A new year and shifting markets – how will investors and property owners fair in 2023? Let’s take a look.
Let’s start by agreeing that no one has a crystal ball that will tell them exactly what will happen in 2023. That said, we can make a few educated guesses based on historical trends and current market conditions. So, here is our outlook for the year and what it means for investors looking to buy, sell, or refinance this year.
- Financial markets and experts expect the Fed to raise rates by 50 basis points to 4.75% – 5.0% over the first quarter, followed by a return to the current 4.25% – 4.50% by the end of the year.
What does this mean for markets? The slowing of rate hikes and the possibility of a stabilized, or an even lower rate, by year’s end will help moderate interest rates. During the first half of the year, interest rates will remain elevated compared to the last several years before gradually dropping towards the latter half of the year.
Interest rates will be a consideration for investors looking to place debt, whether for an acquisition or as a refinance. There will be opportunities to secure favorable financing, but the borrower will need to know which lenders offer the best terms on which property types and asset classes in each market.
- Inflation should continue to abate, with experts projecting the consumer price index (CPI) to drop to approximately 3.5% to 4.5% by mid-year. It is unlikely that we will see the Fed’s target of 2% inflation this year, but if inflation does drop to around 4.5%, it would be half of the 9.1% high seen in June of 2022.
For investors, the decline in inflation would be good news. As inflation decreases, the Fed should be able to drop the Federal Funds Rate, which will loosen capital and stimulate lending. As markets stabilize, we expect to see more capital entering markets in the latter half of the year, but investors shouldn’t expect the sky to open and cash to rain down like manna from heaven.
- Negative leverage loans occur when entry capitalization rates are lower than interest rates. Last year saw the highest number of negative leverage loan originations since before the Great Recession. This trend will likely continue since capitalization rates are still compressed, and mortgage rates will remain elevated for the near term.
What does negative leverage mean to investors – it depends on your model. Negative leverage is not an issue for groups that purchase all cash or with extremely low leverage. On the other hand, the typical syndication model is at a distinct disadvantage in a negative leverage environment. In most cases, syndicators will need to hunt for distressed properties and properties that offer a significant value add opportunity.
- Downward pressure on asset valuations will continue in 2023. In Q3 and Q4 of 2022, there was an increase in repricing as many lenders began increasing interest rates on properties that had not rate locked, which forced buyers to request price reductions from owners. In some cases, sellers were willing to drop their prices; in others, they were not.
How is this affecting markets? With less capital available to buyers, they have to adjust their offer prices. We are seeing valuations down about 15% overall, but this is not the case across all asset types and locations. Cap rates are beginning to decompress, and both buyers and sellers are adjusting their expectations. Additionally, depending on asset class and location, there could be an additional 5% to 10% reduction in valuations before pricing stabilizes.
- Last but not least – many experts are forecasting a mild to moderate recession for 2023, which could last into 2024. Market fundamentals are much stronger, and the economy is far more stable than in the lead-up to the last financial crisis. So, while a recession does seem likely, it is doubtful that it will be as bad as long as the Great Recession.
What would a recession mean for the markets – it depends. A mild recession will likely bring more of what we are already seeing – slowing rent growth, lower property valuations, and a greater potential for some properties to become distressed. A deeper and longer recession will obviously have a profound impact on the markets, but this is not expected to be the case – for now, at least.
All of these factors, when taken together, do not paint a great picture, but don’t be dismayed – there are always opportunities in every market.
Let’s start with buyers.
Purchasing all cash or with extremely low leverage will negate the biggest impact of higher interest rates. If you can buy with all cash or low leverage, you can execute a value-add plan while waiting for more favorable lending rates. This may reduce the number of deals that can be done in the short term, but you will continue to build your portfolio while others sit on the sidelines. Then, when rates drop, you will have more equity to pull out of your properties.
Those not positioned to purchase all cash will need to look for distressed or underperforming properties that can be purchased at a discount. These buyers will likely find heavy competition for distressed properties, so they will need to act fast once they are located.
What about owners?
The good news for owners is that for now, at least, the market still favors the seller. Rental rates are projected to continue to climb over the next year, inventory is limited, and construction starts are down. So, a well-maintained and properly marketed property should get multiple offers.
Owners need to understand that the markets have shifted, which means properties are not commanding the same prices they were in early 2022. The best properties in the best markets will still command a price premium, but simply throwing up a for-sale sign will no longer guarantee a quick sale.
Some owners will have debt maturing in 2023 that need to refinance their assets. One option is to secure financing with an interest-only period. An owner making principal and interest payments may find that their payments are lower during the interest-only period. Depending on the equity in the property, it may even be possible to do a cash-out refinance.
There is opportunity in all markets for the diligent investor, and 2023 will be no different. As the markets shift, new opportunities will present themselves. Let’s work together to make this a great year. Sweetwater Capital offers Investment Sales, Mortgage Brokerage, and Property Management services. Reach out to one of our skilled brokers to discuss your investment needs.
