The uncertainty that characterized 4Q22 continues into the first quarter of 2023. The Fed’s move to increase interest rates seven times in 2022 to tame inflation led to a material slowdown in deal flow in the fourth quarter, though recessionary problems predicted by some market experts have failed to materialize thus far.
According to a new report from LightBox, Early 2023 Barometers: Resetting Market Expectations, “The country’s largest commercial lenders began to retreat from commercial property loan originations in the third quarter of 2022, higher interest rates made capital more costly and shut some borrowers out of the market, and uncertainty over property valuations increased. By year-end, the Mortgage Bankers Association reported that commercial and multifamily mortgage loan originations were a dramatic 54 percent lower in the fourth quarter of 2022 compared to a year ago and down 23 percent from the third quarter.” Commercial property listings and transactions declined in late 2022, and property listing volume in the fourth quarter declined by almost 50 percent year-over-year.
Environmental due diligence activity conducted to support commercial property underwriting fell by 31 percent in the final quarter, according to the LightBox ScoreKeeper model, which tracks U.S. Phase I environmental site assessment activity, an early indicator of how investment activity is changing in response to market conditions.
After declining in late 2022, inflation rose slightly in January and again in February, fueling expectations that the Fed’s next move at its March meeting will be another 25 bps increase in interest rates. While the economic pain is not over, the shift in Fed policy is an encouraging sign that rate increases are moderating.
Among the key takeaways from the LightBox report:
- More than $1 trillion in loans coming due: Record quantities of debt will mature in 2023-2025, posing one of the greatest near-term challenges to the lending community. Nearly one-third of the maturing debt within multifamily mortgages had an initial term of three years or less, which means it was priced at the lowest cost on record and likely involved a transitional asset.
- Ongoing debate of recession: The market turmoil has sparked discussion about the possibility of a recession ahead, with a wide variety of opinions about its likelihood, timing and depth. Among LightBox customers at the Environmental Bankers Association 2023 Annual Conference in January, half said they believe 2023 could go either way, while the other half was almost evenly split between bulls and bears.
- Property valuation reset: There is widespread agreement that a pricing reset is needed, as lenders adjust to their requirements in response to the rapid changes in the market and investors navigate a bid-ask spread that is curtailing deal activity.
- Distressed assets: The market is preparing for an uptick in foreclosures, but the big question is by how much. A negative leverage scenario is playing out across the country, with investors who relied on variable-rate financing or who couldn’t succeed in refinancing feeling a pinch. In some situations, investors are no longer bringing in enough income to cover loan costs.
- Multifamily expected to stabilize: The multifamily sector remains a top asset class and continues to benefit from strong demand drivers. Double digit rent growth is no longer sustainable, but 5%-7% growth is still realistic for 2023 and beyond.
- Stronger H2 activity: Although the year began with widespread expectations of a busier second half, the shock of early March bank failures injected a new wave of uncertainty. The market is adjusting to the news and all eyes are on the Fed to see what comes out of the next few FOMC meetings as indicators of what the second half will bring.
The market is navigating an unprecedented time, with sentiment shaped by a diverse and often competing mix of influences. The Fed’s shift in January to a more moderate interest rate increase was an important first step toward rebuilding confidence. The next few months will be very telling in terms of how the market responds to this month’s bank failures and what the Fed’s next move is in controlling inflation and restoring confidence in the market.
Read the entire LightBox report here.