Here’s How Capital Markets Are Likely to Look in 2023

One of the biggest questions in CRE – perhaps the biggest – is what will happen to the capital markets. Valuations and rents may go up or down, but it’s the cost of financing that is most likely to make or break deals.

Right now, the biggest concern is uncertainty about the Fed’s next steps, as well as a lack of price discovery as markets adjust.

“As the Federal Reserve continues to raise rates to curb inflation, capital markets have reacted with extreme caution until it becomes clear when the Fed will stop and where interest rates are likely to stabilize,” Marcus & Millichap said in a special report. “This uncertainty is compounded by several issues, including stock market volatility, geopolitical risk, slowing rent growth, falling home prices and cap inflation.”

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The firm recently conducted a survey of its clients to gauge their concerns. “Both lenders and investors are taking a careful break to avoid ‘catching the knife,’ using this time to raise funds for what they believe will be a looming problem in the commercial real estate market, as they did in 2020 after starting. pandemic,” they said. “In 2020, capital providers who took the risk to lend or invest tended to come out on top, while much of the market missed the opportunity due to an abundance of caution.”

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But as they say, past performance is no guarantee of future results. Massive amounts of liquidity injections from the Fed and pandemic relief from federal and state governments are not available this time. On the contrary. The Fed is drastically reducing liquidity to slow economic growth in an effort to curb inflation, and Congress is struggling to pass a budget and deal with the debt ceiling.

The firm took the prediction based on the Fed partially slowing the pace of rate hikes, a slightly weaker economy and no other big and unexpected surprises.

The first, cash is king, seems safe if conditions turn sour. Preferred equity and mezzanine debt will predominate and be available for maturing debt. Construction financing will be hard to come by until construction costs come down, but as it is as of 2019, still by more than a third, it may take a long time. Bridge lenders will favor emergency purchases because their lower prices are closer to current values. As the Fed eases rate hikes, improved bond investor sentiment will lead to tighter CMBS and CLO tranche spreads. Borrowers end up refinancing construction loans with inventory loans to keep things afloat long enough to sell.

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And finally (whatever that means in this market), investors will free up a lot of capital that they now have on the sidelines.


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