Hodes Weill's 2023 Market Commentary
Staying the Course
We are pleased to present our 13th Market Commentary since Hodes Weill’s formation in 2009. Our company was born shortly following the Global Financial Crisis (“GFC”), during the last period of significant dislocation in the global capital markets. As we prepare this Commentary, the global financial markets are again in transition and the path forward is opaque.
There’s a French saying, “plus ca change, plus la meme chose”, the more things change, the more they remain the same. At the start of this New Year, it is worth addressing the question: what is different about this market correction, and what can we learn from past cycles?
What is different? Well, this time around, real estate was not a root cause of the market volatility; rather, real estate has been part of the “collateral damage” of rapidly rising interest rates, increasing construction and labor costs and economic uncertainty. Property markets are generally in equilibrium, so unlike past cycles, over-supply and rampant development have not caused the decline. Second, balance sheets are overall much stronger — leverage limitations have done their job and the industry is far less levered than it was going into the GFC. It’s also important to note that given the pivot in sector allocations and preferences over the past ten-plus years, portfolios are in much better shape; increased sector allocations to “beds and sheds” have reduced risk overall by generating more current return, benefiting from end-user demand with lower capex, and easier-to-execute value-add strategies. And of course, we cannot underscore enough the impact of the first global pandemic in over 100 years. That has surely precipitated conditions that none of us have had to deal with in prior cycles. Pandemic-related change will continue to impact demand for all types of real estate assets for many years to come.
So, what’s the same this time around? Needless to say, low-cost debt precipitated an era of exuberance and, together with other government stimulus (e.g., pandemic relief), major economies were set to deliver a lot of “free growth.” This masked a changing market dynamic over the past several years. We acknowledged the potential impact of rising interest rates and cap rates on legacy portfolios and knew there wasn’t a wide margin for error if you’re buying at a 3 cap. Despite the risk of write-downs if rates returned to long-term historic levels, most managers and investors felt there was room to continue with what had been a winning formula for so long. When the music stopped and rates reversed in 2022, no one should have been surprised that well-considered strategies were less lucrative, and some no longer viable. Although there was strong end-user demand and NOI growth across many of the most sought-after asset classes, they couldn’t keep pace with rising costs and the inevitable mark-to-market. Many appear to have been surprised though, at least their liquidity and financing strategies demonstrated their expectations that rates would remain low forever.
It’s an over-simplification to say that this market correction is just another classic credit crunch since there are many other contributing factors. The lingering pandemic, global geo-political considerations — especially the war in Ukraine — along with the rising cost of energy and basic goods and services, have contributed to a volatile economic mix. Inflation used to be good for real estate, but it remains to be seen whether that old formula will prove true this time around. Rents will need to keep pace with inflation to support asset valuations. At the end of the day, the challenge facing the real estate and real asset market is managers’ ability to manage, refresh or entirely re-purpose assets to generate enough NOI growth.
As we gaze into the crystal ball to see what the year ahead holds for our industry, one thing is certain. Investors have enjoyed strong performance for the past several years and the vast majority are not abandoning the real estate and real asset sectors. Despite denominator issues and market uncertainty, we expect allocations to increase for many investors, and for real estate and real assets to attract significant inflows in the year ahead.
As in past years, we have asked our global team to share their observations on key developments and trends impacting real estate and real assets in their respective markets. We hope that you will find their insights of interest and helpful as you as navigate what are sure to be complicated investment and capital market conditions over the months ahead.
Read the complete 2023 Market Commentary below: