Page 32 - September 21-October 4, 2022 Law & Accounting Assurance, tax, and consulting offered through Moss Adams LLP. Investment advisory services offered through Moss Adams Wealth Advisors LLC. Investment banking offered through Moss Adams Capital LLC. Here, the sun rises on fresh ideas and boundless potential. With an abundant spirit of optimism, openness, and enterprise—we help clients in the real estate industry grow, manage, and protect their prosperity. RISE WITH THE WEST. M O S S A DA M S .C OM / R E A L E S TAT E I NS I GHT R I S E S I N THE WE ST A s the overall real estate market has cooled fol- lowing the rise of inflation and interest rates, the Centennial State continues to show its worth. The volume of sales transactions in Colorado is on the rise across all sectors, with cap rates continu- ing to compress, driven by ongo- ing worker migration to the state and heavy demand for technol- ogy, life sciences and multifamily investment. Colorado’s real estate environ- ment runs in sharp contrast to the national picture, where we see an overall decrease in transac- tions and flatlining of cap rates. Real estate investors with plenty of capital to spend are pivoting their strategies in Colorado as the landscape changes; fund manag- ers with a focus on the state have an opportunity to capitalize on positive trends. n Dry powder aimed at Colo- rado. During the height of the real estate market in 2021, U.S. dry powder that was focused on real estate investment reached an all-time high of $217 billion, Preq- in data shows, a 22% jump from Dec. 31, 2019, which was imme- diately prior to the pandemic’s onset. Dry powder remained at $212 billion as of last month, sug- gesting that although fundrais- ing has slowed compared to the record pace in 2021, private capi- tal is still available and ready to be deployed. At the same time, investors are reevaluat- ing valuations and strate- gies as inter- est rate hikes and infla- tionary pres- sures point to a potential looming reces- sion. According to Preqin data released in July, fund managers based in Colorado closed $2.4 bil- lion in committed capital in 2021, compared with pre-pandemic levels of $915 million in 2019. This shift in investor capital focus to more risk-averse markets is underscored by Colorado’s 104% increase in closed and current fundraising of $4.8 billion so far this year. n Colorado continues to transact. It is no secret that Colorado’s recent investment landscape has seen tremendous growth, marked by rising valu- ations and competitive buying situations in all sectors following the large migration to the state of almost 900,000 residents, a 17% increase, between 2011 and July 2021, according to U.S. Census Bureau estimates. Fund manag- ers were challenged with identi- fying deals that met their targeted returns at compressed cap rates across various sectors. A sharp halt on transactions nationally began earlier this year, when the Federal Reservebegan itsplanned action to increase lending rates throughout 2022 and into early 2023. We continued to hear fund managers say they were hold- ing assets off the market to see howpricingwas affected by these policy moves, and that they were slower to the negotiating table due to challenges tied to obtain- ing financing. Although Colorado transac- tions followed this same trend, the state quickly recovered in the second quarter, showing a 14% increase in deal volume that har- kened back to the historic levels of 2021. We anticipate deal activ- ity to remain strong through the end of the year based on deals under contract, a trend that defies the national decrease in transac- tion volume of 4% in the same period. n Cap rate uncertainty. The cap rate (first-year net operat- ing income divided by property price) is a popular measure of valuation in the real estate market and has an inverse relationship to the price paid for a given invest- ment property. Cap rates enjoyed a stable downward trajectory nationally in the years leading up to the pandemic in all real estate sectors. According to CoStar data, from the first quarter of 2017 through the first quarter of 2020, cap rates in all sectors steadily decreased by an average of 3%. In 2021, after the initial uncer- tainty of the COVID-19 pandem- ic eased, transaction volume hit record levels at valuations that far surpassed historic returns. The pandemic then induced a frenzy of transaction activity, resulting in significant acceleration of the drop in cap rates in a condensed period. In early 2022, uncertainty around cap rate trends was at the forefront of discussions. Would the increases in inflation and interest rates and concerns of recession cause valuations to plummet? According to CoStar data, through the second quarter, cap rates in Colorado continue to decline or track with pre-pan- demic levels across asset classes. Multifamily continues to reach unprecedented rates, and the office sector shows strong returns due to increased demand for space in the tech, medical office and life sciences industries. In Colorado, conversion of traditional office space is largely factoring into the cap rate com- pression, compared to national rates which are responding to the lag in returning to office work. Industrial developments have been a main focus in the state over the past two years, pushing cap rates down. However, supply has started to cover demand in this sector, resulting in unstable returns. Retail has also leveled off in 2022. The more recent modest slowdowns in cap rate decline and transaction volume repre- sent a return to more normalized activity within the real estate eco- system. n Takeaway. Colorado has shown its resilience as a lead- ing market, while the overall real estatemarket begins tonormalize. Rising valuations and increased competition will continue to challenge fund managers to find deals to achieve investment goals. Colorado-based managers have the opportunity to showcase their local presence in the market and strategically deploy the capital inflows. In addition, modest cap rate increases in certain sectors will not signal another slowdown in real estate transaction activity, but rather a slowdown in the speed of the market, allowing more thorough due diligence in this environment. Investors can take comfort that rising cap rates still denote an accretion of value, just not the sky-high and unsustain- able run-up of the last two years, while still seeing above-average returns in specific sectors. s Colo. CRE market remains strong, defying national trends Lauren Gerdes Real estate senior analyst, RSM US LLP