(AIMI) for Q2 dropped nationally on both a quarterly and an annual basis, driven mostly by record mortgage rate growth, which resulted in historic results.
The country and 11 markets saw the biggest annual fall in the index’s history. The AIMI index declined 17.9% from the second quarter of 2021 to the second quarter of 2018, or 11.7% overall.
The AIMI index considers employment, multifamily permits, net operating income, and property price to help investors assess the relative worth of investing in multifamily buildings in a few key metro areas.
The greatest annual increase in mortgage rates in AIMI’s history, which began in 2000, was 131 basis points. The 30-year fixed rate reached 6% last week.
Property values climbed significantly over the past year, rising by 21.8%, while net operational income (NOI) jumped by 17.7% and mortgage rates increased by 1.31 percentage points, the highest increase in AIMI history.
Every metro saw growth, and the national NOI increased by 3%. Phoenix had the weakest growth rate with a 4.5% increase, while Miami had the best performance with a 4.7% increase.
This won’t seem normal or enjoyable.
From the start of Q1 2022 until the middle of September 2022, US Treasury rates increased, high-yield loan funding has all but disappeared, and agency spreads have varied between 160bps and 200bps, according to David Fletcher, Managing Director, Head of Acquisitions at Excelsa Properties.
According to Fletcher, the remarkable rent rise experienced in the majority of the United States has kept cap rates from rising as much as they otherwise might have, according to Fletcher.
The option value of purchasing a 4% cap rate in an economy with a 3.4% 10-Year Treasury Rate (2.97% SOFR) will be drastically reduced if the unprecedented rent increase is removed, he claimed.
Fletcher continued, “The enormous rent growth won’t last for much longer.” “Multifamily investors will be compelled to return to a world where producing current yield and working hard to grow and improve properties are the only ways to make money.” While it is typical for anyone who has been in the industry for more than three years, the move away from ultra-low cap rates and loans with 80% LTV at 4% interest rates won’t feel “typical or enjoyable.”
The best deals are made when markets are disconnected.
According to GlobeSt.com’s interview with Neil Schimmel, CEO of Investors Management Group (IMG), “Investors can take advantage of good value by disciplined buying in down or stalling markets.”
IMG is currently engaged in three purchases, a refinance, and three disposals, according to Schimmel, making it the busiest it has ever been. “Market disconnects are when the best transactions happen, therefore I anticipate there will be more alluring entry points in the future.”
In cities like Atlanta or Greenville, South Carolina, where tenant demand is driving up property values, Schimmel said he buys.
He claimed that “our Class B apartment assets are prudently positioned to perform through cycles.”
Prior to 2008, subprime markets grew at an alarming rate, but today’s stronger credit standards have restored stability to the housing market and longer-term fixed-rate mortgages.
Fewer People Can Get Home Loans.
The Freddie Mac Multifamily Apartment Investment Market Index Fewer purchasers are now able to qualify for mortgages as a result of the quick increase in interest rates and subsequent rapid rise in mortgage rates, according to Doug McKnight, President and Chief Investment Officer at RREAF Holdings.
According to McKnight, “this has encouraged more families to stay in, or resort to, rental properties, both single-family and multifamily.”
The consequent increase in NOI and the ongoing decline in vacancy rates have increased rental market values as market rents continue to rise.
According to McKnight, as leverage eventually falls into the negative zone, cap rates will rise, which would probably cause markets to respond by driving down the value of rental assets.
According to him, RREAF “continues to be net buyers of multifamily buildings with a careful focus primarily on locations where migration and economic growth continue to show signs of strength, allowing us to retain returns to investors.”
Shrinking current buyer base
P.B.’s chief financial officer, Jeff Thompson Bell, tells GlobeSt.com that because home ownership is becoming less feasible in the current market due to rising mortgage rates, the number of renters has remained high.
According to Thompson, as interest rates rise, the number of investors in multifamily acquisitions has decreased. “People are still buying and selling even if the available buyer pool is getting smaller and the number of bids in the market is declining. Among other real estate investment options, multifamily is still a desirable option.
Ground-up development hasn’t been greatly hampered on the development side. Strong population and job growth in the Phoenix metro area continue to be favorable for the multifamily market.
