Capitalizing on Disruption – Market Update

Capitalizing on Disruption – Market Update

Aligning with market expectations, the Fed boosted the federal funds rate by 25pb to bring the federal funds rate to a range of 4.5% to 4.75%. The quarter-point hike represents continued tapering from larger increases after a year of more aggressive steps. However, more increases are ahead, with two additional 25bp hikes in March and May expected. Fewer might be needed if weak business confidence depresses hiring and investment, or more might be required if the economy reaccelerates.

The markets see inflation on a declining trajectory.

“Inflation data received over the past three months show a welcome reduction in the monthly pace of increases. And while recent developments are encouraging, we will need substantially more evidence to be confident that inflation is on a sustained downward path,” Fed Chairman Jerome Powell said.

But Fed officials continue to worry that core inflation remains stubbornly high and that upside risks to inflation continue.

The unpredictability of interest rates, inflation and economic performance has significantly slowed the commercial real estate transaction market. A recent survey conducted by Marcus & Millichap found the availability of financing remains a top concern among investors.

Interest rates are not only driving the price of debt it is also the driver of asset values.

Credit spreads have widened as lenders try to assess the impact of higher rates on the economy. With commercial mortgage rates elevated, lenders have lowered loan proceeds, required more equity and reduced the borrower’s leveraged returns to protect themselves further.

There is a tidal wave of loan maturities coming due this year; roughly $160 billion of commercial real estate debt maturing. With capital stacks already battling a less liquid market, rescue capital, mezzanine debt and preferred equity will be in high demand.

The Fed will likely settle with inflation above 2% but below 5%, meaning interest rates will remain elevated for an extended period, leading to many asset classes facing a more severe reset in cap rates and valuations. With the market in price discovery, sellers are less likely to come to market if they don’t think they will get their desired price, and buyers aren’t going to pay the same valuations as they would have in previous lower interest rate environments.

As the market adapts to these lending standards and the higher interest rate environment, transaction volume will improve as we progress through the year.

For hospitality, demand and secular trends bode well for long-term outperformance in this sector. Hospitality fundamentals remain strong, with demand rising above pre-pandemic levels and ADRs at record highs. And with slower GDP growth expected to lead to a potential recessionary period, industry analysts still expect hospitality to remain resilient.

Supporting this demand growth is also the need for more supply of hotel rooms in select markets, which continues to remain muted. Hotels are probably one of the most investable asset classes today, given their ability to reprice daily and efficiently manage around a higher inflationary environment and its historical trend of being less sensitive to interest rate movements as it relates to cap rates.

These factors are creating the perfect storm for Peachtree.  

Our lending operation generates equity-like returns through originations at lower leverage points without taking the last-dollar risk. We also anticipate transaction volume for acquiring hotels at opportunistic pricing to tick up as ownership groups grapple with higher debt service costs and limited capital available for debt maturities and capital improvement projects. In fact, we are already seeing motivated sellers come to market. In addition, with growing room demand and limited supply under construction, our hotel development program will remain active, with numerous groundbreakings and openings throughout the year. All of this translates into a very busy and productive year for Peachtree.