Report: Cap Rate Increases and Cautious Lenders

Market activity is declining. There are fewer bidders and wider bid-ask spreads on properties. Cap rate decompression is ongoing. Lending conditions remain tight.

None of the above is news to those in the commercial real estate industry. But CBRE’s recently released “U.S. Cap Rate Survey H2 2022” generated metrics to match the trends, while also offering outlooks for 2023.

Conducted in November and December 2022, the survey included 3,600 cap rate estimates across 50 geographic markets. Additionally, more than 250 CBRE real estate professionals completed the survey.

One takeaway from the survey is that respondents anticipate cap rates to increase in the upcoming quarters. This is a continuation from what’s been happening during the latter part of 2022, with cap rates increasing, on average 60 basis points (bps) from the first part of last year.

“All property types reported cap rate expansion, paced by the industrial and multifamily sectors,” the survey report said. The reasons? Higher borrowing costs, monetary policy uncertainty and a volatile macro backdrop.

Speaking of borrowing and costs, respondents anticipated that lenders are growing ever cautious, with average loan-to-values (LTVs) expected to fall within the next several months. As a result, some properties eligible for refinancing could have trouble obtaining mortgages. Owners might be forced to sell or default.

Meanwhile, the survey also pointed out that office REITS are trading at a significant discount to net average value as of early 2023. “This reflects investor concerns about falling property values and slower rent growth,” the survey report said.

Furthermore, distress is anticipated to increase in the office sector, especially as lenders are becoming more cautious and less willing to provide financing to lower-quality and older properties. And while conversion to other uses is in the cards, “few believe it can be executed at the scale needed to materially lower vacancy and prevent rent declines for older office buildings,” the survey said.

News is more positive on the retail side, specially among quality suburban neighborhood retail properties. High inflation protection, lower availability rates and little in the supply pipeline could mean an increase in asking rents. As such, “retail may present an opportunity for investors looking for value,” according to the survey.

Hospitality is also showing some positive indicators. The survey pointed out that strong average daily rate (ADR) gains and increases, as well as “improvements in ancillary spends” are resulting in gross profit dollar increases. Even with inflation and increasing operating costs, respondents believe that ADR growth should beat inflation.

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