Freddie Thinks Investment Choices Are “Moderating”
In prepared remarks, Steve Guggenmos, vice president of research and modeling at Freddie Mac Multifamily, stated, “NOI growth is strong even though higher rates and property prices have caused the index to decline.”
The decline in AIMI this quarter is a result of weakening investment conditions brought on by shifting economic trends. Vacancy rates are still low and rents are high because of the overall housing crisis.
We are ready to assist investors with Santa Ana multifamily properties. For questions about Commercial Property Management, contact your Orange County commercial real estate advisors at SVN Vanguard.
Many economists experienced a bad shock last week when the official consumer price index (CPI) was released. In reality, there was only one, and it suggested that the Fed would probably increase its benchmark interest rate by at least 75 basis points, if not more.
According to Charlie Ripley, senior investment strategist for Allianz Investment Management, “it’s becoming more evident to market players that the amount of tightening from the Fed thus far has not been enough to cool the economy and bring down inflation.”
These are the immediate repercussions. However, the company also took note of some additional repercussions through the potential implications that certain parts of inflation could have on the firms that have rent obligations. Groceries and dining are “one area where consumers’ wallets have taken a big hit,” they noted, because despite the fact that food price inflation “slowed by nearly a third last month,” it is still up 11.4% annually.
Value-oriented meal alternatives are popular in both grocery stores and restaurants. Nevertheless, people are once again spending more on dining out than on groceries. According to Marcus & Millichap, “although food prices are rising, eating out offers a convenience and social experience that may offset the higher checks in consumers’ perceptions.”
It’s safe to claim we can respond to the question, “Does history repeat itself? after experiencing a number of recessions and identifying important trends. The answer is a loud “yes,” but we can use what we have learned from the past to lessen the risk by planning ahead more effectively.
The news stories of today make it clear that a recession is either coming or has already begun. In any case, the commercial real estate industry has historically been affected by market downturns, and this situation is no exception.
Although past recessions have had both beneficial and negative effects on companies, from credit restrictions to changes in sales volume, the legal issues that arise are probably the most expensive and long-lasting. Understanding the risks that arose during previous recessions and how they were handled may help lenders and developers stay safe during these trying times.Additionally, being aware of the past might help both parties take the appropriate safety measures to prevent a repeat of the same events.
According to statistics, there are statistically more construction-related litigation cases than any other loan litigation claims in any given year, and these numbers are even higher during a recession. Recessions have caused and are expected to continue to cause a variety of legal problems with building financing. Without market changes, these loans are already risky, but during a recession, cash-strapped contractors or those who underbid a project may end up doing shoddy repairs. As a result, there may be more faults as a result of hurried work, supply chain delays, labor shortages, cost-cutting measures, and/or manufacturing issues.
Construction-related issues can become more common and more expensive to handle during a recession, in addition to a rise in construction-related issues. Government shutdowns can affect the timing of permits and even necessitate the suspension of project work amid a recession and pandemic, in addition to the more usual weather delays, workmanship concerns, and supply chain delays. Events of default under the terms of the loan, fines, or extension costs may be triggered by delays. They may also have an effect on long-term funding sources and result in higher carrying costs. Delays may also result in guarantor responsibility for some loans, making it harder for the project to sustain in the long run.
Of course, variable interest rates are sometimes a sign of a volatile market. Early interest rate locking, however, can have benefits and drawbacks. Variations in interest rates can have a significant impact on the expenses of completion for those uncommon construction-to-permanent loans. Numerous lenders had to make difficult decisions regarding the feasibility of loan commitments during previous recessions in the face of claims from borrowers, which led to many borrowers with forward commitments having loan approvals revoked as a result of shifting interest rates.
Broken promises may lead to protracted legal proceedings and, in rare cases, punitive damages. Additionally, the impact and delays that follow might virtually ruin a project’s feasibility. There may also be personal liability if there are guarantors on the loan and the borrower defaults. Numerous lawsuits involving loan commitment termination were filed during previous recessions, and many courts carefully considered whether the reasons for the termination were valid.
