationary pressures combined with rising capital costs and supply-chain clogs have dragged down even hot sectors like apartments and industrial.
The open question now is whether the strongest asset classes can bounce back any time soon.
"I hear from my real estate clients that they're having meetings about their strategy going forward," said Josh Mogin, partner and real estate finance attorney with Thompson Coburn's Los Angeles office. "'How do we keep doing what we're doing?' they ask. There's a lot of uncertainty, but so far nobody's panicking."
As of Thursday, the S&P 500 has lost more than 23% of its value just since the beginning of 2022. Since a week ago, the index is down 8.7%. The Dow Jones Industrial Average closed below 30,000 for the first time since January 2021, erasing the bump the indexes experienced Wednesday.
With the stock market’s entrance into bear territory, warnings of a recession grew louder Thursday evening, adding to the atmosphere of instability that has hit major commercial real estate companies squarely in the balance sheet as deals teeter.
"As we enter into a rising time of uncertainty — inflation, increasing interest rates, and more — it's more difficult for deals to pencil out with the inherent risks that need to be underwritten," said William Colgan, partner at CHA Partners.
"It takes time to adjust to the increased development costs or increased financing costs," Colgan told Bisnow. "Sellers are still trying to get the same return they were able to previously, but buyers need to underwrite the increased costs in deals and the greater market uncertainty."
Real estate stocks are part of the downward trend, including both REITs and other large publicly traded real estate companies. The FTSE Nareit All REITs index is down more than 21% since the beginning of this year, and more than 5.5% over the last five days.
There are no exceptions to the downward trend among REITs in 2022, though exactly one sector, hospitality, has managed only single-digit losses, down about 6.5% so far this year.
Otherwise, REITs in every sector have slumped significantly this year. The worst hit is regional mall-owning REITs, with returns down about 37.7%. Office specialists have seen their returns down an average of about 30%, self-storage is off 23.3% and healthcare off 13.4%.
Even REITs specializing in the darling property types of the pandemic era—industrial and apartments—have taken a shellacking this year. Industrial REIT returns are off more than 27.7% and apartment REIT returns are off more than 23.5%.
And size provides no protection from the bloodbath.
Office specialist Vornado Realty Trust is down more than 36% year to date, and more than 9.5% in the last five days while Equity Residential, the largest public multifamily landlord by asset value, has seen its stock tumble more than 24% this year, and 4% over the last five days.
Industrial giant Prologis — which recently announced a $26B deal to become even larger in an all-stock acquisition of Duke Realty Trust — is down more than 31.5% so far in 2022, and down more than 7% compared with five days ago.
And REITs aren't the only kind of public real estate companies to suffer from the tumble of 2022.
Brokerage giants CBRE, JLL and Cushman & Wakefield are all down by 38% on average for the year, and off 10% on average this week.
Major investors are feeling the pinch too. Blackstone Group, which has made headlines recently with its multibillion-dollar deals in real estate — such as buying American Campus Communities for nearly $13B — is down almost 30% year-to-date and a whopping 18.6% just this week.
Homebuilders, who have spent the last year trying to meet strong demand for their product, are getting no love from investors either. PulteGroup, for example, is off more than 35% this year, and 16% this week, as news broke that homebuilding starts were down more than expected.
And after a difficult couple of years, the macroeconomic hits just keep on coming, even for the strongest property types.
The Federal Reserve on Wednesday announced a 0.75% hike to the base interest rate, the largest since 1994, in its effort to put a lid on ballooning inflation rates, the likes of which haven't been seen since the early 1980s.
Though still historically cheap, money is much more expensive than it has been in at least a decade. Fed Chairman Jerome Powell also signaled the Federal Open Market Committee will continue its monetary tightening.
Moreover, a recession in the U.S. is coming in the third quarter, according to Destination Wealth Management CEO Michael Yoshikami, though he says it will be "shallow."
“The housing market in the U.S. is really locked up with mortgage rates close to 6% right now, and I think it’s a virtual certainty that we’re going to go into recession next quarter," Yoshikami told CNBC's Squawk Box Europe on Thursday.
JPMorgan Chase & Co. strategists put the probability of a near-future recession at 85%, Bloomberg reports.
Still, even in the tough new environment ahead, some property types are going to do better, or at least not as poorly as others.
Notably, cash-flowing multifamily and industrial assets won’t be as severely impacted, Hudson Realty Capital Managing Principal Richard Ortiz said.
And housing will slump, Thomas Coburn’s Mogin said, but in the longer run, its fundamentals are still strong.
"At the end of the day, we're still in a massive housing shortage in this country, and there is still generally more money than there is product."
There’s no way to know which asset classes will suffer the most, but few, if any, will be able to avoid the choppy economic waters that lie ahead.
"While I don't believe any property type will be immune from rising rates and macroeconomic factors, there are some asset classes that will be more resilient and experience less damage as a result," Ortiz said.