Uh-Oh Growth is Slowing Is CRE Next?

 

Nobody likes being corrected, especially an entire industry. But some are suggesting that one is overdue in commercial real estate. And some outside data seem to say that things are slowing.

JP Morgan cut its third-quarter GDP annualized growth forecast from 7% to 5%, Dow Jones reported. Morgan Stanley chief US equity strategist Mike Wilson reportedly said that as fiscal stimulus ends, the S&P 500 could see a 20% correction, according to The Street. A drop in equities could make them more appealing and draw some money away from alternative assets like real estate.

For some, that future is already here.

“For the first time in over a year, clients are reporting some softness in sale prices in what had otherwise been very strong markets, such as senior housing and apartments,” Kyle Hauberg, director of Dykema’s real estate and environmental services department, tells GlobeSt.com. “This is likely due to a combination of very aggressive pricing by sellers and some hesitation on the longer-term outlook by buyers and investors. Industrial continues to be very strong.”

Certainly, we are seeing cap rates of select asset types, particularly apartments and warehouses, compress at such a tremendous rate that the trajectory is realistically unsustainable, especially if you believe interest rates will increase over the intermediate-term,” Aaron Halfacre, CEO of Modiv, tells GlobeSt.com. “That said, buying opportunities do exist but your strategy needs to be focused and your underwriting thorough. Even with tighter cap rates, we are seeing compelling opportunities in the single-tenant net lease sector.”

Others also suggest a measured and detailed approach. “JPM’s forecasts around Q3 and Q4 are certainly relevant and indicative for the near term,” Brian Ward, CEO of Trimont, tells GlobeSt.com. “However, commercial real estate is inherently a long-term asset class, and unless there are certain transactions priced to perfection requiring near-term execution, then what goes on in Q3 and Q4 should not make a lot of difference.”

“We believe that the recovery momentum will not slow as much given where we started before the pandemic and all the money pumped into the economy from the government,” George Smith Partners managing director Gary Mozer says. “Growth is slowing because of supply chain issues, however conversely, commercial real estate transactions are speeding up because of potential changes to the tax code such as loss of 1031 tax treatment and increasing capital gains rate. This increase in transaction volume should offset much of the effects of the delta variant.”

Mozer adds that given the amount of money in the monetary system and the pressure it creates to invest, “investors are trying to invest in hard assets as an inflation hedge.” He adds, “Perception that the stock market is fully priced, and the bond markets are producing nominal yields, investors are pouring money into real estate. Real estate has historically outperformed on a risk-adjusted basis when economies are expanding, and inflation is diminishing returns.”

Mozer and others do say that some sectors are feeling the pinch. “Offices are still recovering from the impacts of the pandemic,” Dianne Crocker, principal analyst at Lightbox, tells GlobeSt.com.

“With low occupancy daily, corporations are postponing back to work plans.” And yet, she adds that “retail reinvention is well underway as companies are redesigning their spaces to appeal to today’s shoppers demanding more of an experiential visit than traditional brick and mortar.”

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Source: Uh-Oh Growth is Slowing Is CRE Next?

Rents are skyrocketing the most in these US cities

 

The national median rent rose to $1,302 in September, up 15% from a year ago, according to a report from Apartment List, a rental listing site.

After falling for much of 2020, rents are now rising much faster than before the pandemic. Since January, the national median rent has increased by 16.4%. From 2017 to 2019, a more typical rent increase during those months was 3.4%, according to the report.

In September, rents remained below pre-pandemic levels in just five large cities: San Francisco, Oakland, and San Jose, California, as well as Minneapolis and Washington, DC.

But the meteoric rise in rents may be starting to show signs of cresting.

Boise, Idaho, which saw the biggest increase in rent during the pandemic -- up nearly 40% since March 2020 -- did not see a monthly increase in September. Instead, according to the report, the median rent in Boise fell by 0.1%.

That's hardly much relief for Boise renters, but, according to Apartment List's report, it may begin to signal that the market is starting to stabilize.

Rents soar in Sun Belt cities

"What is happening now is a massive rebound in rents," said Anthemos Georgiades, CEO of Zumper, a rental listing site. And much of that rebound has come through steady increases throughout 2021, he said.

Several factors contributed to the higher rates, he said, including people coming back to urban cores for in-person work and school, would-be homeowners remaining renters because they are priced out of buying a home, and an overall lack of housing.

Rents are climbing fastest in Sun Belt cities like Phoenix, where rent for a one-bedroom apartment was up 22% year-over-year in September, according to Zumper.