Finally, a less reliable renter pool can result from recessions. Borrowers are more likely to default on their mortgage payments when tenants are unable to uphold their rental responsibilities. It should come as no surprise that during a recession, there are more foreclosures, deeds in lieu of foreclosure, and collection attempts. Due to the financial uncertainty, there are more bankruptcies.
Contrary to what many commercial lenders and developers may believe, a recession can really present opportunities. With appropriate planning, some risks may even be reduced. I genuinely believe it comes down to these ten suggestions after decades of risk management and litigation in the aftermath and with the benefit of hindsight:
To completely comprehend all of your contract provisions, have a new set of eyes look over your loan documentation, building contracts, and land purchase agreements. Make sure to carefully review your notice requirements and force majeure clauses and to adhere to them. Throughout the course of the project, review your documentation frequently, especially if construction loans are involved.
Ensure that your deadlines are consistent across all of your documents. Give yourself plenty of time to account for conceivable delays that might be unavoidable.
Make sure you start off by keeping precise, thorough records and notes. Follow up on the performance of the contract, noting any deviations or delays.
Inspect the area on a regular basis. Lenders should personally verify that deadlines are being followed while owners and developers should be monitoring their contractors and the project’s progress.
The key is communication. Although it sounds cliche, effective communication can save a relationship and raise the likelihood that a loan or contract can be modified when necessary.
Examine and keep your insurance.
Limit your promises. Although managing expectations may seem easy, it can sometimes make a difference in a project’s success.
Maintain your lane. In a recent ruling, a judge stated that “[i]f a lender exercises excessive control over a borrower, Although there is no fiduciary responsibility, “if a lender takes a particularly active role in the business decisions of the borrower,” it “may become liable for tortious interference,” even in the absence of one., a lender can take on the role of fiduciary rather than creditor.
Make use of specialists who have the expertise and knowledge to handle any issue that may arise, such as construction managers, inspectors, supervising architects, lawyers, and/or accountants.
Request document revisions as needed, secure the relevant approvals, and record any alterations to agreements.
Following these ten procedures will reduce legal risk, if not completely eliminate it, even during a recession.
We are ready to assist investors with Santa Ana Commercial Real Estate properties. For questions about Commercial Real Estate Investments, contact your Orange County commercial real estate advisors at SVN Vanguard.
The good news is that REITs as a group have recently performed well. They were up 4.2% as of last Friday, per BTIG Research. Comparatively, the S&P 500 and Russell 2000 stock indexes saw returns of 3.6% and 4.0%, respectively.
But then there was this line: “Rates are expected to be in focus again for REIT with strong inflation measures on tap for this week’s economic calendar (CPI prints on Tuesday, PPI prints on Wednesday).”
Additionally, Tuesday’s CPI prints, sometimes known as inflation data, fell far short of forecasts. Almost everything else was up, even if oil was down. Core inflation, which excludes food and energy, reached 6.3%, exceeding experts’ expectations by a factor of 2. Consumers suffered from the basics. Monthly growth in food was 0.8%. Shelter increased by 0.7% from month to month. August to July had a 0.5% increase in transportation.
When the Fed meets next week, the benchmark interest rate will likely rise by 75 basis points, with a potential increase of 1 percentage point.
According to a Nareit piece from early 2022, inflation is often advantageous for REITs. The company stated that “REITs have traditionally offered protection against inflation and outperformed the broader stock market during periods of moderate and high inflation,” where it defined moderate inflation as occurring between 2.5% and 7.0% and high inflation as occurring beyond 7.0%.
But there are also interest rates, which the Fed has aggressively raised in an effort to restrict economic growth and bring inflation back to about 2%.
According to BTIG’s analysis, “REITs as a sector have significantly cleaned up their balance sheets since the GFC.” However, in 2022, both the weighted average rate on REIT debt and the ratio of interest expense to NOI will be at historic lows. If rates continue to rise, which they will, this creates a danger to projections and results.
