Julie Whelan:
I welcome our capital markets panel to the screen. Darin Mellott, our Head of Capital Markets Research in the U.S., Henry Chin, our Head of Asia Pacific Research and Global Investor Thought Leadership, and Neil Blake, our Global Head of Forecasting & EMEA Chief Economist. Welcome, Darin, Henry and Neil. So to all of you, we are at the end of a decade-long surge in property values where cap rates have compressed across the world. Are we about to see cap rates move in the other direction? Could you speak each from your perspective regions?
Henry Chin:
Good morning, Julie, and it is very interesting. Capital markets is always very sensitive to the overall economy and is always the first one to reflect the market conditions. But in Asia Pacific, we have not recorded any significant cap rate decompression in the first half of this year, but we are expecting to see cap rates move out in the second half. But given the diversity of Asia Pacific economies, the magnitude of cap rate movements also varies. Despite the strong market conditions, the rising interest rate involvement and the negative carry do put cap rates under severe pressure in Australia, in New Zealand and Korea. We are expecting to see cap rates to move out in those three markets first in a range of 50 to 75 bps. Cap rates will also move out in mainland China because of its weak fundamentals, but the magnitude will be within 25 bps. And the cap rate spread remains so healthy in Japan, despite the strong weight of capital targeting Japan and the lower interest rate involvement in Japan, we still do not expect to see cap compression any further. The cap rate is going to remain stable. The final point I want to make is what we have noticed is that the private capital remain extremely active, particularly in Singapore and in Hong Kong. So they are talking a trophy core asset by those private capital and some institutional capital can be easily priced out during the bidding processes.
Darin Mellott:
And Julie in the U.S. We've seen cap rates begin to decompress. Now, I think it's important to emphasize it's difficult to paint with broad strokes right now. Everything's very deal-dependent. Everything depends on the market, property type that we're talking about, the asset, it's risk profile, et cetera, but generally speaking, we've seen cap rates move out 50 to 75 basis points some more, some a bit less. So for example, prime multifamilies probably closer to 40 basis points. Industrial retail, closer to 75. Office, most impacted. That's gonna be closer to a hundred basis points, but seeing how expectations to reset relatively quickly and long-term interest rates are off of their peaks. Right now, we see a relatively stable outlook for cap rates. But as Richard mentioned, we have an evolving macro picture and so there is some potential for additional expansion there.
Neil Blake:
The situation in Europe is a bit more like the United States than it is like APAC. We're definitely seeing cap rates starting to move out, but yeah, the picture's actually, you know, we've had some increases, we've had some markets still the same, some are in between. It's not a coherent pattern by geography either. By sector, it's quite interesting. The biggest increase in cap rates have actually been logistics which have actually had a very few good years before that. And the slowest have actually been multifamily housing, maybe not surprised there. And retail, I mean, we heard about retail from Tasos before, how it's having a little bit of a comeback and there are some retail cap rates, which would be going down and not just at the prime end, secondary assets as well. So overall we're seeing, cap rates got by up to 50 basis points at the prime end. There's more coming but we are lagging behind the United States.
Julie Whelan:
Okay. Very interesting. So spots of value creation, but a pretty consistent story around the world that cap rates are moving out. So Darin, you talk to our Debt & Structured Finance teams quite a bit. How much has the cost of debt risen and what impact is that having on the real estate market?
Darin Mellott:
The cost of capital has increased materially since the start of the year. So we've seen fixed rate loans going from the low threes to the high fours and low fives. Floating rate spreads have blown out to about 350, that's over a SOFR about 225, and that doesn't include a cap. In terms of lender preference, there's a clear preference for multifamily, industrial some grocery-anchored retail, healthcare, life sciences even some data centers. Other properties are gonna be more difficult to finance. And we've also seen LTVs impacted. So we've seen LTVs come in from the mid-sixties to 50 to 55% range, roughly give or take a few percentage points depending on the asset. But to answer your question, we've seen a shift in pricing and volumes have been impacted. Those financial conditions have tightened and we expect to see continued reverberations from those tightening financial conditions in the form of relatively subdued volumes. Important to note, those volumes are still going to be healthy from a historical perspective. Right now we expect volumes in 2022 to be down 5%-10% from 2021. But again, mentioning that perspective, that's still going to be 47% over the five-year pre-pandemic average.
Julie Whelan:
Wow. So that perspective is so important because so often we view short term historical data and jump to conclusions that are easy to miss if we're not looking at the long-term ones. So since the beginning of the pandemic, there has been an expectation that distress is coming to the real estate market. It's been a constant question that we have received recently, New York University and Columbia released a staggering study suggesting that $500 billion in real estate value is poised to be lost in the market. Are we now, or are we going to finally see distress in the real estate market?
Henry Chin:
Yeah. Hi Julie, this is a fantastic question. We are hoping to see the distress for the over the past 10 years, but unfortunately, we haven't seen much of a widespread distress across Asia Pacific. One big reason is that there are plenty of liquidity in the market and that mainland China probably is the only market we are finding to see distress opportunities. If you look at the past few years over-leveraged developers disposed non-core commercial assets in order to pay off real debt, and the trend is set to continue. But what we are seeing in the news with the headwinds we are seeing in the China residential market and the headwinds we are seeing in the macroeconomic situations, distress opportunities will appear in China, but in a more controlled manner.