Nearby, Scottsdale's one-bedroom median rent rose to $1,850 in September, up 23% from last year, according to Zumper's analysis. Overall, Sun Belt cities posted the strongest rent gains in the country during the end of the summer, according to a report from CoStar Group, a real estate data company that owns Apartments.com. Rents in this region were pushed up by robust economic recoveries and newcomers moving to the area, according to the report. "Sun Belt markets were already seeing good growth pre-pandemic and they are the standouts now," said Jay Lybik, the national director of multifamily analytics at CoStar Group. Other cities seeing rent increases are those that aren't the major city in their region -- like Fort Lauderdale, Florida, or San Diego, according to Zumper. "Maybe people don't need to live in Miami or Los Angeles, but they still want to be close," said Georgiades. Nearby cities often offer a lower cost of living, larger square footage, and an attractive lifestyle. "Only a minority of people will be fully remote going forward. The proximity is a realistic alternative for many people."

New York and San Francisco rebound

Rents in the two most expensive markets in the country, New York and San Francisco, cratered during the pandemic. Now both are coming back, with San Francisco lagging a bit behind.

The borough of Manhattan is heating up the most in New York City, said Nancy Wu, an economist at StreetEasy. "Manhattan residents were more mobile and had the ability to move. That's where we saw the biggest drops in rents [during the pandemic] and the biggest gains back up in the city."

Prior to the pandemic, rents in San Francisco were more expensive than in New York and there was less inventory. San Francisco may not be coming back as fast as New York, Wu said, because the Bay Area's tech industry might not require workers to be in the office to the extent the financial firms in Manhattan do.

Still, she said, New York and San Francisco have more in common than they do with other parts of the country. "They are different than Midwestern and Sun Belt cities that were relatively more affordable and have seen big rent growth."

Rents are not as strong in New York as some analysts thought they'd be at the beginning of the summer due to the ongoing threat of Covid-19. "That still leaves a lot of good deals for renters," said Wu. "You can still negotiate."

The median rent in Manhattan was $3,255 in August, according to a report from brokerage firm Douglas Elliman and appraisal firm Miller Samuel. That's up 1.5% from July, but still 3.2% below last year.

Demand is bouncing back, however, according to Jonathan Miller, President, and CEO of Miller Samuel. Even though leasing activity was strong heading into the fall, said Miller, it was more muted than expected.

"At the start of the summer, there seemed to be a consensus among corporate America that in-person work would resume in the fall," said Miller. "That consensus is much more diffused. Start dates are being kicked down the road, often to January and into the new year."

That uncertainty can be seen in the rental activity, he said. "Instead of having this moment that was going to be a light switch, when things were back to business in a significant way, that has become less of an obvious outcome," said Miller. "Now there is more uncertainty."

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Source: Rents are skyrocketing the most in these US cities

Which 3 Property Types Had the Best Price Growth?

 

• RCA’s Commercial Property Price Index said the below sectors had the strongest YOY price increase as of August
  • •  Suburban Office: +14.8%
  • •  Apartment: +14.7%
  • •  Industrial: +13.6%
• Elevated prices for Multifamily and Industrial is unsurprising – Both registered strong rent growth & falling vacancy
• Meanwhile, Suburban Office prices are driven more by the future outlook than current fundamentals
• As Millennials age, many investors are betting the cohort will start families and move to the suburbs much like previous generations
• As a result, employers could begin to shift office operations out of the CBD and into surrounding areas where their workforce is relocating, strengthening office space demand
• Investors are positioning assets in the path of this growth, hoping to capitalize on the trend

 

What CRE Would You Overpay For Today?

 

As the CRE investment climate continues its aggressive trajectory across virtually all asset classes, some industry experts question whether current pricing remains in line with valuation.  But a better question may be what properties are worth overpaying for today, says John Chang, senior vice president of research services at Marcus & Millichap.

“Integral to this idea is that beauty is in the eye of the beholder,” Chang said in a recent video breaking down the current investment climate. “Some people look at a deal and say ‘whoever pays that much for that asset is nuts.’ Then five or 10 years later the investor who bought the property is proven to be a genius. Maybe it’s luck or maybe the rising tide lifted all boats—or maybe that investor simply says something that others didn’t.”

That, Chang says, is the beauty of real estate.  “There’s a real opportunity for investors to use knowledge and expertise to outperform the market and to create value,” he says.

Chang says the current investment climate is very aggressive, pointing to deals selling with “unheard of cap rates” such as apartment deals in Texas with cap rates in the twos and industrial transactions in major hubs like Southern California’s Inland Empire or Los Angeles selling in the same range.

“There are trades happening that really pressure the pricing envelope” in virtually all sectors, including self-storage, retail, seniors housing, manufactured housing, hotels, and biotech space. Why? Investors are looking at longer-term drivers,” he says, and “baking those factors into their underwriting…and investors are looking for the angle that others simply aren’t considering.”

