The movement for multifamily rent regulation has gained momentum nationwide over the past few years, and the pandemic has increased political and popular support for tenant safety. The effects that these policies will have on their business and their capacity to create housing have been vocally expressed by multifamily owners as a source of concern.
Owners are actively avoiding markets with rent limits or seriously considering leaving markets that enact these rules, according to a report by the National Multifamily Housing Council from earlier this year.
In 2019, Gov. Gavin Newsom signed AB 1482, which places a 10-year cap on how much landlords can raise rent in a sizable number of buildings throughout the state. California has had rent regulations in various forms for decades. Rent increases of more than 5% plus inflation per year are prohibited for multifamily landlords, as well as for owners of condominiums and single-family houses who are 16 years of age or older. According to the statute, landlords are also required to give “just cause” for evictions.
According to Doug Perry, senior vice president of sales at Archwest Capital, the law didn’t have the significant effect that many in the CRE industry had hoped.
The landscape didn’t shift overnight, according to Perry, whose company is a direct commercial lender with a nationwide concentration on multifamily and mixed-use properties. Rent control rules haven’t affected the way we underwrite loans, but they have made some situations a little more difficult.
For instance, it could be more challenging to complete a value-add project that entails purchasing a property with a lot of unfinished maintenance, upgrading it, and then boosting the rent.
There are workarounds that can be useful, such as “cash for keys,” in which a renter is given a lump sum in exchange for leaving a rental property. Most of the time, the rent for the apartment can be changed to reflect market rates. However, it can cost a lot of money to evict residents, and that money isn’t going toward the main goal of these projects, which is to improve the building so that the apartments can draw higher-paying renters.
According to Perry, “Sometimes the cost of doing that drives the cost of the whole project to the point that it’s just not a profitable project, and it doesn’t make sense.”
Value-add deals may take longer to complete if there are eviction moratoria, like the one that is still in place in Los Angeles.
Shahin Yazdi, partner and managing director of George Smith Partners, which arranges loans for CRE borrowers nationwide, said that it is “simply not as realistic” for the borrower to expect to be able to turn an entire building when there is an eviction moratorium and you can’t perform no-cause evictions.
Instead, it is necessary to diminish expectations, either that it will take longer to empty the building or that it won’t be empty enough. This means that the transactions must make financial sense even if only a portion of the building—say, half or a third—is made accessible to new, wealthier tenants. But in other situations, the resilience of multifamily during the epidemic has made this conceivable.
Regarding Los Angeles and its current eviction moratorium, Yazdi noted, “Multifamily continues to be a strong performing asset, even with people not paying. The foreclosure rates didn’t skyrocket. Landlords, maybe they did some deferred payments, but they continue to make their mortgage payments, so it’s a great asset class for lenders.”
Despite the optimistic response from the lender side, a study released in January 2022 by the National Multifamily Housing Council revealed that efforts to enact rent control are having an impact across the country, not just in California.
The study asked 78 CEOs and senior executives at national “apartment-related firms” if the growing number of areas that had implemented, strengthened, or were considering rent control or rent ceilings had an impact on development and investment decisions. According to 32% of respondents, people who practice rent control already shun those markets, and 26% indicated they had reduced their investment in those markets as a result of the local rent control policies.
But nearly as many respondents — 23% — said they don’t plan to change anything about their investments or developments in these areas despite rent control.
Despite the growing popularity of rent control pushes across the country, California seems to stick out among the crowd. Respondents to the NMHC survey were asked to list markets they are specifically avoiding, either due to existing rent control measures or the threat of new policy adoption. Of the 31 respondents who answered this question, 55% indicated specific markets in California or the state as a whole, NMHC said.
On July 6th, the Federal Reserve’s Federal Open Market Committee (FOMC) minutes from its June meeting were made public, and they contained some fascinating information for the real estate sector.
The first was a direct reference to bank lending for commercial real estate:
“Commercial and industrial (C&I) and commercial real estate (CRE) loans on banks’ balance sheets expanded at a rapid pace in April and May. Issuance of both agency and non-agency commercial mortgage-backed securities (CMBS) stepped down slightly in May from its strong pace earlier in the year. Small business loan originations through April were in line with pre-pandemic levels and indicated that credit appeared to be available.”
For a majority of borrowers, residential mortgage credit was “widely available” through the month of May, however independent of the Fed’s observations, persistently increasing rates are discouraging most borrowers. According to information from the Mortgage Bankers Association that Trading Economics has compiled since January, there have been twice as many weeks in which the number of mortgage applications fell in contrast to weeks in which numbers of mortgage applications showed increasing numbers.
