Commercial property sales climbed at double-digit rates in the first quarter of 2022 compared to the same period last year, despite uncertainty around interest rates, inflation, and geopolitical uncertainty. However, since closing a commercial real estate transaction is a process that can take months to complete, the fallout from recent uncertainty has yet to be seen, according to a new report from analytics firm MSCI and its Real Capital Analytics group.
The report includes the latest quarterly edition of the RCA CCPPI All-Property Index, which shows that property prices rose by 17 percent from the first quarter 2021, down from the 19 percent pace set in the fourth quarter of 2021. In an environment where there was no inflation, war and lingering effects of a global pandemic, these figures would be optimistic. But the annualized change in pricing suggests things are slowing.
While this pace in growth would be a positive in a normal environment, property prices are no longer climbing at an average of 300bps of additional growth each quarter; nor have they since the fourth quarter of 2020. This deceleration is said to be a function of the easing of fear that dominated the markets in the height of the pandemic.
Additionally, as inflationary pressure pushes up interest rates, the increasing cost to finance commercial real estate investments is another brewing concern.
“Real estate as an asset class is often touted as one that has some inflation hedging characteristics, but I’m not sure how true that is for all property types and all periods, as it really depends on what kind of inflation you’re experiencing,” Will Robson, MSCI’s global head of real estate solutions research, told Real Estate Capital USA. “And a lot of the inflation at the moment is a cost push inflation, so how much of that can flow through into the rental growth and provide that hedge?”
Robson cites residential and industrial as sectors that could possibly withstand some of the impact of inflation due to strong investor demand.
“There’s some tailwinds that might make investors more comfortable about the potential for growth and inflation hedging characteristics [in these sectors]. And it’s where we’ve seen most of the activity,” he added.
The report, however, notes that the residential sector is showing stress from inflationary trends.
The 30-year fixed-rate residential average pricing for Freddie Mac loans climbed to 4.25 percent in March, up from an average of 3 percent last year. The Freddie survey average fell much more than in commercial rates during the worst of the pandemic, so it is unclear whether commercial mortgage rates will creep back up in the months ahead.
A key takeaway is that commercial debt costs are going up, particularly for riskier product types. And if property income does not grow enough to compensate for higher debt costs as loans mature, losses will be had.
The first quarter of 2022 stands as the strongest first quarter in RCA records for investment in alternative real estate sectors. At $21.3 billion, the quarter’s investment level was 25 percent above that for the same period a year prior.
Investment in tech and data centers totalled $7.1 billion – a third of all investment – while allocations to student housing reached $153m, with Blackstone leading the way. Meanwhile, investment in self-storage hit $2.7 billion, nearly 160 percent higher than the average first quarter period in the three years prior to the pandemic.
“The more traditional institutions and the open-end funds are increasingly looking for more creative ways to gain exposure to niche sectors,” explained Robson. “Given the structural headwinds around sectors such as retail, where having a traditional lease to retail might not be viewed as being as safe or less risky as it was once in the past, it opened up appetite to look at other types of investments.”
The report tracked rising volumes and investment activity in the niche sectors.
“As the more traditional sectors, particularly retail and now office, [continue to present risks] there’s been this tilt to the residential and industrial sectors, but now investors are looking for greater diversification and different kinds of return profiles,” Robson said.