Market Summary
As we entered 4Q 2022, there had been some hope that the gears of the market would loosen and buyers, sellers, and financing providers would be able to find levels to transact. Given the continued economic uncertainty and growing confidence of a recession in 2023, that hope did not come to fruition and overall activity in 4Q 2022 was anemic. The bulk of the transactions that took place were refinancings of maturing loans or acquisitions with fixed-rate loan assumptions. We also saw increased activity in secondary loan sales but the bid-ask spread was generally wide, which limited transaction volume. We believe that peak inflation is behind us but the Fed will continue to seek evidence that their actions are creating the desired results. The Fed has been direct that they will likely hike rates higher than projected three months ago and expect rates to be higher for longer. There is a lot of cash sitting on the sidelines, earmarked to be deployed into real estate. Investors are looking for signs of stability in the capital markets. However, the Fed’s actions have and will continue to have material impacts on the CRE market.
There has been a lot of talk around distress and we touched on this in the 3Q 2022 commentary. We continue to see little in the way of broad distress across markets and property types. There are certainly lenders that are pursuing remedies and owners seeking capital to meet debt service payments, cover budget shortfalls, and fund interest rate cap replacements. Given the muted capital markets activity and limited buyer pools, lenders are working with borrowers to seek solutions rather than foreclosing and taking ownership of the property. We expect the volume of these situations to increase in the first half of 2023 but we do not foresee a scenario like what was witnessed in the GFC.
With that said, the office market continues to be incredibly challenged. Lenders are wary of any exposure and traditional investors, including ones who seek distress, continue to avoid the subsector. We realize that we are speaking in generalities. Newer vintage, class A office properties in key markets with strong tenant rosters continue to be in-demand and easily financeable. It is everything else that does not meet that criteria that is orphaned. To highlight, we currently have no office exposure in the REIT.
The first signs of slowing rent growth and increased concessions were visible among multi-family assets. While we realize that each market has unique dynamics, there are trends that apply across the board. The days of 20%-30% annual rent growth are in the rearview and those markets that had the largest spikes in rents (markets like Tampa, Orlando, Phoenix, Miami) have seen the largest drawdown. However, the rising rate environment continues to present challenges for the ability of renters to convert to homeowners. These tailwinds are expected to persist through 2023, providing support to the broader multi-family asset class.
Update
The property maintained average occupancy of ~89% in 3Q 2022. The decrease in occupancy this quarter was seen market wide with some residents choosing to move out of the state, causing the larger submarket renter base to shrink. The property continues to maintain occupancy levels in-line with its market competitors. The Sponsor continues to increase rent at the property through renovation premiums and organic market growth. The Sponsor completed 4 unit renovations in the third quarter with the units achieving rent premiums of $475 per unit, which is 90% above the anticipated premium of $250 per unit. The Sponsor anticipates increasing the renovation pace in the coming months and having ~30 units renovated by year end. Based on 2022 YTD performance, net operating income was in line with underwritten projections at close.
The property maintained average occupancy of 96% in 3Q 2022, which is ahead of market competitors, which averaged ~93%. The Sponsor increased net rental income at the property by ~8% between 2Q 2022 and 3Q 2022. The pace of unit lease-up was slower than expected due to new supply in the market, resulting in 2022 YTD net operating income being ~15% below projections. Given the property is now fully stabilized, the Sponsor expects actual performance to catch up with projections over the life of the investment with no impact to overall investment returns.
The property maintained average occupancy of ~94% in 3Q 2022. The Sponsor increased in-place rents ~6% compared to 2Q 2022, which are above rent projections at the time of closing. The Sponsor completed interior renovations on 13 units in the second quarter, bringing the total number of renovated units to 20. The renovated units have achieved an average rent premium of $293 per unit vs. the budgeted $157 per unit. The Sponsor intends to increase the pace of the renovation program moving forward, which will continue to drive rising rents. Based on 2022 YTD performance, net operating income was ~3% above underwritten projections.
Outlook
For the first half of 2023, we intend to seek new investments in the higher-yielding debt space that have equity capital behind us and monthly coupon payments. Multifamily and industrial continue to be the favored asset classes amongst institutional investors and we believe in the long term outlook for both.
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