By John B. Levy, a former monthly Barron's columnist for over 23 years

After a slow finish in 2022, the commercial real estate market is trying to build up a head of steam, but volatile Treasuries and surging employment data seem to be standing in the way. Capitalization rates, used for property valuations, have gone up – but not enough to compensate for a larger increase in Treasury rates, especially on the short-term side. Notwithstanding the above, cap rates do seem to be moving in the right direction. For example, during the first nine months or so of 2022, capitalization rates for Class-A apartments were in the 4%+ range. To date, those rates now start in the 5% and up area. Here are a few of our thoughts going forward:

The 2022 total returns for our fixed-rate, first mortgage index – the G-L 1 – was at a disastrous -8.98%, the worst in the Index’s 51-year history! But not surprising as property valuations, in general, were down. For example, the National Council of Real Estate Investment Fiduciaries (NCREIF) Property Index (NPI) showed a meaningful -4.0% mark-to-market price decline for Q4-2022. This was the largest quarterly drop since Q3-2009 when we were near the end of the global recession. For Q4-2022, credit effects for the G-L 1 moved up to a relatively scant 4 basis points. While we don’t wish to call a shift in this measure at the moment, we do think the increase is consistent with a softer commercial real estate market, and a significant pullback in financing availability.

The G-L 2, our high-yield commercial real estate debt index, is nearing the end of its thirteenth year of data. Who’d a thunk it? During Q3-2022, the index showed a return of 2.04% versus 1.94% in the previous quarter. Higher LIBOR and SOFR rates on floating-rate loans helped the return increase. Right now, the index has data on more than 1,000 transactions spread over $300 billion in real estate!

Looking across the waterfront, the office market continues to be the most unattractive sector. But our optimistic side says that won’t last forever. In fact, the office building business is very local. The New York City market may be weak, but that’s not the case in Dallas, Miami, and Nashville. We clearly remember – not that long ago – when you couldn’t give away a retail transaction, or for that matter, a hotel as well. Today, retail is clearly financeable, and hotels are sought after.

If you’re interested in high-yield debt performance in a recessionary environment, we’ve written a recent White Paper detailing expected losses in the event commercial real-estate shows valuation declines as last seen in the Global Financial Crisis. If you’d like a copy, let us know, and we’ll be happy to send it your way.

The Urban Land Institute just published its closely followed quarterly magazine entitled Urban Land. We were asked to write the highly regarded Backpage, of which over 50,000 copies were delivered. If you’d like to take a look, here is a link to the article (Backpage article).

We look forward to your thoughts and comments as always.