Real estate vet outlines needed elements for success amid inflation
As the single-family market began to soften last year in light of inflationary pressures, commercial real estate was seen as something of a darling of investors – another world where values were retained and demand remained strong.
Not anymore. With interest rates continuing to climb as the Fed tries to tame inflation, the CRE sector is no longer immune to market forces. Joseph Rubin, senior advisor at EisnerAmerica’s real estate practice, has assessed the market in determining the ingredients needed for sustainability.
“If it comes as any consolation, the current threat to property values and yields was not the industry’s doing but rather the result of shifts in the economy and the capital markets,” he said. “Supply and demand are relatively in balance and most property sectors have been generating generous returns for their investors.
The ingredients for the commercial real estate market to thrive: Population growth; high employment and good wages; and people willing to spend money on goods, services and leisure. He broke down some needed ingredients to keep the flavor alive in the CRE sector.
What are examples of demographics?
Rubin looks at the importance of demographics. “The long-term health of any economy requires population growth,” he said. “In fact, many countries around the world face the prospects of shrinking populations and the economic woes that follow.
“In the United States, we are around break-even with the population growing very slowly in recent years, around 0.5% growth in 2022. Americans are not having children at the rates needed to organically grow the population, and immigration has slowed dramatically over the last few years due to both policy changes and the pandemic.”
Migration patterns fueled by the pandemic have altered the dynamics of many markets, he said. “A lot was written during the pandemic about population migration around the country that is fueling growth in some markets at the expense of others,” Rubin said. “These migration patterns have been ongoing for decades but certainly accelerated recently, helping markets in the Sun Belt and western and mountain states.”
But a key driver of such moves is the search for a lower cost of living, and the influx in some markets has altered the old calculus – particularly in the way of housing costs, he noted: “Metropolitan areas with the greatest in-migration have gotten so expensive that they are no longer affordable to many families. In addition to spectacular rent growth, Phoenix, Atlanta, and Miami had the highest inflation rates of the metro areas, according to Yardi Matrix.
“While these communities remain attractive, we expect migration patterns to shift in the next few years and investors will need to monitor these trends in local demand. Demand is already rising in midwestern and northeastern cities (see more on the multifamily sector below). The winner for in-migration and rent growth in 2022 was not Austin but Indianapolis.”
The aging Baby Boomer population is emerging as a major metric: “According to the Pew Research Center, about 10,000 Boomers have been turning 65 each day since 2010, and their average age is now about 66,” Rubin said. “Over the next few years all 70+ million Boomers will be of retirement age, and some will be in their 80s.
“The group is already draining the labor force and will be consuming less while requiring more health care services. This is a demographic dynamic of unprecedented proportions for the real estate industry that will bring extraordinary opportunities for those who respond to changing demand for new products and designs accommodating the changing needs of this aging generation.”
Why is increasing employment important?
Employment, considered by Rubin as real estate’s greatest tailwind, is another key ingredient. “A strong job market is the single most important driver of real estate demand,” he said. “And despite all the economic turmoil, employment remains on fire.”
While some claim the nation is already in a recession, the strong jobs market stands as something of a rebuke to the notion, he agreed. Despite other travails, the economy gained a massive 4.5 million jobs last year, he noted, pushing down the unemployment rate to 3.5% at the end of the year.
In January, an additional 517,000 jobs were added, almost three times the market’s estimate, bringing down unemployment to 3.4%. What’s more, he noted, the ratio of open positions to unemployed workers has risen to 1.9x.
“Technology companies may be laying off tens of thousands, but small businesses remain desperate for talent,” Rubin observed. “A recent Barron’s survey indicated that 93% of business owners seeking to hire in December had few or no qualifying applicants. The shortage of workers has been caused by many factors including the lack of immigration, the on-going and increasing rate of Boomer retirements, and a surprising number of Gen Z staying out of the work force, particularly less educated younger men.
“Making matters worse is the lack of mobility of the American workforce due to high housing costs and mortgage rates – many people won’t give up their current low mortgage rate and move to a new job opportunity when mortgage rates have doubled.”
What is the importance of consumption in the economy?
Consumption also is critical, Rubin noted. “American consumers are still spending, just a little bit less,” Rubin said. “They have jobs with higher salaries and about half of the pandemic stimulus checks are still in their bank accounts. Credit card balances, at $930 billion at the end of the third quarter of 2022, have returned to their pre-pandemic high after falling $150 billion during the lockdown.
“No doubt inflation has taken a bite out of the spending budget, especially due to volatile gas prices and groceries rising at an astonishing 11%. Inflation, the threat of a recession, and job cuts in the headlines are understandably making people nervous.”
