As the Federal Reserve continues its rate hikes to curb inflation, the capital markets have responded with overwhelming caution until there is clarity on when the Fed will stop and where interest rates are likely to settle. Several questions compound this uncertainty, including volatility in the stock market, geopolitical risk, decelerating rent growth, falling home prices, and cap rate inflation. Lenders and investors alike are taking an observant pause to avoid “catching a falling knife,” while using this time to raise funds for what they believe will be impending distress in the commercial real estate market, much like they did in 2020 after the onset of the pandemic. In 2020, the capital providers that took the risk to lend or invest tended to come out on top, while much of the market missed the opportunity, due to an abundance of caution.

A recent client survey conducted by Marcus & Millichap concluded that the availability of financing is a top concern among investors for 2023. While no one has a crystal ball, this report will discuss some of the potential trends that the capital markets may have in store for the coming year. These eight prognostications are based on a few key assumptions, including that the Fed eases up a bit on its pace of rate hikes, the economy weakens modestly — but doesn’t plummet — and there are no other unexpected black swan events or catastrophes.

Expect higher leverage options to remain less available — particularly for construction loans, renovation loans, and other highly transitional business plans. This is due, in part, to constraints in debt service coverage ratios that are trumping debt yield and loan-to-value limits for the first time in recent history. As interest rates rise, leverage will reduce further, leading to a necessity for price decreases to hit target yields. All cash buyers, or buyers who can take a lower leverage level of “negative leverage,” will be able to acquire assets at lower price points, as they will not be held hostage to the current capital markets environment.

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Fed Funds Rate (midpoint), Treasuries, Bank Prime Rate and CRE Cap Rate as of Nov. 30, 2022, 30-Year Fixed Rate Residential Mortgage as of Nov. 23, 2022; Table average for 1977-2019 Average cap rate for apartment, retail, office and industrial sales $1 million and greater Sources: Marcus & Millichap Research Services; CoStar Group, Inc; Federal Reserve; Real Capital Analytics