Chang says he’d overpay for assets that capitalize on a long-term trend that’s not already baked into the price—think a hotel catering to vacationing young families or suburban office buildings in markets with strong in-migration of talent and companies. Other solid bets: seniors housing catering to aging baby boomers, self-storage facilities in supply-constrained areas with rising millennial populations, and retail centers positioned for new uses.

“Honestly, there are countless properties that could be a big winner for investors with a vision, but there are three really important ingredients,” he says. The first: information. Investors must understand the property, the market, and submarket, as well as forces that will impact the property over the next five to 10 years, Chang says. The second is insight: what can the property be in the future? Finally, the third factor is perspective: can you align the piece of real estate within the context of who the tenants will be and what the submarket will look like in five years?

“Yes, the anomalies and nuances affecting the market today can create opportunities, but in real estate, the big payoff usually comes over the span of years,” he says.

Chang has previously said many investors will find selling is a much better option now than holding for one to three years, especially if capital gains taxes and interest rates rise.

In remarks this summer, he recommended considering new markets and out-of-favor liquidity types to balance portfolios. “The market could shift quickly, and opportunities may not stay long. There is a relatively short window of opportunity,” Chang said then.

 

Which CRE Property Types Were More Impacted by COVID?

 

• Property types most impacted by COVID – Hotels, Seniors Housing, Retail and Office
• Summer travel surge supported Hotel recovery; Bifurcation evident depending on the segment
  • - Buy-side sentiment at 9-year high as investors pursue an opportunity
• Seniors Housing is on a slower path to recovery, but trending in the right direction
  • - Consolidation by large operators driving much of the investment activity
• Like Hotels, Retail sector facing steep bifurcation, but elevated consumer spending is positive
  • - Necessity-based centers doing well while in-person retailers & older indoor malls struggling
• Office sector outlook still shrouded in uncertainty; COVID containment and future of WFH key
  • - Absorption turned positive in 2Q 2021, but Delta surge and return to work delays damaging
• Although these asset classes faced hardship over the last year, opportunities still exist
• Some investors opting to consolidate or pursue value-add/adaptive reuse investments

 

HOUSING RESEARCH BRIEF: SEPTEMBER 2021

Housing Construction Pushes Toward a Record; Still Not Enough to Meet Demand

Tight multifamily vacancy supports permit surge. Across the residential sector, permit activity climbed in August. The rise was mostly attributed to multifamily, as filings for single-family houses remained relatively in line with preceding months. Meanwhile, apartment permits soared 15 percent month over month, reaching the highest level since June 2015. Greater construction is warranted by extremely tight vacancy, as apartment availability in June fell below 4 percent for just the second time in the past 20 years. Preliminary data points to additional downward vacancy pressure in the third quarter, reiterating the housing shortage and putting upward pressure on both rents and home prices.

A large 2022 pipeline is imminent, but the ceiling is capped. Residential starts in August were up year over year, even as single-family groundbreakings tapered over the past few months. The 53 percent annual advance in multifamily starts spearheaded the rise. Some previously stalled developments pushed forward as the lumber price index retreated by 36 percent over the past two months. Still, the cost of lumber remains 30 percent above the pre-pandemic level. Elevated material costs and labor shortages limit the potential supply output next year, but recent permit activity and starts signal a weighty pipeline nonetheless. Early forecasts project 400,000 apartments will finalize, while the single-family addition will be the largest since 2006.

Builders face tall tasks in catching up with demand. Despite multifamily completions in 2022 expected to be a 40-plus year record, oversupply concerns are mostly absent. Instead, the new supply will continue to lag demand as the aging millennial cohort drives robust household formation. The U.S. is expected to add 1.5 million additional households next year, given there are enough residences available to support the demand amid a housing shortage. Apartment vacancy sits at a historical low, and demand for single-family homes has consistently outpaced supply, driving inventory down and pushing up prices. The influx of apartments next year is especially crucial as these will provide living options to those priced out of homeownership.

 

WHICH CRE PROPERTY TYPES ARE OUTPERFORMING?

 

• Investor sentiment elevated for the outperforming sectors – Apartment, Industrial and Self-Storage
• All three property types saw operations hold steady or even improve over the past year
• Economic recovery & positive demographics drove Apartment net absorption to an all-time, record high in 2Q 2021
• Industrial properties, an asset class favored pre-pandemic, got a boost from the jump in eCommerce usage and retailers increasing safety stock amid supply chain disruptions
• Vacancy for Self-Storage dropped to the lowest level ever as remote working/learning drove additional space needs in people’s homes
• All three sectors have strong investor expectations for rising values over the next 12 months:
  • - Apartment:     74%
  • - Industrial:       74%
  • - Self-Storage:  62%