Higher Inflation Means More Competition for CRE Assets

 

There are three factors driving inflation right now, including a housing shortage.

Supply chain problems, labor shortages, and the housing shortage are all fueling inflation to eye-popping levels – and for CRE investors, that will mean greater competition for assets.

Headline inflation is up 7.1% from last year, the biggest uptick since 1982. And that rising inflationary pressure is forcing the Fed to switch gears and tighten policy. This will in turn put upward pressure on interest rates, raising the cost of capital for CRE investors, says Marcus & Millichap’s John Chang.

Supply chain is the first contributing factor to inflationary pressures: “It’s hard to move products from the manufacturers to the customers,” he says, pointing to shortages in raw materials, limitations on foreign port capacity, shipping container shortages, backlogs at domestic ports like those in Los Angeles and Long Beach, and a shortage of trucks.

“Basically, people want to buy more stuff than our supply chain can handle right now, so there are shortages and that means prices go up,” he says. Retail sales are up 16% over 2019 numbers, while the amount of product moved by trucks in the US is down 5.1% over the same period.

The second issue? Labor shortages, which continue to stoke inflation. Quite simply, “the US has never experienced a labor shortage like this,” Chang says, “at least not in the last 22 years, when records have been kept. As a result, companies are competing for personnel, and that’s driving up wages.” Average hourly earnings are up 5% over last year, and sectors like accommodations and food services have seen labor cost increases of more than 15%. And “rising wages create broad-based long-term inflation,” Chang says.

The third challenge is the housing shortage: there are not enough houses to buy or apartments to rent right now, and the problem will likely continue at least in the near term. There are currently about 1 million houses for sale in the US right now, about two months’ worth of supply; typically, four to six months’ worth of supply is required to maintain stability in the market.  Housing prices shot up 14.9% last year in response to the shortage.

In addition, there are only about 480,000 apartments available for rent, a vacancy rate of 2.6%, the lowest on record. Rents rose 15.5% last year.

“The Fed will be taking action to curtail the rising costs,” Chang says. He notes that Fed Chairman Jerome Powell has already announced plans to accelerate the end of quantitative easing that was put in place during the pandemic, and says this will likely put upward pressure on long-term interest rates. The overnight rate is also on track to increase three times or more this year, which will put upward pressure on short-term interest rates.

As a result, Chang says, interest rates are likely to continue to rise. The ten-year Treasury rate is already up about 30 basis points from the beginning of December to a little over 1.7%.

For investors, this will equate to more competition.

“Commercial real estate is viewed as one of the best places to invest money during periods of high inflation, especially properties that can increase rents with the market, like apartments, hotels, and self-storage properties,” Chang says. “Rising interest rates, and increased investor demand, implies that levered yields will compress this year. Basically, more commercial real estate buyer competition will push cap rates lower while the cost of capital, or interest rates, rise. That means CRE levered returns may tighten.”

But several property types still offer higher yields, like well-positioned office assets, retail assets, medical office buildings and some hotels, he says – and properties in softer markets harder-hit by COVID restrictions could also offer higher yields and stronger multi-year returns.

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Source: Higher Inflation Means More Competition for CRE Assets

https://www.creconsult.net/market-trends/higher-inflation-means-more-competition-for-cre-assets/

First Ever 4Q Occupancy Increase in 2021

 

In the 4th quarter of 2021, the U.S. apartment market saw occupancy tighten for the first time ever during the seasonally slow leasing period.

The nation’s apartment market generally operates on a predictably seasonal cycle. The last few months of the year are typically the slowest for the market, as renters hunker down for the holidays and the start of winter. This time frame follows prime leasing season – the cyclical bump that generally occurs during the 2nd and 3rd quarters.

However, COVID-19 disrupted the market’s seasonal behavior in 2021, resulting in big demand and therefore a big increase in occupancy at the end of the year.

U.S. occupancy climbed 30 basis points (bps) in the 4th quarter, pushing occupancy to 97.4% at the end of the year. In comparison, in the past three decades, occupancy has declined an average of 40 bps during the 4th quarter.

Markets that logged the nation’s biggest occupancy jumps in the 4th quarter of 2021 were New York and Newark, with the growth of around 100 bps. A handful of areas weren’t far behind, with increases of 70 to 80 bps seen in St. Louis, Houston, San Antonio, Cincinnati, and San Francisco.