As a result of rates being so low for so long and seeing so many false starts, the company added, “We think there is a danger that interest expense has been rooted in consensus projections.” To put things in perspective, the current SOFR forward curve indicates an average rate of 3.84% in 2023, before taking into consideration any credit spreads. As a result, the weighted average rate for total REIT debt throughout the industry in 2023 will be higher than the average 1-month rate at present. Unhedged variable-rate balances will be impacted by this, and there may be volatility for external growth if buyers are compelled to reevaluate their financing assumptions.
Experts predicted that inflation would decline as a result of the decline in oil prices, which moderated the strong impact energy has had on the economy. Not at all. It became worse.
In one sense, it wasn’t by much—the rise was 0.1 percentage points. But given the expectations, it came as enough of a shock for the markets to tremble. As of 10:15 a.m., the S&P 500 was down around 2.6%, the Dow was down 2.3%, and the Nasdaq was down 3.2%, according to S&P Global Market Intelligence.
As this episode of inflation shows to be anything but “transitory,” Cliff Hodge, chief investment officer at Cornerstone Wealth, said in a statement sent by email, “Misses on both the headline and core are disappointing.”
There are two things it means for CRE. First, it is unlikely that the Federal Reserve will stop raising interest rates. Consider that in its scheduled meeting next week, a minimum 75-basis point increase is a given. It’s possible that it would increase by a full percentage point in response to the shift, which would result in significantly higher financing costs for all real estate projects. If you previously borrowed at significantly lower rates and are getting ready to refinance, this is bad news for you.
According to Charlie Ripley, senior investment strategist at Allianz Investment Management, core inflation, which excludes food and energy, increased “twice as quickly” as predicted by experts, reaching 6.3%. Market investors are starting to realize that the Fed’s current level of tightening is insufficient to slow the economy and lower inflation, according to Ripley. The Bureau of Labor Statistics emphasizes the second aspect of the impact, which is more indirect and has to do with the specifics of inflation.Since the beginning of the year, the main causes of inflation have been energy and related commodities. The biggest declines are now visible, but inflation is still rising. Even still, the annual increase in energy is still 23.8%. Hodge stated that “price hikes were prevalent,” with more than 70% of the CPI basket increasing by at least 4% annually.
Monthly growth in food was 0.8%. Even though it’s the slowest expansion since February, the unadjusted 12-month growth rate of 11.4 percent is still impressive.
Rent and similar housing costs for homeowners increased by 6.2% annually and 0.7% month-over-month. The core services sector continues to see housing prices lead the way, rising 0.7%, the fastest monthly gain since January 1991, according to Oxford Economics.
Transportation increased by 0.5% from July to August and has increased by 11.3% annually.
Consumer confidence will undoubtedly decline as they experience a tighter strain on necessities, which will also affect their capacity to spend money on other things. The pressure on retail and hospitality might possibly increase, posing a bigger risk to owners and operators from tenants. Casual travel and hospitality could suffer as a result. Because forcing people back into the office would increase costs for the employees, the office, which is already under pressure, might discover that tenants don’t feel they can do it as easily.
Overall, there is no positive news.
We are ready to assist investors with Santa Ana Commercial Real Estate properties. For questions about Commercial Real Estate Investments, contact your Orange County commercial real estate advisors at SVN Vanguard.
According to a recent study from Trepp, CMBS delinquency rates in August 2022 were 2.98%, finally dropping under 3% for the first time since the pandemic. They had hardly decreased below 6% the previous year. Six months have passed since they fell below 4%.
Delinquency for CMBS peaked at 10.34% in July 2012, marking its all-time high. 10.32% was the pandemic’s peak in June 2020.
The percentage of loans that were at least 60 days past due, in foreclosure, REO, or non-performing balloons was 2.89%, which does indicate that the majority of delinquent loans face significant issues. Following that, foreclosure properties accounted for 100 basis points of the total. According to Trepp, “If defeased loans were taken out of the equation, the overall 30-day delinquency rate would be 3.14%.”
Commercial mortgage-backed securities are a significant component of CRE. The CMBS structure enabled lenders to free up capital for additional investments by bundling commercial mortgages into financial instruments that resembled bonds and offering fixed-income to investors in exchange for upfront payments.
According to the Trepp analysis, the decline in delinquency rates is not unexpected. As loans in those categories “continue to see steady improvement each month as loans in those categories cure and/or pay off.”
