Appraisal Values Finding a Bottom

Real estate marked its sixth consecutive quarter of negative returns at the beginning of 2024.^[1] However, prices picked up slightly in transactions markets.^[2] The disconnect is not unusual: Historically, appraisals have lagged market fluctuations.^[3] The question is: Have they now reached a bottom?

Valuation metrics suggest that they are getting close, in our view. Historically, long-term BAA corporate bond yields of 6% are consistent with cap rates in the high-5% range (see Exhibit). Appraisal cap rates were well below that in the first quarter, at 4.7%.^[1] However, after four years of strong rent growth, there is an extraordinary gap (18%) between in-place and market rents, primarily in the industrial sector, but also, to a lesser degree, in other sectors.^[4] On a mark-to-market basis, appraisal cap rates (5.5%) arguably have a bit further to rise — and values to fall — to reconcile to today’s interest rates, but not much.^[5] In our view, the adjustment will be complete in short order, likely in the second quarter of 2024.

Sources: Moody’s (BAA); NCREIF (cap rate); Altus (mark-to-market); DWS (calculations). As of March 2024.

Importantly, interest rates do not need to fall to allow for a real estate recovery. Following the valuation reset, elevated cap rates may reward investors with stronger income returns and buoy rental growth by squeezing the supply pipeline. Of course, another interest-rate spike would upend the market once again, but with inflation easing, we believe this is unlikely.^[6] In our view, the recent firming in market prices augurs well for a return to positive returns in the second half of the year.

Additional Resources

Embracing the New Normal in the U.S. Office Sector

The office sector is going through a period of change intensified by COVID-19 lockdowns.

U.S. Real Estate: Risk or Opportunity?

Doomsday headlines may persist, but do not be fooled: The outlook for real estate is getting brighter.

^1. NCREIF. As of March 2024.

^2. GSA. As of April 2024.

^3. NCREIF (valuations); GSA (prices); DWS (calculations). As of March 2024.

^4. Altus. As of March 2024.

^5. DWS. As of March 2024.

^6. Bureau of Economic Analysis. As of March 2024.

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