Major CRE sectors enter 2022 with optimism of varying degrees, ranging from robust recovery to continued record-setting performance.
Multifamily vacancies dropped from 6.7 percent in 2020 to 5.1 percent last year, according to NAR, with that figure forecasted to dip to 4.8 percent in 2022. Accordingly, rents grew 7.8 percent in 2021 and are expected to continue to increase at an accelerated rate of 10 percent in 2022.
“The home ownership market and the rental market are deeply out of balance,” Bitner says. “In a lot of locations, the rental markets have rebounded very strongly overall, particularly in the Sunbelt and suburbs, but home prices have been even stronger.
“If you think of rents versus home prices as being in some kind of equilibrium in terms of the attractiveness of paying rent or a mortgage, it’s more favorable to rent. I don’t expect home prices to creep back downward to any meaningful degree in 2022, which points towards continued growth for multifamily, although a bit slower growth than 2021.”
Supply is ticking slightly upward, with 364,700 completions coming online in 2020, according to the National Multifamily Housing Council. But fundamental obstacles to supply, including zoning ordinances and other state and municipal regulations, don’t appear to be dissipating, though regional migration trends align with locations more accommodating to developments. The Sunbelt, Texas, and Rocky Mountain states are seeing inbound migration, while the Midwest, Northeast and California saw net losses in from January 2020 to June 2021.
“There are great reasons for people to move to Florida — it’s a consumption economy, a great vacation destination, and a great retirement spot,” Costello says. “It just makes sense for Florida to be seeing population growth. But it’s not something where every investment bank in New York is going to pick up and move all their staff down there.”
The Return of the Office?
The office sector had another roller coaster of a year in 2021, as the growing momentum toward workers returning to offices across the country was wiped out by the midyear arrival of the delta variant. While that hiccup, along with the ensuing omicron surge, extended remote work for millions of Americans, leasing activity sustained an upward trajectory.
After bottoming out at 25.8 sf in 4Q2020, leasing space nudged up in the following three quarters, eventually reaching 39.2 million sf in 3Q2021, according to JLL Research. More than 100 million sf of office space is under construction, which is a decrease from 2019’s 126 million, but any new supply in a market that saw -7.3 m sf of absorption in 3Q2021 tilts the deck further in favor of tenants.
“With a large construction pipeline through the end of 2022, however, conditions will remain tenant-favorable for the foreseeable future, while an accelerated rate of relocations to newer supply will lead to even greater divergence in performance across office assets,” according to Phil Ryan, director of U.S. office research for JLL. “Even with a more gradual reentry process and potentially more balanced hybrid plans than initially expected, the crucial role that physical offices play in fostering corporate culture, productivity, and innovation will underline the longer-term need for space that meets evolving tenant and employee preferences.”
“The office recovery is going to take longer as people return to work, but investors are going to deploy capital into that sector,” Bitner says. “And as long as you’re putting new money in, you can ride that wave.”
While one deal doesn’t mean a complete recovery for the sector, Google’s $2.1 billion purchase of 1.3 million sf of space in New York in September 2021 is a signal that capital will return. The deal could be the biggest in the U.S. since COVID-19 hit, and it highlights interest in major urban markets. Usual suspects like New York (20 million sf), Boston (7.53 million sf), and Silicon Valley (5.9 million sf) lead the way in construction, according to JLL Research.
But capital expenditures in the wake of a global pandemic are a bit more complicated. Public health and safety, ergonomics, and worker comfort are necessary considerations in developing new or renovating old assets.
“The capex issues are just huge,” Costello says. “If you do come back to the office, someone is spending a lot of money on new filtration systems and healthier settings for the building. You want to make sure the elevators can run in a rapid fashion and try to [minimize] crowding. That’s significant spending. Who’s paying for that?”
That question remains to be answered in a broad sense, but it will not be a deal-breaker for capital looking to be deployed in a sector that’s showing signs of recovery.