Lodging delinquency was 5.18%, down from 12.05% a year before. Retail is down from 10.43% last year to 6.45% this year.
Due to continuous pressures around work-from-home, including many employees’ want to continue working from home, office still confronts difficulties. The firm warned that because most businesses are bound by five- and 10-year leases, the effect “will take years to play out.” The office delinquency rate is 1.50% currently, compared to 2.12% last year.
Gerard Sansofti, an executive managing director and the head of JLL’s debt and loan sales platform, claimed in an interview with GlobeSt.com in February 2022 that the general financial meltdown in 2008 resulted in major improvements to the structures of CMBS issuances.
The structures are likewise less important to the projects. Over 50% of the market used to be CMBS. “Today, 10% to 15% of the market is affected. There is substantially more capacity at banks. Additionally, insurance firms have a lot more money. I don’t see the liquidity problem we experienced previously.
Our Orange County commercial real estate brokers will help you every step of the way in finding the right commercial investment property, contact us for details.
As output boosted the US economy in July, volume at The Port of Los Angeles reached its sixth all-time high in seven months, raising concerns about the area’s infrastructure, warehousing demand, and rate structures.
A total of 935,345 Twenty-Foot Equivalent Units (TEUs) were processed in July, breaking the previous record from 2019 by 2.5%.
At a news conference on Wednesday, Port of Los Angeles Executive Director Gene Seroka stated, “Remarkably, we continue to move record amounts of cargo while working down the backlog of ships by almost 90%, a remarkable accomplishment by all of our partners.
Observing that ships are now waiting for space at numerous other ports across the US, Seroka claimed that the supply chain environment in Southern California has improved.
Regarding the biggest port in the world, Seroka remarked, “Our terminals have capacity. For cargo owners looking to re-chart their course, come to Los Angeles. We’re ready to help.”
“We are also seeing many third-party logistics (3PLs) and warehouse users over-order their supply, as it has been hard to get goods from overseas since the pandemic started.
“The record volume has caused rental rates for industrial to rise dramatically. There is not enough warehousing supply to meet the influx of containers and product flooding the Southern California industrial market. With a sub 1% vacancy rate and a scarcity of industrial land, tenants are having a difficult time securing the space needed to store these goods.”
“We predict that tenants will be forced to be searching for warehousing in more peripheral markets where there is more supply of industrial land.”
Highest Rent Gains in Boston, New Jersey, and the Inland Empire
Supply-chain issues, according to Doug Ressler of Yardi CommercialEdge and GlobeSt.com, are making it more important than ever to be strategically situated and pay a premium for space in port areas, which have had the biggest increases in in-place rents in the past year.
According to Ressler, the areas with the highest rent increases are the Inland Empire (8.7%), Boston (8%), New Jersey (7.8%), Los Angeles (7%) and Orange County (6.8%). Additionally, port markets have the lowest vacancy rates. The Inland Empire is at 0.8%, Los Angeles is at 1.9%, and Orange County is at 3.1% in Southern California, which has the narrowest region.
According to Ressler, “The United States is a consumption-driven economy, and most goods come into the country from elsewhere, Estimates peg transportation as accounting for at least half of companies’ supply-chain costs. Although energy prices have fallen of late, those costs are still elevated compared to historical averages.
“Recent supply-chain stresses have illuminated exactly how dependent the U.S. is on other countries for both raw materials and finished products. As a result, firms are now exploring reshoring and nearshoring of manufacturing, which would reshape supply chains but also lead to new challenges.”
Many states around the US, including Florida, California, Minnesota, New York, and Nevada, continue to discuss and implement rent control.
According to a study released this week by the National Multifamily Housing Council, a number of proposals have either been passed, rejected, or put on the ballot in November (NMHC).
According to Ric Campo, the company’s chief executive, apartment operators like Camden recently said in The Wall Street Journal that “it will not build in a rent-control market.”
According to Sean Rawson, co-founder of the California-based Waterford Property Company,“From a public policy perspective, rent control is an extremely short-sighted way to provide housing affordability.” As a developer and investor in affordable housing, Waterford is a strong supporter of income-restricted housing; yet, imposing rent control unfairly burdens private investors, deters new investment in communities, and costs the long-term rental advantages.
