Trinity's Reflection on the Commercial Real Estate Market
Key Highlights from Dr. Linneman's Talk
Recession – GDP fell first two quarters of 2022, which has historically defined a recession. However, over the first eight months of 2022, the U.S. added 3.5 million jobs, saw industrial output rise by 2.7%, and witnessed real combined retail and wholesale sales growth of 3.2%. This all occurred while the unemployment rate hovered around 3.5%. Taken together, these are not indicators of a recession (yet).
Interest Rates - Interest rates are now normalizing to about their 2019 levels, which were generally viewed as benign. In fact, the economy did just fine at the time with those interest rates and they remain low from a long-term historical perspective.
Inflation - Two basic economic truths that are largely forgotten are: that for everyone paying a higher price due to higher inflation, someone else is receiving a higher price; and for every additional dollar paid by borrowers as interest rates rise, a lender is receiving an additional dollar in debt service. The Fed thru its increases is trying to curb price increases but it will take some time to take hold, and likely require a much longer duration to be effective.
Saving Rates - Households, businesses, and even state and local governments are flush with cash, relative to their respective pre-Financial Crisis and pre-pandemic balance sheets. This bodes well for stimulating the economy once consumers retain their confidence.
Job Market - A contributing factor to confidence may be that unemployment remains at historic lows, with continued strong job postings - despite recent tech layoffs - employers continue to struggle to fill vacant positions—particularly in the Puget Sound region. Reflecting the tight job market, wage gains are positive—nearly double over the past year vs. the last decade.
Our Reflection on the Commercial Real Estate Sectors
Multifamily (apartments) - Rents continue to increase, although somewhat tempered in response to recent employment slowdowns. Occupancies continue to remain stable, and favorable—but inflation is putting pressure on bottom-line performance with across-the-board increases in operating costs. Overall, job growth is positive, new supply is relatively modest, and the population is increasing. Add to that the increase in mortgage rates, making moving to ownership out of reach now for many first-time buyers. This all adds up to consistent demand and upward pressure on rents.
Industrial - Industrial has always been an attractive option—with stable demand, low vacancy rates, and low turnover costs. With Amazon’s recent announcements that they are pulling back on new warehouses, and laying off employees, it may be signaling some saturation in the industrial segment. We’re expecting modest rent increases, coupled with continued stable occupancy.
Retail - Surprising to many, a good amount of the surplus retail we’ve had over the past number of years has been re-purposed and/or converted. Good quality neighborhood centers and smaller strip malls continue to fair well, with limited new supply. Always location-dependent, yields are attractive for many retail investments and should be attractive going forward.
Office - The office markets are the most uncertain. The idea of remote working has been around for decades, but the pandemic forced the issue on millions of workers for the first time. As of this writing there are numerous unknowns, and conflicting indicators (much like the economy). Most employers/managers want workers’ back full time. Yet most workers (who can work remotely) want to have greater flexibility. It appears the likely result of this will be a hybrid model—where remote working is coupled with returning to the office. The ultimate impact is yet unknown, but more than likely will be a significant roll-back of occupied space over the next couple of years. We expect vacancies to climb significantly. Rents in the office sector are likely to fall in the intermediate term.
Hotel - Hotel fundamentals bottomed in February and March 2021. As expected, travel is booming in a post-COVID world. As Americans adjust to a new normal in the post pandemic era, travel and hotel occupancies will commensurately rise over the next 2-3 years. Linneman Associates continues to believe that occupancy will reach the 2019 level by year-end 2023.
In summary, we recommend staying the course. While interest rate increases and pricing pressure are causing some disruption in the market for the short-term, we are still believers in the commercial real estate sector for the long-term. As such we are advising our clients to take a long-term perspective when transacting in today's market. Next month, we plan on sending out additional commentary on the transactional health of the marketplace - stay tuned. As previously mentioned our Trinity team is cycle-tested and based on this experience, we have seen some very good results come out of times with economic headwinds. Please feel free to reach out to any of us at Trinity to discuss any of your real estate concerns or if you would like to receive advice on the asset management of your commercial real estate asset(s). Happy New Year!