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Commercial real estate investment is suffering from an identity crisis. With a whiplash-inducing rise in interest rates and the possibility of a recession coming in late 2023 or early 2024, investors aren’t quite sure how to proceed. Accordingly, commercial real estate investment volumes are down 53% so far in 2023 — but not for want of trying. There’s still tremendous investment appetite and plenty of capital to pursue it. The Wall Street Journal reports that $205 billion in cash is allocated for commercial real estate property deals this year, and deals are continuing to close every day.
However, there is one caveat. To place that capital, investors are reassessing the market, deal structures and agreements, and adjusting transaction standards to align with the new economic environment. The deals that are getting done look a little different than they have in the past. As a result, new transaction trends have emerged this year, and real estate developers—who eventually become property owners and sellers—need to know what the most common deals look like today and what they could look like tomorrow.
Here are four key trends that are shaping real estate investments this year.
Multifamily and Industrial Remain Investor Favorites
The commercial real estate investment market has slowed down significantly since the Federal Reserve began increasing interest rates in March 2022. Investment volumes have fallen significantly across asset classes for five straight quarters, while sellers and buyers have been in a standoff on pricing. Although deal volumes have waned, multifamily and industrial assets have continued to be investor favorites. In the first half of 2023, multifamily investment accounted for 32% of all acquisition activity across commercial asset classes, and industrial properties accounted for 25% of total investment, according to research from DLA Piper. The investment market is undeniably challenging, but developers with multifamily or industrial projects can feel reassured that there is still a healthy appetite for these property types. There was good news for other asset classes, too. Deal volume improved year-over-year for retail, hotel and data center properties.
For developers, the decrease in acquisition activity could lead to longer hold times following project completion. Some developers have started to underwrite an 18 month hold for multifamily, for example, with the expectation that interest rates may remain elevated for longer.
Financing Contingencies Are Flat
Investors are also facing a constrained capital market, which is serving to further hamper deal volumes. This year, loan origination volumes were down 40% in the first quarter and are expected to fall 38% this year as banks have reduced lending capacity. Industry stakeholders expect the constrained capital market may lead to an increase in financing contingencies. So far this year, however, financing contingencies have not been placed on most new transactions. The midyear report from DLA Piper found that more than 94% of transactions moved forward without a financing contingency. Of the 6% of deals that had one in place, nearly 2% were loan assumptions.
While this is great news for developers, as deals are proceeding without financing restrictions, it could also signal the types of investors active in the market today are likely those with reduced exposure to the debt markets, like private equity groups and investment funds. Still, financing contingencies could grow in popularity as the capital markets remain constrained and interest rates remain high.
Survival Periods Are Up
While investors aren’t adding on financing contingencies, they are seeking to mitigate acquisition risk in other ways. Survival periods—the period of time that a seller’s representations and warranties are legally enforceable following the sale of a property – have increased significantly in the last year. Typically, the survival period on a commercial property averages six months, but it can extend as long as 12 months. Today, buyers are requesting an extended survival period to mitigate their risk in the sale due to changing market conditions. In 2023, a nine-month survival period is the new standard, and 22% of buyers are requesting 12 months or longer.
Survival periods began to increase in 2022, but the average was still between six months and nine months. In 2019, half of transactions had a six-month or less survival period. Today, more than 50% of transactions have a survival period that is nine-months or longer.
Insurance Premiums Are a Storm Cloud
Despite the ardent focus on interest rate movements, capital availability, and a recession watch, rising insurance premiums and insurance availability are among the most painstaking trends to hit the property investment sector this year. Weather-related events and disasters, like the increase in wildfires on the west coast, severe snowstorms in the northeast and hurricanes in the southeast, have driven up insurance premiums. In some cases, it’s even forced major insurance providers to exit high-risk markets, deeming certain areas of the country uninsurable. In the first quarter, insurance premiums spiked 20.4%, the first time in 22 years that insurance rates have increased more than 20%. For property owners that filed sizable claims due disaster-related property damage, premiums tripled.
Insurance-related costs are making it difficult or even impossible to underwrite properties at current pricing and interest rates—and this trend is unlikely to subside. Commercial property insurance is expected to increase 10% to 25% annually through 2025.
It is critically important for real estate developers to understand and respond to investment trends—but the outcome of a ground-up development starts to take shape during construction. New technologies like Northspyre are using automation, machine learning and predictive analytics to streamline project management, reduce human errors and significantly reduce tedious administrative work. The software has a direct impact on the bottom line, reducing budgets, cutting down overages and keeping projects on schedule.
Creating efficiencies during construction can make a challenging investment market manageable once the property delivers. Developers with a well-managed project have the flexibility to field and survive economic challenges, no matter when they strike. By paying attention to evolving industry trends and using new technologies, developers will ensure a successful investment from start to sale – and everything in between.
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Tag(s): Real Estate Development
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