“In my opinion, the long-term negative effects far outweigh any short-term political benefits for elected leaders.”
Building permits in Florida often take two years to obtain
These administrations keep citing a lack of homes and rising demand. The recent declaration of a housing state of emergency in Lake Worth, Florida, was considered as the first step toward attempting to enact rent control.
Governments continue to use regulation to stall the building of new homes. According to a recent survey by NMHC and the National Association of Home Builders, the average cost of developing a multifamily property is 40% accounted for by regulations at all levels of government.
According to the Florida Apartment Association, some Florida developers have to wait up to two years to get their building permits.
A review of the status in each state
A resolution to put rent control on the ballot was approved by Orange County’s County Commissioners in Florida. If adopted by voters, the resolution would set a one-year limit of 9.8 percent on rent increases in Orange County.
The city councils of Tampa and Saint Petersburg both voted down initiatives to place rent regulation on their November ballots.
The influential Culinary Workers Union Local 226 in Nevada committed to keep working for passage, and according to NMHC, “we expect a fight at the state level in 2023.”
Kingston, New York, became the first upstate city to establish rent control in the state of New York. 90 miles north of New York City is Kingston.
According to local reporting, the legislation applies to structures with six or more units constructed before 1974, which corresponds to around 1,200 units.
In California, Richmond’s city council decided to put a rent control issue on the November ballot. Richmond is located immediately north of Oakland.
According to NMHC, “if passed, rent increases would be capped at 3 percent of a tenant’s existing rent or at 60 percent of the Consumer Price Index, whichever is lower.”
In November, a rent control referendum will also be held in Pasadena.
Commercial real estate has continued to test its speed limit on the path to normalcy through mid-2022. Though coming off 2021 highs, price momentum in the sector has sustained throughout the first half of 2022, generally following deal volume activity over the same period. The Industrial sector continues to lead the post-COVID hierarchy, pushed by a prolonged shift in warehouse demand as goods inventories pile up amid complex supply chain and consumer demand dynamics. The Multifamily/Apartment sector is close behind, benefiting from robust demand that has only intensified in recent
months as homebuying becomes increasingly unaffordable for many would-be buyers. Meanwhile, the Office sector continues to lag behind its peers as space demand settles at a new post-pandemic low, driven by remote work adoption. The Retail sector, despite a slow start to begin the recovery, achieved record annual price growth in Q1 2022, which coincided with a seven-year high in deal volume. In this commercial real estate mid-year update, the SVN | Research team explores MSCI Real Capital Analytics (MSCI RCA) data on transaction volume, pricing, and cap rates, comparing current trends to ones observed before and during the onset of the pandemic.1
Through July, measured by MSCI RCA’s Commercial Property Price Index (CPPI), commercial real estate prices have risen by 16.8% from one year ago. The latest figures are just a tad under the record 19.9% pace that was registered earlier this year and reflect an industry that continues to be a bright spot amid a storm of economic headwinds. Properties that are located both inside and outside of gateway metros have moderately slowed in recent months but have shown the ability to absorb the early effects of monetary tightening, climbing by 8.9 % and 19.3% year-over-year, respectively, through July.
Growth in gateway markets has consistently trailed non-gateway metros throughout the pandemic recovery, as corporate America inched its way into a new normal within larger cities. Somewhat surprisingly, the divergence only intensified as the United States moved beyond COVID-era policies and activity restrictions.
The growth spread between non-gateway metros and the top six major metros was relatively unchanged between December 2020 and July 2021 but began to balloon as the Delta variant took hold in the Fall. As Delta subsided to start
2022, inflation in the US intensified, with non-major metros experiencing a higher degree of cost increases relative to larger cities. So-to did the growth spread between gateway and non-gateway metros, which swelled to 10.43% through July 2022 — more than double its growth spread from one year ago.
The variation between gateway and non-gateway inflation rates likely explains a significant part of why we are seeing a similar pattern among commercial real estate price growth.
