Colorado-Real-Estate-Journal_384814

Page 4 — Multifamily Properties Quarterly — February 2024 www.crej.com MULTIFAMILY: INVESTORS We treat your asset like it’s our own. 720.236.1400 NewBusiness@AssetLiving.com From property preservation to cost savings, we’re determined to maximize NOI at every opportunity. T oday’s market is challenging for both buyers and sellers of commercial real estate assets. Over the last two years, we’ve seen an increas- ing bid-ask spread and declining valuations. Now, as the Federal Reserve signals interest rate cuts, some owners feel optimistic that their asset values and equity posi- tions should improve. After all, when debt was cheap, pricing was high, and thus we should theoreti- cally see a competitive buying envi- ronment once again. The truth, in fact, is that the ramifications of rate cuts extend beyond merely the cost of capital, and instead deserve a more comprehensive understanding of our local market dynamics. One of the prevailing challenges facing the real estate market since the beginning of the rate hikes in 2022 is the rising cost of capital. Transaction volume took a huge hit and we’re still experiencing the results. Now, with signals of rate cuts, optimism persists that capital should become more affordable and readily available. Instead, what we believe is that our forward-looking market already includes potential short-term rate cuts baked into our borrowing costs. Generally speak- ing, even more cuts than the Fed has signaled are already priced in. The outlier is a recession. This would likely result in rate cuts of a substantial size that would make a difference in the longer end of the curve and our five-, seven- and 10-year Treasuries. This would force the Fed to reevaluate its policy, which as of now is still beating inflation down to 2%-2.5%. It’s been multiple years since we’ve broken the 3% inflation floor, and with positive employ- ment numbers, inflation will remain the Fed’s priority and thus will probably keep rates restricted. A soft landing is where we’re headed (or being told), so, effective- ly, the cost of capital should remain mostly steady, with a conservative estimate of around 25 basis points plus or minus by year-end. We’re still digging out of negative leverage pricing, and although we’re close, we simply aren’t there yet. And while the cost of capital remains a cornerstone in determining prop- erty values, several other local fac- tors more recently contribute at a greater level. I’m referring to what we all already know – new apart- ment supply in 2024 and 2025, high- er vacancy, slowing rent growth, absurd operating costs, new legisla- tion and a general lack of depth in the buyer pools. It’s my opinion that these other factors will continue to weigh heavily on buyer underwrit- ing and will persist as an anchor to asset values, working in tandem with a steady cost of capital still significantly higher than we saw in 2020 and 2021. Rate cuts signal an expected cool- ing in economic growth. When we saw economic cooling in the early 1990s and late 2000s, we saw vacan- cy rates rise and asset prices fall. There is evidence to suggest that as we hover over our concerns, we’ll see similar impacts to our mar- ket. Economic cooling will result in greater impacts to net income preservation. The factors mentioned earlier, like supply and vacancy, working together with slowing rent growth, operating expenses, and costly legislation, will nega- tively impact net operating income growth. If we see NOI decline and current borrowing costs stay con- sistent, it’s a recipe for declining values. So while operators focus on preserving net income, values will continue to deteriorate. Those who have owned a long time or are experiencing positive growth and occupancy have the opportunity now to evaluate the risks of hold- ing longer. While our current buyer pools remain small, some groups remain with capital investment requirements and are capable of closing on deals with positive yield. It’s those properties, with successful operating histories, that are primed for monetization. On the operations side, amid these challenges, opportunities for strategic navigation present them- selves. Investors and property own- ers must adopt a disciplined and focused approach, recognizing the shifting dynamics and adapting Fed signaling rate cuts may result in value decline Kenny Clarke Associate adviser, Pinnacle Real Estate Advisors Please see Clarke, Page 22