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Source: First Ever 4Q Occupancy Increase in 2021

https://www.creconsult.net/market-trends/first-ever-4q-occupancy-increase-in-2021/

Webcast 2022 Economic Overview and Real Estate Outlook

 

General Information Thursday, January 27, 2022 Register Now >>

Summary Join us for a lively discussion with the Honorable Henry M. Paulson, Jr. The CEOs of Marcus & Millichap, TruAmerica Multifamily and ICSC are honored to host the former CEO of Goldman Sachs and 74th Secretary of the United States Treasury. The conversation will span the economic outlook, inflation, Federal Reserve Policy, and factors impacting commercial real estate.

 

Featuring Henry M. Paulson, Jr., 74th Secretary of the United States Treasury/Former Chairman & CEO, Goldman Sachs Robert E. Hart, President & CEO, TruAmerica Multifamily Tom McGee, President & CEO, ICSC

Hosted By: Hessam Nadji, President & CEO, Marcus & Millichap

 

How Can We Help You?

Are you looking to Buy, Sell, or Finance/Refinance Multifamily Property?

contact us

https://www.creconsult.net/market-trends/webcast-2022-economic-overview-and-real-estate-outlook/

U.S. Inflation Shows More Staying Power After Hitting 7% in 2021

• CPI will remain close to 7% for a few months, Wells Fargo says
• Persistently high prices ramp up pressure on Fed, Biden to act

U.S. consumer prices are likely to extend their eye-popping gains after soaring last year by the most in nearly four decades, further burdening Americans and ramping up pressure on policymakers to act.

The consumer price index climbed 7% in 2021, the largest 12-month gain since June 1982, according to Labor Department data released Wednesday. The widely followed inflation gauge rose a faster-than-expected 0.5% over the month. Investors took a relatively sanguine view of the data, which were broadly in line with expectations.

Though many economists anticipate inflation to moderate to around 3% over the course of 2022, consumers are likely months away from a meaningful respite, especially as the omicron variant of the coronavirus worsens labor shortages and prevents goods from reaching store shelves.

If signs fail to materialize that inflation is moderating, Federal Reserve policymakers could be forced to embark on a steeper path of interest-rate hikes and balance-sheet shrinkage. It would also make it even tougher for President Joe Biden and Democrats to retain their congressional majorities in November’s midterm elections or pass their tax-and-spending package.

“The breadth of gains in recent months gives inflation inertia that will be difficult to break,” said Sarah House, senior economist at Wells Fargo & Co. “We expect the CPI to remain close to 7% the next few months.”

The report did offer some comfort to American families. Energy prices fell last month for the first time since April, and food prices -- while still rising -- moderated somewhat as the cost of meat fell. Biden said that reflected “progress” from his administration while acknowledging there’s more work to be done

Workers’ wages are simply not keeping up. Despite a slew of robust pay raises last year as businesses sought to fill a multitude of open positions, inflation-adjusted wages were down 2.4% in December from a year earlier.

Whether inflation falls as expected will depend on supply chains normalizing and energy prices leveling off. However, higher rents, robust wage growth, subsequent waves of Covid-19, and lingering supply constraints all pose upside risks to the inflation outlook.

While moderation is expected in some categories like vehicle prices and apparel, there’s “no particular reason to expect much of a cooling for the rest of the core,” Stephen Stanley, chief economist at Amherst Pierpont Securities LLC, said in a note.

“Sure, there will be goods categories that cool off once supply bottlenecks begin to ease later this year, but at the same time, the pressure from wages to prices is only going to ramp up,” Stanley said.

Omicron is poised to further disrupt already-fragile supply chains, due in part to quarantines and illness that have prevented many people from working. It’s also curbed demand for services like dining out. Bloomberg Economics’ daily gross domestic product tracker suggests activity was down sharply in the first week of 2022.

With omicron hitting the supply side of the economy through staffing, “inventory levels are likely to take even longer to normalize as a result, keeping upward pressure of goods prices through the year,” House said. That’s likely to be coupled with stronger services inflation, she said.

Last year, the increase in the CPI was largely due to high goods inflation. Excluding food and energy, the agency’s price index of goods surged 10.7% last year, the largest 12-month advance since 1975. Services costs climbed 3.7%.