The Apartment market continues to be a stalwart not only for commercial real estate but for the US economy at large. According to MSCI RCA, Apartment transactions rose by $18 Billion from Q1 to Q2 2022, a 26% increase quarter-over quarter and up 42% from one year ago.
While transaction volume in the sector has receded from the record highs achieved in 2021, it continues to benefit from robust housing demand amid increasingly limited supply. If Apartment sector volume were to continue its pace set during the first half of this year, it would amount to more than $309 billion in sales, second only to 2021’s record level.
Through Q2 2022, unit prices are up 25.6% year-over-year — an all-time high for the sector. Amid rising prices and increased buyer activity, cap rates have continued to fall to new lows, dropping 10 bps to 4.3% in Q2. Between 2011 and 2019, a rough approximation for the last real estate cycle, cap rates fell an average of 17 basis points annually. According to the latest data, cap rates are down by a weighty half-percentage point from one year ago.
Transaction volume in the Office sector continues to trail pre-pandemic levels as remote work gains what signals to be a permanent foothold in the US labor market. Through the second quarter of the year, MSCI Real Capital Analytics has tracked $57.7 billion worth of Office sales, an improvement from the same period in 2021, but roughly $10 billion below
the first-half 2019 pace.
Projecting out the half-year data over the rest of 2022, the annualized total of $115.4 billion would amount to just 80% of both 2021 and 2019 volumes. However, it is worth noting that transaction volumes across most property types tend to peak in the fourth quarter — in the five years before COVID, CRE transaction volume was 22% higher on average during the second half of the year compared to the first. The seasonality was exacerbated in Q4 2021 as inventors readied for the impending Fed tightening cycle — Office sector transactions achieved near record-volume in Q4 2021 ($56.6 billion).
The trend suggests that 2022’s first-half improvement over last year may be a more reliable signal than the annualized projection. Still, as 2021 ended, Office investors still largely anticipated a normalization of attendance levels as pandemic era activity patterns waned. So far in 2022, all evidence has pointed to the contrary, and Office transaction volumes are likely to stall in the fourth quarter of 2022 compared to previous years as a result.
Entering the pandemic, office space on average was transacting at $238 per square foot. Pricing fell to a low of $235 per square foot between Q2 and Q4 2020 and has since rebounded to new highs — reaching $278 per square foot in Q2 2022. As of Q2 2022, office space is transacting at an average of $289 per square foot, up 13.3% year-over-year and 2.2% quarter-over-quarter. Cap rates on Office properties continue to reach historical lows, falling to 6.0% in Q2 2022. Over the past year, cap rate compression in suburban offices has driven much of the reduction in the broader sector.
The Retail sector has shaken off early pandemic headwinds, registering its highest first-half of the year transaction volume since 2015. Further, through the second quarter of 2022, Retail led all sectors with a 46% year-over-year increase in deal volume. Notably, compared to other CRE types and their sub-sectors, Retail has experienced the largest variation in sales growth between its two sub-sectors over the past 12 months. Transaction volume at shopping centers rose 186% year-over-year through Q2 2022, while shop sales rose just 52%.
Though annual growth has fallen below the triple-digit increases seen throughout 2021, much of last year’s high marks were due to base effects stemming from an anemic market in 2020. If Retail volume was to continue at its current pace for the remainder of the year, it would set a record $89.2 billion in transaction volume. Considering that this projection does not factor in the typical volume uptick during the fourth quarter, Retail is poised have a banner year in 2022, all else held constant.
Retail cap rates ticked down 10 bps quarter-over-quarter to a new all-time low of 6.0% in Q2 2022. While cap rates in the sector held relatively steady throughout much of the pandemic, they have fallen by 40 basis points over the past year as property values have risen more rapidly than rents. Retail price per square foot reached $313 in the second quarter, the highest mark on record.
Moreover, the price per square foot for transacted Retail assets has risen on a year-over-year basis for five consecutive quarters. Prior to the recent string of price growth, annual pricing had declined for four consecutive quarters. Through Q2 2022, Retail price per square is up 24.9% year-over-year, the fastest annual pace on record.
