Ever since the Fed embarked on its tightening campaign starting in the early months of 2022, the real estate market experienced the most immediate impact due to rising mortgage rates negatively affecting home affordability.

Initially, publicly traded real estate stocks saw deep drawdowns while private real estate performed much better. Now, this gap is beginning to shrink as private real estate has been following public real estate lower. One factor is that it’s increasingly becoming clear that high rates are not going to disappear anytime soon due to the resilience of the economy and inflation. In fact, inflationary pressures seem to be reigniting given the recent strength in oil and auto workers striking.

In terms of when private real estate will bottom, some indicators to watch are an increase in transaction volume even at lower prices, a change in monetary policy, and increase in lending standards. Currently, all 3 are working against private real estate given that many markets are ‘frozen’ as sellers are unwilling to cut prices, while buyers don’t see many attractive deals at current yields. The Fed’s focus remains on stamping out inflation whether through further hikes or keeping rates ‘higher for longer’. Finally, lending standards are unlikely to loosen especially with so many banks struggling with balance sheet issues and/or an inverted yield curve. 

Finsum: Private real estate was immune to the weakness in public real estate for so long. Find out why this is starting to change.

REITs are in the midst of another leg lower and have effectively wiped out their gains from May and July with a 9% decline over the past six weeks. Year to date, the sector is down by 7% while it was up as much as 9% at its highest point in the year as measured by the Vanguard Real Estate ETF. This follows even steeper, double-digit losses in 2022.

In recent months, the weakness of the long-end of the Treasury curve has hit all types of yield-generating assets like REITs and dividend-paying stocks. Fed fund futures markets are downgrading the chances of rate cuts in 2024 while extending the duration that rates will remain at these levels. There is even increased chatter about how the Fed’s terminal rate must even go higher in order to truly stamp out inflation.

It’s a double-edged sword for REITs as the bulk of the sector continues to deliver impressive financial results with defaults remaining low especially in areas with strong fundamentals like healthcare and industrials. Yet, the stocks are unlikely to rally as long as rates remain elevated at these levels even despite attractive yields.

Finsum: REITs are in the midst of another leg lower and falling to new annual lows due to an uptick in inflationary pressures and the Fed coming out more hawkish than expected.

One of the consequences of tighter monetary policy is to curtail housing demand by squeezing affordability. As a result, all sorts of housing activity has cooled such as mortgage applications, new home construction, renovations, and house flipping. While there are all sorts of losers, it’s presenting an opportunity for many private real estate funds who are finding a buyer’s market.

 These funds raise money with multi year holding periods so are less affected by the change in the funding environment at least in the short and intermediate-term. Another factor in the real estate market is that many regional banks are pulling back from extending credit given their balance sheet concerns. Overall, it’s a risk for the broader economic outlook but a unique opportunity for private real estate investors.   

And, more money is being allocated to real estate - public and private. In the first-half of the year, 43% of institutions surveyed, increased their allocation to real estate by an average of 76 basis points. Sovereign wealth funds also increased real estate exposure from 6.9% to 7.9%. In terms of geography, private real estate continues to be dominated by North American investors.