High interest rates, inflation and fears of a recession are increasing challenges for CRE companies seeking financing.
During the Construction Blueprint Series Economic Outlook webinar hosted by the Building Congress & Exchange, MacKenzie Capital President John Black and Vice President Brendan Harman discussed current financing conditions and the 2023 prospects for different market sectors.
“This is not like the last recession with respect to lack of liquidity in the marketplace. There is still money out there for good projects,” Black said. “But the rising interest rate environment is unprecedented, including the speed of the increases that have occurred over the last 12 months… Someone told me a long time ago that in real estate it is either fear or greed. We had greed for a long time in the low-interest-rate environment. It is going back to fear winning out over greed.”
“The rapid increase in the cost of capital has hit all types of funding up and down the capital stack,” Harman said. “That has given some developers pause because some projects don’t work [financially] anymore.”
The impact of those rate hikes was seen in late 2022, he said. Typically, the number of development deals and total transaction value experience a “tremendous increase” in the fourth quarter of the year. That big increase did not happen in Q4 2022.
“This was a softening due to interest rates that peaked in the third quarter,” Harman said. “People are trying to figure out how to make capitalization work for their projects. We think this softening is going to continue into 2023.”
As a result, firms like MacKenzie Capital are busy “slicing and dicing the capital stack” to make projects work, Black said. “With the first mortgage lenders getting scared, they still want to make loans…but on a conservative leverage basis.”
Smaller and lower risk projects are more likely to gain financing, and many projects “are using all and various sources to plug [capital stack] gaps whether it is C-PACE money,” additional mezzanine financing or other joint-venture, private equity partners, Black said.
The funding challenge, however, is not impacting all projects equally.
“I have not seen a market this disjointed – both on a capital and a property level – since the 1980s,” Black said.
According to MacKenzie’s analysis, grocery-anchored retail is one of the top performing assets currently. The hotel sector is “bifurcated” with very high-end hotels and resorts exceeding their pre-pandemic performance. The strong multi-family and industrial markets have begun to show signs of weakening. Office projects have become very difficult to finance, but developers are seeing strong markets for specialty products, including self-storage facilities, life science and laboratory spaces, and marinas.
Black and Harman predicted that two types of projects could become more attractive this year: redevelopments that add new value to existing assets and public-private partnerships.