The uncertainty caused by higher interest rates and a higher cost of capital has had a marked impact on property investment. Q2 2023 was the third successive quarter during which global deal volumes were down by more than 50 percent, and the slowest quarter since Q2 2020. The slowdown is broad based: no large market and none of the major sectors recorded an increase in investment activity versus the same period 12 months ago.
The illiquidity in the global property market can be quantified by a newly launched data set, the MSCI Price Expectations Gap. This data set is based on a proprietary model that uses pricing and deal data from the MSCI Real Capital Analytics transaction database to infer the gap between buyer and seller price expectations.
By quantifying the gap, we demonstrate to what extent participants on either side of a deal would have to change their reserve prices for market liquidity to return to its long time average. When there is a negative gap, sellers would have to drop their prices to bring buyers back into the market; a positive gap indicates a booming market, which sellers could cool by increasing prices.
The data demonstrates that in many markets there is a mismatch between where sellers are willing to trade and what investors want to pay to acquire buildings. This dynamic is typical of periods of dislocation and, without the incentive to sell, can lead to an extended period of low deal volumes.
The office sector is the nexus of many of the issues impacting property – both cyclical and structural – and this is exemplified in the price expectations gap in some of the world’s biggest office markets. San Francisco has seen a major withdrawal of investor confidence, due to low office occupancy combined with social issues in the downtown area. The current price expectations gap of -43 percent is the worst on record for San Francisco, and tells us that sellers would have to make significant downgrades to their reserve prices to return liquidity close to its long-term average.
The price expectations gap is negative in Manhattan, but not to the extent that it is in San Francisco. This tells us that while the deal market remains illiquid, conditions have not deteriorated to the same extent as they have on the west coast. The liquidity measure is relative to each market’s own history, and while few Manhattan office sales are completing, even fewer properties were sold during the post-GFC period, when the market almost ground to a halt.
Tokyo is the best performer on this measure out of the major markets featured. The Japanese property market has not experienced the same interest-rate cycle as markets in Europe and North America, and this is reflected in the data, with a price gap closer to equilibrium than elsewhere. In addition, the issue of office usage and occupancy is not impacting the Japanese market to the extent that it is in the US: Cushman and Wakefield reports Tokyo office occupancy at 80 percent of its pre-pandemic figure, which compares to 41 percent in San Francisco, as per data from Kastle Systems.
Pressure on industrial
The price expectations gap can also be used to demonstrate the relative liquidity across different property types and geographies. The contrast is most striking between industrial and office and retail. In four of the countries shown in the second chart there remains a positive price gap for industrial assets, which indicates demand is outstripping supply, leading to upwards pressure on prices. However, the gap is negative for office in all countries shown, and for retail in all but one. The positive outturn for industrial rests on expectations around the performance of the occupier market, which is not subject to the same structural risks as office or retail and remains supply constrained in some of the most desirable locations.
The price expectations gap provides a new way of measuring market liquidity. It can also tell us where the market clearing would be during periods of uncertainty, and complements other pricing analyses based on transactions and valuations.