Indraneel Karlekar, global head of research and portfolio strategies, real estate, Principal Asset Management, believes it could be six to nine months before the commercial real estate market has more clarity on the direction the Federal Reserve – and the investment and lending markets unlock.
The firm believes the main theme of 2023 will be investing through turbulence, with Karlekar noting it will be critical for investors to be able to separate signals from noise.
“The two signals that will matter the most to investors in 2023 are inflation and how inflation drives central bank action,” Karlekar said. “Those two signals will, in turn, determine your cost of debt and the pace of economic growth and ultimately will have a huge impact on how investors step back into the transaction market.”
Karlekar believes the first half of 2023 will look more like the second half of 2022, with slower and more selective lending and investment volume. “Price discovery is occurring, particularly in the private markets, as investors try to figure out where and how this slowdown will play out,” he added.
Lenders in the coming year will be working with refreshed targets and parameters, with Karlekar noting much of the focus could be on lending in the core and light value-added bridge space.
“Many lenders are cautious about values but are also constrained in a risk-based capital environment, which will put a little bit of a lid on their exposure to commercial real estate,” Karlekar added. “I think the private lending markets that have been so active, particularly in that mezzanine space, will remain quite busy in 2023 particularly in transactions where the senior lenders won’t be able to step up beyond that 50 to 55 percent leverage level, and you will need someone to step up and fill that gap.”
Principal sees some investment opportunities in the commercial mortgage-backed securities market. “We are very interested and intrigued about what is happening in CMBS as the bond market is dislocated. It could be a really interesting time to step into CMBS – even some of the investment-grade tranches are priced for recession,” Karlekar said.
The REIT market, which has seen prices fluctuate dramatically as the equity markets have risen and fallen, could also present an opportunity.
“Let’s also not forget REITs, which are a leading indicator of real estate values. That market sold off pretty hard and has come back a little, bit but on a relative basis, REITs are looking quite interesting and could become even more so as 2023 plays out,” Karlekar added.
Heading into 2023, Karlekar noted there is also the potential for true opportunistic plays as distress starts to emerge. “If there is some dislocation in the private markets, there will be a true time for the classic broken deals that are in need of recapitalization. We think that is something that could emerge,” he added. “It is always darkest before dawn, and I think we are setting up for some interesting opportunities in the next 12 months.”