But this year, economists expect service inflation to pick up steam as housing costs become a main driver of inflation.

Shelter costs, which were already one of the largest contributors to December’s gain, are expected to accelerate this year, offering an enduring tailwind to inflation. Other gauges of home prices and rents surged last year, but the full extent of those increases has yet to be reflected in the government’s measure.

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Source: U.S. Inflation Shows More Staying Power After Hitting 7% in 2021

https://www.creconsult.net/market-trends/u-s-inflation-shows-more-staying-power-after-hitting-7-in-2021/

The First Round Of Rental Assistance Reallocation Is Here And It's Underwhelming

 

Cities and states have accelerated their distribution of Emergency Rental Assistance funds, leaving less extra money than expected in the pool for those who need it most.

The Treasury Department announced the first round of reallocations under the ERA program on Jan. 7, with $1.1B to change hands from jurisdictions that couldn’t or wouldn’t send their respective chunks of federal funding to those who either have run out of funds or will soon. The vast majority of the reallocations, about $875M, come in the form of voluntary transfers within individual states.

Only the first pool of ERA funds, just under $24B when accounting for administrative spending, was eligible to be reallocated, the announcement stated. Further reallocations from the ERA1 pool, as the agency labeled it, are forthcoming over the next few months, with the next deadline for requests being Jan. 21. The process of reallocating the second pool of rental assistance funds, or ERA2, is not legally allowed to begin until March 31.

The largest single transfer of funds was the state of North Dakota returning $149M of the $352M it received from ERA1 to the federal pool, which did not include any cities or counties within North Dakota among the reallocation recipients. North Dakota officials explained the decision by noting that a huge portion of the 120,000 renters in the state were not aware of the program, the Grand Forks Herald reports.

The most significant transfers of funds were from states to some of their largest jurisdictions. The highest dollar transfer came in Indiana, with the state transferring more than $91M to the city of Indianapolis. Wisconsin gave the cities of Milwaukee and Madison $61M and $35M respectively, with another $50M going to Milwaukee County. Nebraska gave the cities of Omaha and Lincoln $50M and $30M respectively, while Arizona sent $39M to Phoenix’s Maricopa County and Louisiana sent over $34M to New Orleans.

Of the money distributed directly by the Treasury Department to states, counties, and cities, the state of California was the biggest beneficiary, receiving over $50M. New York, where ERA distribution was notoriously slow to get off the ground, received $27M, while New Jersey, which fared considerably better, received $42M.

Only 21 jurisdictions had funds involuntarily recaptured by Treasury: seven states, 13 counties, and one city. The agency prioritized jurisdictions with demonstrated need within the same state when deciding where to reallocate those recaptured funds, but no data was publicly released laying out where exactly those funds wound up, unlike voluntary transfers within states. The Treasury Department declined to comment on the reallocation process beyond the press release, it told Bisnow through a representative.

The state of Idaho had $33M recaptured, while the only in-state recipients on Treasury’s list, the city of Boise and Ada County, received $7.2M and $3.7M, respectively. The rest of the recaptured $33M, the largest sum in the list of involuntary recaptures presumably went out of state.

Delaware, Montana, Ohio, South Dakota, Vermont, and West Virginia were the other states from which Treasury recaptured ERA money, with Laredo, Texas, being the only city to have funds recaptured in that fashion. Counties that had funds recaptured included Tuscaloosa in Alabama, five Texas counties, and New Jersey’s Union County, which sits across the Hudson River from New York and counts the key port city of Elizabeth as its largest municipality.

Only jurisdictions that requested additional funding and had obligated over 65% of their ERA1 allocations by the first application deadline of Oct. 15 were eligible to receive reallocations, and Treasury used both demonstrated need and effectiveness in spending ERA1 funding to prioritize recipients. But it couldn’t even come close to meeting the need in some jurisdictions.

The city of Philadelphia asked for $400M in reallocation funds based on the number of applicants and the average payout, which has been about $11K per applicant, said Rachel Mulbry, an assistant program manager for the Philadelphia Housing Development Corp. tasked with overseeing the city’s distribution. Treasury reallocated $8.4M to the city, which it has yet to receive, Mulbry and PHDC CEO David Thomas told Bisnow.