The Industrial sector has seemingly had the wind at its back ever since the end of the Great Recession, and this was only intensified by the positive shift in goods consumption that we saw take place during the pandemic. Through the halfway mark in 2022, sector growth remains as strong as ever. According to MSCI Real Capital Analytics, $74.9 billion of Industrial asset sales have changed hands through the first two quarters of 2022, amounting to 134% of 2021’s first half volume. Annualizing the first two quarters of sales suggests that the sector is on pace to hit $149.2 billion worth of
transaction volume by the end of the year.
Like the pattern evident across all CRE sub-sectors, Industrial transaction volumes could accelerate during the second half of the year. For instance, in Q4 2021 Industrial transaction volume totaled a massive $77.3 billion, roughly $20 billion more than the first two quarters of 2021 combined. While last year’s market was partially fueled by monetary policy tea leaves, if Industrial experiences an uptick in Q4 2022 that is anywhere close to what we saw last year, the sector will set an annual total that is well ahead of what it has to date.
Like all other sectors, cap rates for the Industrial sector continue to chart new lows, falling 10 bps quarter-over-quarter and 40 bps year-over-year. On the other hand, asset pricing continues to reach record highs both in terms of observed levels and annual growth rates. As of Q2 2022, Industrial assets are trading at an average of $175 per square foot, rising $8 from the previous quarter and $32 from one year ago. Through the second quarter, asset price growth in the sector has achieved a new record high of 32.0% year-over-year first achieved in Q1.
The US economy is sending mixed signals, to say the least. Inflation continues to sit near generational highs, with the Consumer Price Index (CPI) climbing by 8.5% over the previous 12 months through July. A flattening of headline CPI between June and July has escalated hopes that the Federal Reserve’s monetary tightening may be having an impact on price pressures. Still, Fed Chair Jerome Powell along with several other FOMC voting members have indicated in recent statements a willingness to push ahead with hikes until the economy has achieved a sustained reduction in price growth.
The feared double-edged sword of rising rates has indeed begun to poke out in both directions. Real GDP declined by an annualized 0.6% in Q2 2022, according to the latest estimate released by the Bureau of Economic Analysis (BEA) in August, the second consecutive quarterly reduction. A fall in private inventory investment, residential fixed investment, federal government spending, state and local government spending, and nonresidential fixed investment over the quarter fueled the decline. Notwithstanding, consumer spending remains robust while US exports increased in the second quarter. That sustained economic activity is evident in the continued strength of the labor market, which added 528,000 jobs in July as the unemployment rate ticked down to 3.5%.
Whereas in 2020 and 2021, commercial real estate success was propelled by unprecedented economic stimulus followed by a momentous reopening of the economy, it is now being fueled both by late-cycle demand and the cascading of costs related to supply shortages. The above can be inferred because, while each major sector besides Office saw an annual transaction volume climb through Q2 2022, all four sectors saw a decline in the numbers of properties transacted. Builders have sounded the alarm for months on the challenges brought by labor and materials shortages that are hampering their ability to complete new projects. These added costs amid the backdrop of sustained demand are adding significant value to assets.
Each sector of CRE will have its own key factors to look out for as we progress through the second half of 2022. Apartment assets should continue to benefit from consumers trickling out of the home buying market and into the rental market. New home sales fell sharply in July, down -12.6% month-over-month and -29.6% year-over-year. Much of the would-be housing demand will overflow into apartments, but tenant affordability concerns will likely intensify. The fate of Industrial assets will largely depend on Retail inventory volume in the coming months. Retail inventories excluding autos increased by 1.5% in July, according to the Census Bureau, as pent-up orders from earlier in the year get stocked away. However, many Retail market watchers expect record discounting this holiday season as firms look to reduce inventory — an important signal to keep an eye on.
Office appears to be settling into a new post-COVID equilibrium, but one where quality, accessibility, and amenities are arising as key differentiators for space demand relative to centrality. Retail has enjoyed a sizeable rebound so far this year, and where consumer spending evolves from now will be a key barometer for the look ahead. While many consumers remain skittish about inflation and are enduring tough spending decisions in each paycheck, consumer sentiment has begun to rebound from its historic low reached in June. Even with a few traffic jams along the way, commercial real estate and the US economy as a whole are still moving forward with pace.
