Commercial Real Estate Debt: Values Have Likely Peaked

Sales volumes slowed again in the first half of 2017, and valuations have likely passed their cyclical peak.

August 16, 2017


This Commercial Real Estate Debt sector report is excerpted from the Third Quarter 2017 Fixed-Income Outlook.

Sales for the first half of the year are down 8 percent over the same period last year, and continue the trend of lower volumes since the peak in 2015. Apartment and retail sectors have seen the biggest declines at 17 percent and 16 percent, respectively. The only increase was in the industrial sector, which was up 10 percent. The slowdown in sales is a function of investors’ concern with slowing growth in net operating income, potentially higher interest rates, and the volume of new construction, especially for apartments. The slowing growth in net operating income is one of the top determinants of price as investors no longer view real estate as a double-digit growth vehicle. This has caused investors to be less aggressive on purchase prices and cap rates over the last year; combined with declining sales volume, this indicates to us that market valuations have peaked for this cycle. Meanwhile, sellers are under no significant pressure to sell as interest rates are still low, inflation is benign, and most properties other than retail are performing at high levels of actual net operating income. Neither side is willing to meet in the middle. With investors hesitant to buy, and sellers under no real pressure to sell, prices will likely remain flat to slightly down for the rest of the year for most properties. The industrial sector may be the outlier as the expanding economy has provided significant demand, led by new e-commerce participants.

Net Operating Income Dips Across All Sectors

The slowdown in U.S. real estate sales is a function of investors’ concern with slowing growth in net operating income, potentially higher interest rates, and the amount of new construction, especially for apartments.

Net Operating Income Dips Across All Sectors

Source: Real Capital Analytics, Guggenheim Investments. Data as of 7.27.2017.

Most Real Estate Prices Have Likely Peaked

With investors hesitant to buy, and sellers under no real pressure to sell, prices will likely remain flat to slightly down for the rest of the year for most property types. Industrial properties may be an exception due to demand from e-commerce tenants.

Most Real Estate Prices Have Likely Peaked

Source: Green Street, Guggenheim Investments. Data as of 7.25.2017.

With the slowdown in sales volume and the tail end of the ”wall of maturities” on lender balance sheets, we expect origination volumes to decline by 5–8 percent. Large deal activity is down 16 percent year to date compared to the same period last year, and single-asset transactions are down 6 percent. We do not think this trend will change in the second half. This slowdown will cause lenders to be aggressive, and they may lower spreads over the next few months to increase production.

With CMBS and Agency lenders quoting aggressively on 10-year terms, we like five- and seven-year paper, and longer terms up to 15 years where pricing is less competitive. The bridge and mezzanine space is still attractive, but spreads are being compressed due to the significant supply of capital to these higher-yielding transactions.

—William Bennett, Managing Director

 
Important Notices and Disclosures

This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. It contains opinions of the authors but not necessarily those of Guggenheim Partners or its subsidiaries. The authors’ opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is no guarantee of future results.

Investing involves risk. In general, the value of fixed-income securities fall when interest rates rise. High-yield securities present more liquidity and credit risk than investment grade bonds and may be subject to greater volatility. Asset-backed securities, including mortgage-backed securities, may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity risk. Investments in floating rate senior secured syndicated bank loans and other floating rate securities involve special types of risks, including credit risk, interest rate risk, liquidity risk and prepayment risk. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Real Estate, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited, and Guggenheim Partners India Management. ©2017, Guggenheim Partners, LLC. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC.


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