State of the U.S. Property Market and Investing in a Turbulent World
July 14, 2022
By Roopa shree Venkatesh Maistrypalya
High inflation, skyrocketing interest rates, and a volatile U.S. market make us wonder where the real estate industry is headed. The economic outlook doesn’t seem to be great for 2022, and it seems as though we’re headed for a bumpy ride.
David Bitner, Global Head of Capital Markets Insights from Cushman & Wakefield, recently shared his outlook on the current U.S. market and the trends in the real estate industry at EisnerAmper’s Real Estate Principals Luncheon.
- Economic growth will soon begin to slow. Anemic growth is a certainty for 2023 and recession in the second half of the year a distinct risk.
- Job growth remains robust with nearly 1.8 open jobs for every unemployed person today. This is a good sign for the economy in the near-term, but the Federal Reserve will need to drive unemployment higher in order to contain inflation.
- Consumer finances are still in great shape, which is supporting spending. However, inflation has driven a sharp decline in consumer and business confidence, which will ultimately drag down spending.
- Supply chain stresses remain elevated but seem to have peaked.
- Consumer inflation remains broad-based. Much of the recent inflation has been driven by energy and goods inflation. These forces are starting to ease, but services inflation alone is still enough to drive inflation above the central bank’s target. Moreover, inflation from the housing market has only begun to trickle into inflation figures. There is little prospect of inflation falling back to target without a large increase in interest rates.
Trends in Different Sectors of Real Estate Industry
- Office: The pandemic hit the U.S. office sector hard, which gave rise to high vacancy. Though people are not back to the office fully, the office usage has increased in 2022. Regardless of work-from-home (WFH) dynamics, there is hope that buildings will re-populate. This is mainly because millions of office jobs are being created, which will drive demand. Office performance is highly bifurcated between the trophy and commodity product, and this distinction will only become larger as the permanent hybrid work transition continues.
- Multifamily: The number of people aged 25 and over (those most likely to rent or own)
has exploded in the U.S. while the net change in housing stock has failed to keep up over the last decade. In short, the U.S. has underbuilt homes. 1.3-1.5 million new households are expected in 2022 and 2023. Pent-up demand from the pandemic and demographic factors will fuel the surge. U.S. vacancy will hold steady, generating healthy rent growth; it would be cheaper to rent in most markets. The multifamily sector has several years of strong fundamentals ahead of it. Indeed, NOI growth should remain positive even through a recession.
- Industrial: Shifts in consumer spending have benefited the industrial sector. Supply is expected to surpass demand once again by 2023; however, the vacancy impact will be minimal. The vacancy will remain at or below 4% over the next two years. Over the next five years, rents are expected to climb by 32.4%. Increases will be sharper over the next few years. Even more than multifamily, industrial fundamentals should be recession-resilient in the sense that NOI’s will continue to grow. However, the recent elevated pace of NOI growth is not sustainable and will moderate in the coming years under all economic scenarios.
- Retail: Vacancy for 2021 ended the year 70bps below the ten-year historical average of 6.5%. Retail foot traffic is essentially back to normal, but the recovery has varied dramatically by region. Sunbelt markets have been the quickest to recover. Disciplined construction and increased occupier demand will continue to elevate asking rates. Indeed, after years of underperformance, there are reasons to believe that core retail assets could provide some of the best returns in coming years.
We have started off 2022 with strong liquidity. Apartment and industrial remain favorites, but the capital is beginning to rotate back to office and retail.
What Do Rising Rates Mean for CRE Values?
The relationship between the interest rate and values is not determinative; there has not been any clear relationship between the interest rates and cap rates. Cap rates are influenced by a range of factors such as NOI growth, supply of capital, interest rates, and risk aversion. Market believes the government will contain inflation but with substantial rate hikes. Core CRE lending tends will fall between the BBB and BB corporate bond segments. The increase in both yields and spreads suggests that economic growth prospects and willingness to take risk are not offsetting increases in rates. The result is enormous upward pressure on cap rates. These risks have already materialized in the REIT market and are increasingly being felt in the private markets. A major pricing adjustment is underway, especially for multifamily and industrial properties but so too for office and retail. It is unclear how long the private market adjustment will take, but we expect data to show significant increases in cap rates between now and 2024. The data will lag the reality, since for some period of time, the pricing adjustment will be shrouded by reduced liquidity.