“The information we received from Treasury is that they anticipate us receiving the funding in the coming weeks,” Mulbry said.

The same day the reallocation data was released, Philly was forced to close its rental assistance application portal due to a lack of funds. Only a small portion of those who already applied will wind up getting assistance, even with the extra $8M, which would cover about 750 applicants at an average of $11K per household.

“It seemed unfair to have people’s expectations out there looking for relief when we couldn’t provide it,” Thomas said. “We were hoping not to close, and we were hoping legislators would figure out how to reallocate more funds, but it just hasn’t materialized.”

Even if Philly were to somehow receive the entire $400M it requested, it likely wouldn’t meet the demand if the city program were to reopen, though PHDC would probably attempt to open it if it received such a sum, Thomas said.

The divide between the need for rental assistance and the available funds still looms over the horizon, even as jurisdictions set a new high-water mark for money sent out the door in the month of November, according to Treasury data. Using November data to project forward, the agency estimates that $25B to $30B was distributed to tenants by the end of last year from the combined $46B available from ERA1 and ERA2.

The nature of the federal coronavirus relief packages was to treat the economic conditions caused by the pandemic as an acute crisis that demanded short-term funding to see people through to the other side. Though the economy has not shut back down through the emergence of the variants, the lost income that catching the disease could cause are still immediate dangers to housing stability, said Michael Spotts, a senior visiting research fellow at the Urban Land Institute’s Terwilliger Center of Housing. That includes unexpected burdens like remote learning when families don’t have daytime childcare options.

“People might have exhausted the minimal savings they had or taken on more debt to pay rent,” said Spotts, who authored a research report published in December for ULI about housing stability and the rental market. “The pre-existing conditions that contribute to [housing] insecurity will likely have worsened for a lot of people. So there will be a continued need for emergency rental assistance for people who suffer shocks going forward.”

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Source: The First Round Of Rental Assistance Reallocation Is Here And It’s Underwhelming

https://www.creconsult.net/market-trends/the-first-round-of-rental-assistance-reallocation-is-here-and-its-underwhelming/

Chart: US Apartment Sector Momentum Across Markets

 

The U.S. apartment sector has experienced a rebound in both deal volume and asset pricing, but the performance varies across markets. The strongest growth in asset pricing tends to be concentrated in the Non-Major Metros, as shown in the chart below.

The simple average of annual price growth in the Non-Major Metros outpaced that of the 6 Major Metros in Q3 2021. Across the non-major areas, the average price growth stood at 14.8% while that across the 6 Major Metros averaged 4.5%.

In the 6 Major Metros, there is a loose relationship between the rebound in the pace of sales of individual buildings — the bedrock of the market — and subsequent price growth. Even with a triple-digit rebound in sales volume, some of these markets were still experiencing price declines in the third quarter. Markets such as San Francisco and Manhattan have faced stronger headwinds.

 

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Source: Chart: US Apartment Sector Momentum Across Markets

https://www.creconsult.net/market-trends/chart-us-apartment-sector-momentum-across-markets/

Deferred Sales Trusts: A Real Estate Tax Strategy

What is a deferred sales trust?

A deferred sales trust is a method used to defer capital gains tax when selling real estate or other business assets that are subject to capital gains tax. Instead of receiving the sale proceeds at closing, the money is put into a trust and only taxed as the funds from the sale are received. This strategy allows you to reinvest the money from the sale into investments that aren't allowed by other capital gains tax deferral strategies.

Deferred sales trusts work with  Internal Revenue Code 453, which is a tax law that prevents a taxpayer from having to pay taxes on money they haven't yet received on an installment sale.

The idea behind a deferred sales trust is to sell the real estate asset to the trust with an installment sale. The trust then sells the real estate to the buyer, and the funds are placed in the trust without paying taxes on the capital gains.

The trust doesn't have any capital gains taxes because it sold the real estate asset for the same amount it paid for it with the installment sales contract. As the seller, you don't pay any capital gains taxes yet because you haven't constructively received (physically received) the funds from the sale.

The installment contract from the sale can be set up any way you wish. You can begin receiving installment payments right away or defer them for several years.

The third-party trustee can invest the funds however you like. You can earn interest income on the money from the real estate sale while it sits in the trust. You only begin paying capital gains taxes when you start receiving principal payments.