“Even with this bump in the road, macroeconomic indicators remained optimistic, albeit slightly downgraded compared to forecasts from earlier in the year,” Ryan reports. “The office market showed signs of promise and the beginnings of tenants firming their longer-term utilization plans.”
Back in Business
For a CRE sector that can be linked to the day-to-day news of COVID-19, retail looks to be in a promising position entering 2022 according to a number of industry experts. Largely overshadowed by stellar performances in multifamily and industrial, the sector saw its share of overall investment transaction activity in CRE drop to a historic low of 9 percent in 2021, according to CBRE data.
But after last year, where capital continued to flood those stronger sectors, retail may have found its footing and could attract more attention in the next 12 months.
“Investors have been a little slow to pick the ball up on the improvement in the retail,” Bitner says. “I’m not talking about the ghost malls or strip centers in economically challenged areas. Investors have been a little slow in returning to retail in areas that are strong, where there’s an emphasis on personal services and grocery-anchored centers.”
By late 2021, the discount rate in public REITs for shopping centers was -2.3 percent and regional malls was -8.3 percent. Retail boasts the highest cap rates — 6.4 percent — compared to office, industrial, and multifamily, but they are starting to compress as investors reevaluate the market.
“The improvement in the discount ratio to net asset value shows [the growing confidence of investors] in the retail sector,” writes Daniel Diebel, a retail economist with CBRE, in a December 2021 report. “Stock prices for major retail REITs have bounced back since early 2021. Rising stock prices reflect investors’ optimistic expectation for the performance of retail properties going forward.”
While e-commerce was the story of 2020 as lockdowns and quarantines rolled across the U.S., its share of overall retail sales ebbed in 2021. According to seasonally adjusted U.S. Census Bureau data, e-commerce has steadily declined from 13.8 percent of all retail sales in 3Q2020 to 13 percent in 3Q2021. Brick-and-mortar retail is hardly doomed, but not all assets are equal.
“Retail was already under a lot of stress before COVID-19,” Costello says. “For example, malls are having a lot of trouble in the older industrial cities in the Midwest, where jobs were already leaving and income was moving away. But there are high-income areas across the country where retail is thriving, where you have wealth and plenty of in-person shopping.”
Knowing the Variables
As every economic forecast for 2020 taught us, the unforeseen can change everything in an instant. Accordingly, entering 2022, many CRE experts still include disclaimers about uncertainty around COVID-19. Just as the delta variant dashed hopes for a smooth reentry to the workplace for millions of workers last summer, omicron is presenting a reminder that the pandemic may not have an expiration date.
Inflation grabbed its share of headlines as well in the back half of 2021, with economists trying to understand if it will prove to be transitory or endemic.
But outside of transitional investments on a tight timeline, CRE has the ability to look at the longer term. Analysis and modeling can include potential adverse public health events — and investors are well aware of market fluidity.
“If I’m an investor looking at [omicron and other potential variants], it’s unclear what will happen,” Costello says. “If in this first year, say it’s a worst-case scenario [that includes] going to more lockdowns. Ask yourself, what’s that going to do to income and how is that going to impact my returns? You need to play out scenarios to make sure that you’re comfortable with the potential downsides. That’s all you can do right now — play out scenarios because, realistically, nobody knows what may happen and how bad it’ll be.”
Inflation grabbed its share of headlines as well in the back half of 2021, with economists trying to understand if it will prove to be transitory or endemic.
“Most forecasters believe that inflation may be peaking around now or it could be elevated through the end of the year, but the idea is that it’s normalizing,” Bitner says. “Given where cap rate spreads are, inflation shouldn’t be a problem in terms of stressing valuations. I did rigorous statistical analysis of historical return data looking at public and the private markets. I saw that commercial real estate really does act as an effective inflation hedge. My message [is], if you’re really worried about inflation, definitely go buy real estate.”
By Nicholas Leider | Winter 2022
Courtesy: CCIM.Com
