Matias Recchia is Co-Founder and CEO of Keyway, the commercial real estate technology platform designed for small and medium businesses.
The ever-changing landscape of the real estate market has experienced significant shifts in recent months, with higher borrowing costs and wide bid-ask spreads leading to a temporary pause in bustling commercial real estate investment activity. However, despite the macroeconomic backdrop, shrewd institutional investors with stable capital can seize once-in-a-decade deals, particularly in small-scale commercial real estate
The Multifamily Opportunity
As an example, let’s examine multifamily demand in Dallas, Texas. For the past two years, multifamily sales in Dallas have led the nation with $44 billion in total sales, pointing to the burgeoning demand for multifamily housing to accommodate the region’s strong job growth.
The strength of the residential real estate market, which continues to display relative resilience, has benefited from persistent demand tailwinds and limited supply, which has continued to drive steady annual price appreciation. While the typical U.S. home value fell slightly from December to January (hovering at $329,542), U.S. home values are still 6.2% higher than a year ago.
Housing availability—and affordability—remain an issue. At the 2023 International Builders’ Show, housing economists blamed high construction costs, a sluggish economy and surging mortgage rates for triggering recent dips in new home sales and construction. According to the National Association of Home Builders, more than 18 million households were priced out of the market in 2022 as interest rates rose steadily from 3% to 7%.
Compounding these dynamics are existing homeowners who secured their mortgage two to three years ago when rates were low. Throughout 2020 and 2021, $5.5 trillion (registration required) in mortgages were refinanced. I’m seeing homeowners who borrowed at these relatively lower rates are disinclined to sell now, as refinancing would equate to a significantly more expensive new loan.
I believe these macroeconomic dynamics create a strong foundation for the multifamily sector, where those who continue to be priced out of home ownership, combined with a burgeoning population of young adults forming households, are bolstering the demand for rental housing.
Small-scale Commercial Real Estate: Looming Debt Maturities
Small-scale commercial real estate, particularly in multifamily, represents an attractive investment opportunity that I’ve noticed has largely been ignored by institutional investors. How can investors access this sub-sector?
First, with difficult-to-access asset information, technology is essential to aggregate data and centralize information to make better investment decisions. From sourcing and underwriting to transacting and managing, technology can streamline the investment process. For example, my company, Keyway, is using AI and machine learning to make deals faster, smoother and more efficient for commercial real estate stakeholders. It is my belief that real estate investors who lead with technology will have a competitive advantage in building and scaling commercial real estate portfolios.
Second, there are also concerns about looming debt maturities and the prospect of tighter lending across the commercial real estate spectrum. Many small-scale commercial real estate owners will need to refinance debt in the coming year, which could lead to financial pressure on their balance sheet and potential asset sales. However, I find that this event-driven dislocation could create a buying opportunity for investors with stable capital as these property owners may be forced to sell their assets at a discount.
Cap rates rose in the second half of 2022, and additional increases are expected in 2023. I believe investment activity will likely be more modest in the first half of the year, before accelerating in the second half. This presents an alluring opportunity to snap up these properties at discounted prices and position for long-term gains.
Will there be a “blood in the water” scenario akin to the Great Recession? I think not. However, the rate caps that expire will create an impetus for some owners to sell, and lack of demand will create some great deals across multiple sectors.
How To Choose The Right Deal
Real estate investment means making predictions about what will happen with cap rates, demand and other factors. Shrewd investing also means making concrete decisions with imperfect information. Case in point, the future of interest rates remains one major unknown. Whether the Fed decides to keep cutting rates or hold and hope for a slowdown in the job market, I find what’s clear is that conviction-driven investors will continue to generate returns in markets with strong fundamentals.
This is one area in which job and population growth is a key metric to keep an eye on, especially in emerging markets like the Sun Belt. While interest rates may cause some deals to look less favorable, there are still opportunities for investors despite elevated borrowing costs.
If investors focus on core fundamentals and identify profitable acquisitions in asset classes like small multifamily in regions buoyed by job and population growth, then opportunities are readily available despite current macro headwinds.
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