How does a deferred sales trust work?

A deferred sales trust has to be set up properly, and specific rules have to be followed throughout the process to enjoy the tax benefits.

The process for using a deferred sales trust looks like this:

1. A third-party trust is formed that will be managed by a third-party trustee.
2. The real estate asset is sold to the trust with an installment sales contract.
3. The trust sells the real estate to the buyer and receives the funds.
4. The third-party trustee invests the funds or distributes installment payments at the seller's direction.
5. Capital gains taxes are paid on any principal amount the seller receives from installment payments.

Capital gains taxes are paid when you profit from the sale of an investment property,  commercial real estate, or other business assets. Using a deferred sales trust doesn't get you out of paying capital gains taxes, but it does allow you to defer them while you reinvest the money.

What are the benefits of a deferred sales trust?

The primary benefit to a deferred sales trust is that you are able to defer taxes on capital gains while earning additional income from investing the proceeds from the sale. As an investor, you're able to invest more because you haven't had to pay the taxes on the capital gains yet.

For example, if your capital gain on a real estate sale is $1 million, you can invest that full amount if you defer the taxes. If you receive the sale proceeds yourself, you'll have to pay a 15% capital gains tax. After paying the taxes, you only have $850,000 to invest.

A deferred sales trust can be an alternative to a  1031 exchange for deferring taxes on capital gains if you don't want to continue investing in real estate. With a deferred sales trust, you have many more investment options including:

1.  Other real estate .
2.  Stocks .
3.  REITs .
4.  Bonds .
5.  Mutual funds .
6.  CDs .
7.  Angel investments .

A deferred sales trust also allows you to receive payments as you need them. You can choose to only receive income payments on the interest earned or structure principal payments however you would like. This can be a great option for retirement income, or to continue receiving cash flow on the real estate you sold.

How can you use a deferred sales trust to save a 1031 exchange?

If you've started the process of a 1031 exchange but are unable to complete the purchase of the replacement property for any reason, your qualified intermediary may be able to put the funds into a deferred sales trust to prevent you from receiving any money you would have to pay taxes on.

With a 1031 exchange, a qualified intermediary receives the funds from the sale of your real estate and you have 180 days to purchase a replacement property. When you close on the replacement property, the qualified intermediary uses the funds from the sale of your property to purchase the new real estate.

If you aren't able to purchase the new property within the time allotted, your exchange will fail and you'll be left paying the capital gains taxes you were trying to avoid.

If the qualified intermediary puts the money into a deferred sales trust for you, you will have more time to locate and close on a replacement property. The trust doesn't have a time limit to reinvest like a 1031 exchange does.

How does a deferred sales trust affect your tax liability?

When using a deferred sales trust to sell your real estate asset, you won't pay taxes on the sale for any money you haven't received. This doesn't mean you'll never have to pay the taxes, but you can defer the tax payment for as long as you want, as long as you don't personally receive cash from the sale.

Any payments you receive from the trust on the interest earned will be subject to income tax just like any profits earned from other investments.

While a deferred sales trust allows you to defer capital gains taxes, you can't defer depreciation recapture taxes for any amount depreciated beyond what straight-line depreciation would have been.

How do you create a deferred sales trust?

The actual process of forming a deferred sales trust can be quite complicated, and very specific rules have to be followed. To set up a deferred sales trust, you should contact a professional estate planning team or a tax professional that is experienced and knowledgeable with deferred sales trusts and deferring taxes on capital gains.

A proper deferred sales trust must be a legitimate third-party trust with a legitimate third-party trustee. The trustee must be independent and not related to the beneficiary or the real estate transaction. The third-party trustee is responsible for managing the trust and the money in it according to the taxpayer's risk tolerance, so choosing the right trustee is extremely important.

Deferred sales trust can be a useful tool for deferring capital gains taxes when selling an investment property. There are a lot of things to consider with any type of real estate tax deferral strategy, so working with a professional who understands the tax code for each will help you choose the best tax strategy for your real estate investments.

 

 

Source: https://www.fool.com/millionacres/taxes/deferred-sales-trusts-real-estate-tax-strategy/

https://www.creconsult.net/market-trends/deferred-sales-trusts-a-real-estate-tax-strategy/