What’s Keeping CRE Capital Sidelined? Several Things

“Capital is on the sidelines” seems to be the ever-repeating mantra for commercial real estate. Putting a dollar figure on this, a recent estimate by Preqin said that approximately $200 billion is ready to deploy into CRE assets. But John Chang, Marcus & Millichap’s senior vice president, national director research and advisory services, indicated that this amount is only a drop in the bucket.

“It doesn’t completely factor in private capital,” Chang said in Marcus & Millichap’s recently released video, “What’s Holding Sidelined Capital Back?” Private investors, historically, make up about 40% to 45% of the total real estate investment dollar, he explained. This brings the amount of sidelined capital to about $300 billion. Furthermore, “if that capital is levered up with a 60% loan to value, that would be about $750 billion of commercial real estate sales volume,” Chang explained.

Changes Among the Sellers

So why is all that money on the sidelines rather than buying real estate? A couple of reasons, one of which Chang dubbed the “expectation gap.” “Sellers are still in the process of recalibrating their pricing expectations from where the market was in 2021 and 2022,” he explained.

The second reason? Sellers aren’t motivated to, well, sell.

“In 2021, it wasn’t unheard of for buyers to make big offers in the highly competitive market,” Chang said. Sellers took many of those buyers up on those offers. But those large offers aren’t forthcoming today. “Seller motivation is basically back to normal,” Chang said. “Property owners need a reason to sell their commercial real estate.”

Buyer Reluctance to . . . Buy

On the other side, Chang pointed out that buyers are holding back. “Investors have told me the same thing, over and over again,” he said. “’Prices are too high. Cap rates are too low.’ Or they (buyers) are simply not willing to buy a property with negative leverage.”

But Chang doesn’t buy any of this. “If you knew a property’s rent was going to surge by 20% next year, you’d probably buy it, even if the cap rate today is 50 or 75 basis points below the prevailing mortgage rates,” he commented. Furthermore, if potential buyers understood that mortgage rates could drop by 100 basis points in 2024, “you’d probably buy as much property as you could get,” Chang said. “You could refinance when the rates go down.”

And while it’s anyone’s guess what the Federal Reserve will do to the Effective Federal Funds Rate, Chang pointed out that most of the Federal Open Market Committee voting members noted that the overnight rate at the end of 2024 could be 25 to 100 basis points below where it will be at the end of 2023.

In addition, reluctant buyers aren’t focusing enough attention on creating value. “Creating value in property is a cornerstone of commercial real estate investing,” Chang pointed out. “Investors who can look at a property and find potential upside opportunities are the ones doing deals today, and they’re the ones who are getting the jump on the market.”