CRE Sales Remain Low but Steady. Have We Reached the Bottom of the Cycle?

Since March 2022, commercial real estate values have been pummeled by persistent increases to the Federal Funds rate, which to date has risen by more than 500-basis points over a very short time frame.

Adding to the distress, the Fed has indicated that — given the relative strength of the U.S. economy — it may continue to raise rates, meaning uncertainty about CRE asset pricing and other factors will continue to linger into the foreseeable future.

Against this backdrop, when investment sales figures for the first quarter of 2023 were released, they underscored what most market participants believed would happen: quarter-over-quarter sales activity contracted significantly, by more than 60%. In the second quarter of the year, sales activity mirrored first quarter transaction levels, indicating that volumes remain historically low.

One upside to the Q2 levels is that the market did not erode further compared to the first quarter, a dynamic that may indicate the market is beginning to bottom out. While two quarters do not make a trend, it is important to note that midway through the third quarter, at $21.1 billion, sales volume is on track to come in at nearly the same levels posted in each of the previous two quarters.

“I think we'll probably see similar transaction volume over the next couple of quarters,” said Chad Littell, national director of U.S. capital markets analytics at CoStar, the publisher of LoopNet. Sales could be a little higher or a little lower, he added, “but I don't think [it will be] materially different.”

Total sales volume in Q2 for office, industrial, retail and multifamily assets combined reached $55.6 billion, compared to $55.1 billion in the first quarter of 2023, a slight increase of 0.9%, according to data compiled by CoStar. The number of transactions fell slightly, roughly -2.4%, from 20,841 to 20,363. But the quarter’s sales volume is a mere fraction of the peak sales volume posted in the fourth quarter of 2021, which came in at $239 billion, a decline of 76.7%.

Data for office, industrial, retail and multifamily sales break out as follows:

Office. Sales volume increased from $9.2 to $9.7 billion (a 5.2% increase), and more buildings traded (3,538 in Q1 compared to 3,718 in Q2). Compared to the historical peak in Q4 of 2021, the Q2 figures represent a -73.5% decline in sales volume and a -49.1% decline in transaction count.

Multifamily. Sales volume reached $19.1 billion compared to $18.1 billion in Q1, a 5.3% increase. The number of units sold increased over the quarter from 131,871 in Q1 to 135,242 in Q2. These figures are -83.5% below the figures posted in the peak quarter, Q4 of 2021.

Retail. Sales volume declined slightly from $13.0 to $12.8 billion on sales of 10,069 in Q1 compared to 9,403 in Q2. Compared to the historical peak in Q4 2021, Q2 sales volume was off by -61.8% and transaction count was down by -50.2%.

Industrial. Sales declined slightly from $14.8 in Q1 to $13.9 billion in Q2. The number of sales fell from 4,258 to 4,098, figures that are -73.9% and -58.4% respectively below the Q4 2021 peak.

One way Littell is assessing current market conditions is by looking at transaction volume and segmenting sales by price. For example, for transactions of $3 million or less, he compares the number of deals trading in that price range today to the number that traded during the peak sales quarter of Q4 2021.

He segments transactions in tranches of less than $3 million, $3 million to $10 million, $10 million to $25 million and $25 million and above.

“The general takeaway is that in the $25-million-and-over category for all property types, the transaction count is down 79% from the peak. [This figure indicates] that the big, sophisticated capital is not trading right now.” But as you move toward the $3-million-and-under segment, “that's [only] down about 53% from the peak,” Littell said.

He is examining this data quarterly to see how it’s trending and believes that when deal velocity for transactions of $25 million and over increases, this will be an indication that institutional capital sees discounts large enough to bring them back into the market.

He cautions against looking at total deal value exclusively because in a market like today’s where transaction counts are very low, “if you see a one-off $500 million or $1 billion portfolio trade, that can skew what's going on.”

“When we start to see deal counts in the $25 million and over [category] start to pick up, and you can see increasing deal volume over multiple quarters in a row,” that will start to signify that the market is gaining real clarity about where pricing is going, Littell said.

“Price discovery, [the process of determining a market price that is acceptable to both buyers and sellers], will need to play itself out. It doesn't happen over a quarter or two and generally [it] takes a couple of years to see the process unfold,” Littell said. This is because the number of trades needs to increase so there are enough sales comps to establish clear market prices.

Additionally, he said that “pricing adjustments are needed along the way to lure capital back in.” As such, he believes low transaction volume will remain through the rest of this year and into the next. “It will probably be the second half of 2024 and early 2025 before we see activity pick up in a meaningful way.”

Littell anticipates that institutional investors will remain on the sidelines for the rest of this year. They might try to sell some high-quality assets and rebalance their portfolios, but Littell does not believe that allocating large sums of capital is in their business plans for the back half of this year.

Littell added that current sales volume and transaction counts are so far below the peak, that bouncing along at this pace over the next couple of quarters will not translate to a lot of deal flow. “I would suspect that we could see a little bit of a pickup in deal volume in the back half of the year, particularly in the industrial sector,” he said. That's due to the fact that industrial rents continue to grow in the high single-digits and vacancies are much lower than what we see in the office sector.

Additionally, Littell said that small retail properties have posted “pretty vibrant transaction activity” compared to larger properties. He added that retail assets priced below $3 million made up most of the retail sales. “A lot of these buyers don't use debt, so they're not as exposed to interest rate movements,” nor do they answer to investment committees, he said.

They buy for their own personal or family accounts or estate planning reasons through 1031 exchanges, Littell said, meaning they “price right through a lot of the interest rate changes that institutions can't.” As a result, he said steep price declines for smaller retail assets have not materialized, but for larger retail assets, “you're seeing double-digit price declines.”