The minutes stated that “While refinance volumes continued trending lower in April and May amid higher mortgage rates, outstanding balances of home equity lines of credit at commercial banks posted the first significant increase in more than a decade, likely reflecting a substitution by homeowners away from cash-out refinances.” Bank interest rates for C&I and CRE loans have climbed, and yields on non-financial business bonds are far above pre-COVID levels.
According to Alex Killick, managing director at CWCapital, “Commercial real estate has historically been a hedge against inflation, and we continue to see sturdy rent growth in the multifamily and hotel sectors.” That being said, Killick noted that cost inflation, notably for staffing and insurance, is impacting NOI margins, particularly on office and retail properties where tenants are on long-term fixed rent leases with escalations of 2% to 3% annually, below the rate of expense inflation.
Killick also states, based on Fed notes and plateauing trends of some commodity prices, looming fixed rate loan maturities in 2023 and 2024 represent “the biggest near-term risk in CMBS,” with projected refinancing charges between 1 and 2 percentage points higher than current rates. Where NOI has also been influenced by rising expenses, may go through a level of distress that is greater than anything we haven’t experienced prior to the 2020 COVID default wave,” he adds.
Al Lord, CEO of Lexerd Capital Management, which largely focuses on multifamily – what he claims is a present bright spot. Lord says interest rate increases would negatively influence financing costs of commercial real estate projects and on the margin, we anticipate some projects to be canceled. The demand for rental housing is so robust that, despite increases in the cost of financing MF real estate projects, this asset class is predicted to do well for investors through at least 2023.
According to one market observer, investors “shouldn’t be concerned of an oncoming recession” and instead should think about the economic outlook over the next 3, 5, and 10 years.
Because there are so many different economic crosscurrents at play, it’s difficult to predict whether and when the next recession will occur. According to John Chang of Marcus & Millichap, these factors make it very hard to anticipate a recession, and even while “the risks are mounting,” a recession is not a given.
On the one hand, according to Chang, job growth is strong, with 488,000 new positions added each month on average this year. 3.6 percent is the current unemployment rate, and 5.2 percent is a significant pay growth rate. Additionally, despite recent stagnation in retail sales, they are still growing by almost 8%.
According to Chang, ” “Those are all positive economic readings pointing to a steady growth outlook.” Chang also notes that on the other hand, we have rising interest rates, a declining stock market, a record-high inflation rate of 8.5 percent, and declining confidence levels. There is in many respects a fear element at play that can force individuals to cut back on their spending and bring about a recession.
Therefore, is it really important if the US experiences a recession? Chang says it depends on the situation.
Chang claims that the current situation is unlikely to experience the liquidity shortage that the Great Financial Crisis did, which limited real estate investment. Although there are many different reasons and repercussions for recessions, Chang believes the US is likely to see one similar to that of the 1981 or 1990 downturns. Strong growth and rising inflation in the years before both of these periods influenced the Fed to raise interest rates aggressively, as we are seeing today. Chang observed significant variation among property types, with apartments, for example, holding up well in the 1980s and dipping mildly negative in 1991 – though “nothing like the hit the sector took in 2009,” he says. Yields softened in both recessions, but not to the extent of the decline in 2009.
The location and asset will determine a large portion of the risk to CRE investors. However, according to Chang, “in general, real estate has generated good returns through most recessions.” “And even when returns fell, there was typically strong, steady growth in its wake. Therefore, yes, economic downturns do affect commercial real estate, but not nearly as much as we may think.
We are ready to assist investors with Santa Ana commercial properties. For questions about Commercial Property Management, contact your Orange County commercial real estate advisors at SVN Vanguard.
Stephanie Suarez is an Administrative Assistant at SVN Vanguard. Stephanie was born and raised in Orange County, CA. She received her AA degree from Santa Ana College and is currently working on a degree in Communications at Cal State University – Fullerton.
Stephanie has worked in property management since 2017 and is excited to be gaining more knowledge in the industry. In her free time, Stephanie enjoys books, a nice of tea, a good movie, and a hearty laugh.
Fullerton, CA – April 14, 2022 – SVN | VANGUARD, one of the nation’s premier commercial brokerage firms, has negotiated the sale of the Vanguard Business Center, a 35,093 square foot, office building located at 2601 -2651 Chapman Avenue in Fullerton, CA to an undisclosed buyer for $9.25 million.
Jon Davis, Senior Vice President at SVN | Vanguard represented the sellers in the transaction.
