As rising interest rates and economic volatility have stifled buying power for investors over the last six months, commercial real estate sellers often have found themselves somewhat of a standoff with potential purchasers.
Who will make the first move in adjusting expectations?
For the brokers sitting in on those negotiations daily, it comes down to serving both sides a dose of reality about market conditions. And that isn't accessible medicine for buyers or sellers to swallow right now.
"The reality is, sellers still want 2021 pricing, but buyers just can't step up to that number," Joe Powers, regional manager of Marcus & Millichap's Chicago downtown office, told Bisnow.
The bid-ask spread between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept proved to be a challenge in 2022 and continues to be one into 2023.
"It's become more important now, I think, than in recent years because, for a while there, you could throw a number out there, and someone would grab it, whereas now, real information is dictating the market," Powers said.
In office space especially, the bid-ask divide has become particularly wide, reaching a spread of about 30%-40% as of November and December 2022, according to Wei Luo, global associate research director at CBRE Investment Management. Before the pandemic, the bid-ask spread hovered around 10%-20% for offices.
"It's common for a spread between the bid and asks. That's why we need brokers," Luo told Bisnow. "It's not uncommon, but I would say once the gap reaches beyond 30%, that's when the sector has a problem. That's when activity will be coming to a standstill. ... When people go to a negotiation, they're not expecting to cut 20% off their price."
In its 2023 Trends to Watch in Real Assets report, MSCI estimated that London office prices would need to fall 29.3% from October 2022 levels, and New York offices would need to drop 10.4% to bridge the gap between what sellers want and buyers are willing to pay, Bisnow reported.
Meanwhile, CBRE predicts another 5%-7% decrease in investment values in 2023, coming off a 10%-15% decline across the first three quarters of 2022.
"As the market has become more difficult the last four to six months, people have struggled with, from a sell side, how tough do I become, and from a buy side, how much am I willing to move up?" Steven Weinstock, regional manager of Marcus & Millichap's Oak Brook office, told Bisnow. "The sellers have been unwilling to move because 'I still own the real estate, so why am I going to make the first move? Nothing is causing me to make the first move.'"
In the case of office buildings, the spread is starkest when it comes to the differences between modern Class-A buildings and older buildings.
"When more modernized offices have become available, I think that's when you start to see that spread because investors now realize the bifurcation has begun, so you have two different assets — one that's kind of future-proof, one that's going to be obsolete at some time in the future," Luo said.
Office buildings that might have been built in the 1980s or '90s and weren't well maintained are bearing the brunt of the hit to their values, mainly as the pandemic brought into question the future of the office, Luo said.
However, new developments built with environmental, social, and governance principles in mind and modern amenities have seen demand outpace supply even in a downturn as investors participate in a flight to quality, she added.
"For any owners that are trying to sell right now, their goal is to get liquidity," Luo said. "They want to sell the office asset they own to get capital, to get cash so that they can recycle the capital into better-performing assets. But for the buyer who's in the market trying to buy an office, they want to buy low and sell high. They're looking for discounts when the owners are looking for capital."
Because both sides have misaligned goals and differing price expectations, Luo said, "it's tough to bridge when you're in such a tightened credit condition."
Luo said that retail, industrial and residential properties face price adjustments based on higher borrowing costs, but the bid-ask gap is relatively small compared to the office.
If interest rates stabilize, that will help close the gap, but office owners, in particular, will need to take some write-downs, which she said they have already started doing,
"Many office investors in the industry have started to do that because that's the reality. We can't bury our heads in the sand," Luo said.
The brokers at Marcus & Millichap have found that widening the pool of potential buyers has helped sellers become more realistic and get a sense of fair market value for their assets. Marcus & Millichap aims to bring at least five offers to the seller.
"The bid-ask gap has become a 'who's going to blink first?'" Weinstock said. "Sellers have started blinking. They started saying, 'I got enough offers. I have enough interest. I know what the market pricing is. Even though I wanted more, if I want to transact, I've got to take the market price.'"
The real estate brokerage has opened up its property listings to all of its 2,000 brokers across North America and taken a collaborative approach across markets — something Weinstock said has been a rarity in his 34 years in the industry.
"It works if you take a property and bring it to market, expose it to the most people, and create competition," Weinstock said.
Of the firm's 2022 Chicago transactions, about 66% were from out-of-state investors, Powers said. The typical average of out-of-state transactions falls around 45%.
"In 2001, money didn't go across state lines. You stayed local," Weinstock said. "In 2023, you're not concerned where the property is anymore, so it's become very robust."
Marcus & Millichap train its brokers to work with the buyer and seller to understand how each is coming to its pricing.
"It's a lot of coaching," Powers said. "It's a lot of conversations that are harder than others because you have a seller that has a number that they need or want, but sometimes that isn't necessarily achievable. So, our job is to bring them to market.
"There are two reasons why a property doesn't sell. It's either exposure or pricing, and if we've been able to generate multiple offers from qualified buyers, the market has spoken, and it's a function of pricing."
During this time of economic turbulence, WHe said Weinstock encourages sellers to sit down with their financial advisers to discuss their options, which aren't just to sell or own anymore; they can also decide to hang onto their assets and make improvements or to refinance and use the additional capital for other investments.
Industry players told Bisnow they see the gap narrowing by year's end.
"We always come out of it, and statistically, mathematically, the succeeding 12 months after whatever economic uncertainty there is have always produced a significant gain for the commercial real estate market," Weinstock said. "All we have to do is help our clients during this turmoil, however long or short."
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