Darin Mellott:
Julie, we haven't seen distress in the U.S. However as macro conditions worsen, one area of particular concern is with several billion dollars of floating-rate loans that are gonna require refinancing in the near term. So that bears worth watching.
Neil Blake:
Yeah, there's no obvious sign of distress in European property markets at the moment. Sure, cap rates are going up. Values might be under pressure, but it's after several very, very good years. If you do want to punch around to see where there might be problems, it's probably the supply of debt, and it's harder to get debt for the secondary investment. It's harder to get debt for development. It's really, the lender has actually been risk-averse in the face of impending or possible recession. You also gotta remember as well that now might not be the time to look for this. There might be problems refinancing down the road, but just let's remember that Europe by and large is in a recovery from the pandemic mode as far as occupying markets go. You know, vacancy rates are still relatively low. They're recovering. People are paying their rent and as long as that keeps going you don't get distress. And let's remember we're expecting a relatively mild recession, not another GFC.
Julie Whelan:
Great, thanks for those comments. So Henry with your front-row seat to investor sentiment, how is the outlook right now impacting investor sentiment?
Henry Chin:
I think on the back of a rising interest rate environment, what we are seeing, investors across the globe are acting cautiously, when it comes to new acquisitions. However, it does not necessarily mean that investors are putting their investment on hold because plenty of dry powder is sitting on the sidelines, looking for the good opportunities. As a result at CBRE we do believe that there are three distinct vintage strategies that could apply globally. The first is to identify the value between public and private markets. We advise investors should look into REITs which potentially trade below their Net Asset Value and other listed vehicles that seem to be undervalued. We do believe opportunities should be U.S., U.K. And Australia. The second, to look at the debt investment strategies. I think debt investment strategies become so attractive, particularly during the time of uncertainty and the rising interest rate environment. And the focus should be senior to junior loans for the U.S., U.K. And Australia, particularly if you are the core or value-added investors. If you're an opportunistic investor, distressed opportunity is going to happen in mainland China, as we mentioned earlier. The third is to target the best-quality asset globally. We do believe the best-quality asset could potentially be trading at a 5%-10% discount to its book value. However, look in the past: this buying window of opportunity has been relatively short; therefore do be prepared for this opportunity.
Julie Whelan:
Thank you for that investment strategy education, Henry, very valuable. So final question for all of you to answer in just a few seconds, we wanna leave the audience with optimism. So from a geographic and asset class frame, where are the opportunities, following what Henry said for investors today.
Henry Chin:
In Asia, send us everyone logistic and offices are the focus. I want to highlight offices because return to the office is so real in Asia Pacific, but we also are seeing increasing level of interest into new economies, such as the cold storage, data center, multifamily and life-sciences-related investments, because APAC is likely behind the U.S. And Europe. But we also start seeing clients to look at retail selectively because of attractive pricing and also reopening the borders. And we love shopping.
Darin Mellott:
In terms of inflation hedges, I think multifamily and industrial fundamentals are gonna keep those property types quite attractive. Again, speaking to strong fundamentals, I think there will be opportunities across property types in Sunbelt. But depending on the type of capital, I think there are gonna be some interesting opportunities in the next year perhaps even generational opportunities in the gateway markets amid less competition in the near term. Also I think it's worth mentioning current financial and economic conditions aside, when things change, there are always opportunities. And to that end there’s going to be opportunities to enhance value and frankly, the need to protect asset values as ESG criteria is further integrated into the investment landscape. And that's also worth keeping in mind, Julie.
Neil Blake:
Well, Julie, Europe's got the same secular favorites that a lot of other people have mentioned logistics in particular, also data centers, life sciences and things like that. A particular shout, I think for multifamily housing, I think as Jen's mentioned it's an emerging section from Europe and it's seen as a potential inflation hedge, basically doubly attractive, so they're ones to watch. In offices, there's quite a wide range of experience going on. Henry's mentioned the flight to quality. That's certainly part of it. Also in Europe, we've got impending ESG legislation and prime is seen as somewhat ESG-proof. That new build, they're usually fully certified. So that's nothing to worry about immediately for the investor. And add to that, we are actually looking forward to a pause in completions for a couple of years. A lot of projects were put on hold during the pandemic.
Neil Blake:
They've been further delayed cause of high construction costs, so that actually could help to maintain the demand-supply balance of the market. But don't forget prime comes at a cost. Cap rates might be going up. You can still argue that it's cheap, but for some investors so often it's quite expensive. And there's a whole lot of secondary offices out there as well to think about. Might be good reason, but for the well-located, I stress, the well-located secondary office, which is secondary cause it doesn't meet ESG standards. There's a value-add opportunity there. It needs CapEx, meaning without spending there’s gonna be a shortage of well-located offices sometime in the future. And when you've got that kind of challenge, there's always that possibility of mispricing. So I think some investors will be taking quite a lot of particular attention to that at the moment. So it's not all prime. Sometimes opportunities does where ESG creates as well as it destroys.
Julie Whelan:
Great. Well, thank you Darin, Henry and Neil for closing out our session today and showing us the route towards opportunity in this environment. And thanks to my colleagues for their education and insight and thanks to our audience for joining this call. We've learned that we have both reason to be cautious and optimistic as we finish the back half of 2022. As you navigate the remainder of this year and beyond, we welcome you to reach out to the CBRE professionals on this call to answer any questions you may have. We also welcome you to visit the cbre.com Research and Insights page to learn more about the topics we discussed today. Wishing you all health and wellness. Have a wonderful day.