The site has been approved for a student housing development as it is in close proximity to California State University, Fullerton. The site is across the street from an existing mixed-use student housing development known as Alight Fullerton. Other notable educational institutions in the area include Hope International University and Fullerton College.
About SVN | Vanguard
SVN | Vanguard is an independently owned and operated SVN® firm with offices in Santa Ana & San Diego, CA. The SVN® brand is a globally recognized commercial real estate entity united by a shared vision of creating value for clients, colleagues and communities. Currently, SVN comprises over 1,600 advisors and staff working in more than 200 offices across the globe. SVN’s brand pillars represent the transparency, innovation and inclusivity that enable all our advisors to collaborate effectively with the entire real estate industry on behalf of our clients. SVN’s unique Shared Value Network® is just one of the many ways that SVN Advisors create outsize value for all stakeholders. For more information, visit www.svn.com.
Whether you own, or you’d like to own multifamily, retail, office or industrial properties, the SVN Vanguard team can help. Contact us for details on our commercial properties for sale and lease.
As the pandemic sent corporate America from boardrooms to bedrooms in 2020, long-held assumptions about productivity are now rightfully up for debate. On one side of the spectrum are those that argue that office spaces facilitate an agglomeration of ideas, culture, and productive output. On the other hand, many argue that long commutes into places of work are outdated norms, and the commute time saved by remote work can generate both greater worker productivity and improved quality of life — a classic case of having the cake and eating it too. Now, with 2021 in the rearview, and after two distinct COVID waves derailed back-to-office timelines, there has been little resolution to the so-called big questions from a year ago.
According to The Pew Research Center, as of January 2022, for American adults who report being able to complete their jobs from home, 59% are doing so most or all of the time, and 18% do so some of the time. The VTS Office Index (VODI), which measures new Office leasing demand, remained down by 42% relative to its pre-pandemic benchmark through the end of 2021. As the public health threat lessens, these data will undoubtedly improve, but the question is by how much. In a tight labor market, the desires of workers can quickly transition into leverageable demands.
According to Morning Consult’s tracking of remote workers, 84% have enjoyed being remote, 79% feel they are more productive working remotely, and 76% would be more likely to apply for a job that offers remote work.1
SVN® Product Council Office Chair Justin Horwitz notes that “arguably, Office properties were the most negatively impacted of all the product types as a result of the pandemic.” However, he holds that 2021 was a year of recovery as sales volumes came back to peak levels thanks to returning “investor demand for quality office buildings, […] particularly for well-stabilized assets in strong locations.”
In their Q4 2021 report, Moody’s Analytics REIS attests that while the stage was set for Office sector distress in 2021, the incoming performance data failed to show it.2 Effective rent growth remained negative to begin last year but had returned to growth by the third quarter. Through Q4 2021, of the 82 markets that Reis tracks, 59 had positive absorption, 53 had improving occupancy, and 61 saw improving rent growth — a stark contrast from one year ago.
The open questions over the workplace of the future and its role in our daily lives appear most pertinent to Gateway markets such as New York. According to New York’s MTA, ridership of NYC’s subway system is forecast to be a long way off pre-pandemic ridership levels through 2025.3 Moreover, many of its stations seeing the largest declines in ridership are in Central Business Districts (CBDs) such as Midtown and Manhattan’s downtown Financial District.
Outside of Gateway markets, the picture on the horizon appears a bit rosier. According to a Chandan Economics analysis of Real Capital Analytics data, Suburban Office valuations continue to soar. Over the past three years, the relative price per square foot premium an Office sector investor would have to pay for a CBD asset over a Suburban asset shrank from 79% to just 49%. Mr. Horwitz notes that “suburban markets are the beneficiary of businesses adjusting to the “new normal.”
Transaction volumes for Office assets saw considerable improvement in 2021. According to Real Capital Analytics, more than $139 billion of asset value traded hands last year, a 56.5% improvement over 2020’s total. Still, despite the improvement, the Office sector was the only major CRE property type that did not eclipse its 2019 peak in 2021, as transaction volumes fell about $5 billion short.4 While the resumption of strong trading volumes is encouraging, the apparent lack of pent-up demand that has been observed in other property types may signal continued concern for the sector as hybrid work figures to be a market-shaping force for years to come.
