CrowdStreet on the Impact of Inflation.
Inflation is hitting multi-decade highs, and the US Federal Reserve is raising interest rates rapidly in a rear guard action aimed at taming what is effectively a hidden tax. While the administration claimed for many months that rising prices were “transitory,” nothing can be further from the truth. Real wages have been declining after a few years of the middle class experiencing a rapid rise in real income. Later this week, Q2 GDP numbers will be released, and the White House is already preparing for the worst by attempting to alter the narrative by adjusting the definition of a recession. Soon, the Fed will raise interest rates once again with expectations of a 75 basis point increase a foregone conclusion.
Real estate markets have experienced several years of heightened demand due to historically low-interest rates and a shift to low-cost, business-friendly states as virtual offices became commonplace. In recent weeks though, mortgage rates have started to bite, and the housing market, even in the hottest markets, is starting to slow.
Recently Crowdfund Insider connected with Tore Steen, CEO and founder of CrowdStreet, a commercial property investment platform. CrowdStreet offers retail investors the opportunity to invest in both single properties as well as funds. Both residential as well as commercial property offerings. CrowdStreet claims the title of the “nation’s largest online private equity real estate investing platform.” While individual returns have a wide range, overall, CrowdStreet reports an annualized IRR of 19%. So in light of the challenging economic environment and fears of inevitable recession, CI chatted with Steen to gain insight on what he and CrowdStreet expect in the real estate sector in the coming months. Our conversation is shared below.
How are rising interest rates impacting real estate markets?
Tore Steen: As interest rates have risen over the course of this year, real estate markets have begun adjusting to the increased costs of borrowing through minor price adjustments.
As of July 7, Greenstreet’s Commercial Property Price Index, which tracks pricing across all asset classes, is now down 4.9% from its high in March. The deal flow we are seeing is also reflecting price reductions of 3 – 10% relative to last year. It’s important to note that a portion of the price reductions we are seeing are attributable to a rising rate environment, while a portion is attributable to a softer economic outlook over the next two years relative to last year.
With that said, generally speaking, a moderately rising interest rate environment can be good for the CRE industry. Last year’s market dynamic of near-zero interest rates, combined with the amount of liquidity injected into the economy, drove an unsustainable pace of price appreciation in 2021. That was beneficial for investors, but from our vantage point, the CRE market is better served over the next few years if interest rates stabilize around levels consistent with the latter part of the previous cycle.
How is this impacting CrowdStreet?
Tore Steen: With rates getting higher, we’re paying extra attention to the debt service coverage on potential deals and ensuring the project is modeled correctly before it comes to our Marketplace. Absent attractive price reductions, target returns are also compressing due to money being more expensive and margins thinning, so the Investments team is constantly asking, “What are the chances this could default?” and “Is this deal correctly priced in the current environment?” Obviously, no one can guarantee anything, but we want to protect the quality of our deal flow by always evaluating downside scenarios.
In a challenging economy, where do you see value?
Tore Steen: It’s all on a deal-by-deal, market-by-market basis. But it’s important to remember that real estate doesn’t operate in weeks or months–it’s calculated in years. A lot of deals will go full cycle well after the current conditions shake out, so it’s important to think in the long term. In the current environment, we still see value in the multifamily sector, provided that going in pricing is appropriately marked to market, and we are beginning to see office properties trade at prices that look attractive from a risk-adjusted basis. In our opinion, office is the sector with the greatest amount of uncertainty and the greatest amount of headline risk, which means that certain opportunities can be inefficiently priced.
Certain markets have boomed. Do you see a bubble anywhere?
Tore Steen: From our perspective, the events of 2022 have mitigated the risk of a real estate bubble. Had the rapid appreciation and massive cap rate compression of 2021 continued for another one to two years, then we would have characterized the greater market as being in a bubble.
In a current market environment that is seeing an expansion in cap rates and, correspondingly, a reduction in prices, we now believe the overall market is “recalibrating” to normalization. While the remainder of 2022 may likely be choppy, overall, we feel that the market is regressing toward its positive trend. At this point in time, we do not view any asset class as currently in a bubble.
How has the work from home / virtual office trend impacted commercial real estate markets?
Tore Steen: The office as we knew it still has an uncertain future. Office utilization rates (the number of people who actually go into an office on a daily basis) remain relatively flat year-over-year so, at least in the short term, working from home is still creating a drag on the office market. In addition, work-from-home and hybrid office models are still being formulated. How many days a week will employers expect their teams to be in the office? How many employees are actually willing to go back? And what kind of office are you going back to if and when you do? In the short term, unanswered questions are still mostly kicking the can down the road on office leasing, and a softening economy has only added to that trend. We believe more clarity will come to the office market but likely not until we get through the current macro instability. 2023 should provide more answers.
Are you planning any new offerings or potentially entering new verticals in the coming months?
Tore Steen: We have new deals launching every week in a variety of property types–multifamily, industrial and life sciences are some of the most popular among our investor community. We keep our finger on the pulse of the commercial real estate market and constantly seek deals that we believe capture the best opportunity in the market.
You offer funds for immediate diversification. How have these been performing?
Tore Steen: We’ve raised over $300 million across all our real estate funds in a variety of strategies–e-commerce, build-to-rent, opportunity zone, opportunistic and more. This year alone, our Fund portfolio team has invested over $100MM across dozens of deals on behalf of those investors.
What are your expectations for market performance for the rest of 2022? 2023?
Tore Steen: We’re wondering what kind of opportunistic deals will be shaken loose by the end of the year. In a market where asset values are currently declining, we view the second half of 2022 as a great period to acquire deals in scenarios where the pendulum has swung too far in the direction of a pessimistic outlook and leverage that situation to obtain a compelling going in basis. Deals that need to get refinanced could provide unique opportunities for our investors.