Why CRE's Capital Markets Freeze Is 'Upside-Down' From The Great Financial Crisis

Inflation, interest rates and a very cloudy view on the return to offices mean the nation’s biggest landlords are navigating how to run their properties with little to guide them, all while battling dipping values and a perception problem.

“There’s very little new stuff coming to the market,” Savanna Managing Partner Chris Schlank said at Bisnow’s New York Economic Forecast Event at 7 World Trade Center last week. “… On the office side, any office building that comes to market now gets punished, because anybody that brings an office building to market now, the market perceives as distress. There's an upside-down capital market there.”

Last week, the Federal Reserve lifted its benchmark rate to between 3.75% and 4%, its fourth consecutive hike of 0.75% this year. The central bank’s attempt to tackle inflation — which cooled slightly last month, according to data released Thursday — has put a freeze on the investment sales market.

The economy entered the 2008 recession in a higher-rate environment, leading the Fed to lower rates in a bid to speed up the economy. With Fed Chairman Jerome Powell saying last week the central bank will likely raise rates "higher levels than we thought," more uncertainty surrounds the cost of debt than underlying business fundamentals.

"The difference today between the [Great Financial Crisis] is that in the GFC, you didn't know where rents were going, right?” Schlank said. “The capital markets were screwed up and banks were getting rid of debt that they owned. … The question mark was in rents. Now there's a lot of transparency in the office market, meaning that you know that the good buildings are leasing really well … but the capital markets are completely unknown, so you can't get financing. So there's this inverse now."

CBRE Investment Management Senior Managing Director Sondra Wenger said there is capital on the sidelines for both debt and equity — it is just unclear when exactly they will get back in the game.

“There's no liquidity crisis,” she said. “There's a great pricing restructuring that we're all having to sort of swallow. And I think that's the real challenge. What we're struggling with on the office front is just transparency of return to office."

She added, however, that when there were layoffs at content companies in LA, there was a boost in the numbers of people coming to their desks.

“The most important amenity, it's not your coffee machines and your bocce ball courts; it is the other employees in your office,” she said. “So to get them back, that is the best way that you can get people back to office."

Investment sales in New York City commercial real estate slowed for the fourth straight quarter in the period between July and September. Less than $5.2B of commercial properties sold in the city, down 11% from Q2 and 16% below the trailing four-quarter average, per Avison Young.

Brokers have predicted a challenging end to 2022 as buyers increasingly seek reductions, even after contracts are signed.

“Let's not fool ourselves, right? The market has changed. The cost of debt has changed,” Meridian Investment Sales Executive Managing Director Helen Hwang said. "In a market like this, where you have a lot of turbulence and opacity in the marketplace, you need a super highly motivated seller and buyer. That's how the deal will get done.”

Hwang said the most activity is with high-quality assets and in the multifamily space — but across the board, almost everyone is seeking pricing adjustments.

”It can be very exhausting, so every morning I wake up, take two shots of espresso, come in every day like, ‘It's a new day,’" she said. "You have to have the tenacity, you have to have the focus, you have to have optimism ... because the market is so sad, right? Now everybody comes in like, ‘Oh, nothing is working, there's no debt.' If you come in with that mindset, it won't get done.”

Multifamily has become the preferred asset class because rents have soared over the last year. In Manhattan, the average face rent last month was $5,435. In Brooklyn, the median net effective rental price was $3,457 in October, up 27% from October 2021.

But even market-rate apartments in a supply-constrained market, where landlords can feel confident that rents won't bottom out, Hwang said the market is still a starkly different environment from the start of the year, when buyers were accepting capitalization rates below 4%.

“What is really shocking is, we took a survey in first quarter of this year and there was so much optimism and the investor psyche was totally different,” she said. “It was a different world then. Fast-forward to today, and rent growth is so muted and basically just matching expenses.”

The office market is where the most challenge is for real estate owners right now, as workers still aren’t fully back in the office. Wenger said CBRE Investment Management has been focusing on life sciences, medical office and self-storage assets.

Increasingly, there is an expectation that a gloomier economic outlook and job security worries will push a greater return, but the theory is still unproven. National average office occupancy has dropped each of the past four weeks, according to Kastle Systems.

Empire State Realty Trust Chief Financial Officer Christina Chiu said one big factor that could engage tenants is offering a workplace that will help companies hit their ESG mandates.

“A lot of large public companies have to publish their own corporate sustainability reports. They will look for landlords to feed them the data,” she said, adding that landlords are going to need to work with tenants as strict new carbon emissions laws loom. “Local Law 97, that's real, right? The deadlines are 2024 and 2030. Landlords can't get there on their own, so the only way you will be able to actually cut carbon emissions operationally is if you engage with the tenants and change tenant behavior.”