Cap rates for Office properties declined steadily throughout 2021, finishing the year with a sector average of 6.2% — down 31 bps year-over-year.5 Suburban Office assets continued their bull run in 2021 as pandemic-induced migration patterns and remote work adoption has proven broadly supportive of suburban commercial real estate at the expense of central cities, especially in Gateway markets. Last year, cap rates for suburban Office assets sank by 38 bps, settling at 6.3%.6 As recently as mid-2019, the cap rate spread between suburban and Central
Business District located Office assets stood as high as 147 bps.7 Through Q4 2021, this spread has fallen to just 55 bps.8 Medical Office assets also saw significant cap rate compression last year, declining 38 bps to 5.9%.9 Meanwhile, Single Tenant Office assets saw cap rates fall by just 4 bps, landing at 6.5%. Central Business District Office assets, the most maligned property group in the sector, saw cap rates rise by 18 bps in 2021, settling at 5.8%.10
Prices for Office assets finished 2021 up an average of 6.1% from the year earlier. Single Tenant Office assets were the clear laggard of the group, as prices increased by just 5.4% year-over-year through Q4 2021. CBD assets followed next with annual price appreciation rates of 10.4%. Again, Suburban and Medical Office properties were the clear winners in 2021, as prices grew an average of 15.1% and 15.5%, respectively.
The major Office success stories throughout the pandemic have come from outside of the traditional globalized markets like New York, San Francisco, and Los Angeles. Instead, outflowing residents and businesses from the traditional hubs into tertiary alternatives has generated momentum for a number of well-positioned smaller cities.
Nevada continues to be a standout in this area. Las Vegas seemingly has gleaned lessons from the Great Recession, and over the past decade, it has made significant progress in diversifying its labor market. Las Vegas led all other metros for the largest gains in Office sector property valuations last year (+13.2%), according to CoStar. For nearby Reno, it is a similar story. The rising competitiveness of Reno saw its Office sector post the nation’s third-biggest jump in rents (+4.9%) and the fourth largest jump in occupancy rates (+1.6%) last year.11 The Economic Development Authority of Western Nevada credits Reno’s recent success to a decade-long labor diversification plan adopted in Washoe County.12 Reno’s unemployment rate sat at a rock bottom 2.8% at the end of 2021 — 1.1 percentage points better than the national average.13
Moving beyond Nevada, several other secondary cities in the West continue to see their stock rise. San Diego posted a sizable jump in Office space net absorption totals in Q4 2021, coming in at 648,414 square feet, surging from just 2,913 square feet in the same period the year prior.14 Colorado Springs, CO, stands as a rare example of a metro where there are more employees today (310k) than there were entering the pandemic (305k).15 According to CoStar, the relatively small Colorado city posted the fifth biggest jump in Office sector valuations last year, rising a healthy 8.8%.16
In Spokane, WA, short-term headaches created by the pandemic are pitted against long-term improving fundamentals. According to Guy Byrd of SVN | Cornerstone, “Spokane’s CBD has been the weakest performing market in the last year as a significant number of tenants are choosing the increasingly popular hybrid work model.” He goes on to cite that “recruiting top talent and providing attractive work environments for workers who now prefer remote work is a significant new challenge.” Still, Washington State anticipates that Spokane will be a site for significant growth in the years ahead. While Spokane County is home to just over half a million people, the State’s Office of Financial Management projects that its resident population will swell by another 90k by the year 2040.17 Despite the ongoing headwinds, Mr. Byrd notes that vacancy rates improved last year as “users were forced to reinvent the most effective office environment.” Moreover, sales volumes also ticked up in 2021 “due to low interest rates and minimal new office construction,” a trend that forecasts should carry into 2022, “subject to economic conditions vital to the market.”
Success begets success. Florida saw its population grow by 211k people in 2021 — more than every state not named Texas.18 With the influx of new residents, there is increased demand throughout all verticals of commercial real estate. After all, these incoming residents need places to live, places to shop, and places to work. Florida’s Office markets, including in suburban settings, saw statewide success in 2021.
Fort Myers, a smaller Office sector compared to Florida’s more developed alternatives, has seen demand far outpace supply as it currently boasts the highest market-level occupancy rate (95.5%) in the country.19 Moreover, between the end of 2020 and the end of 2021, the Office occupancy rate rose by the second-highest clip in the country, growing by 1.8 percentage points.20
According to SVN | Commercial Advisory Group’s Larry Starr, Sarasota is “boasting some of the strongest office rent growth in the country,” a claim that is backed up by CoStar data, which shows rents in the area growing by 5.3% last year.21 “Office demand has remained strong in Sarasota throughout 2021, pushing vacancies to new lows.” In Tampa, a metro that has seen as much commercial real estate success as sporting success over the past half-decade, saw firming demand last year. Mr. Starr notes that Tampa remained a standout as “both asking rents and office demand improved throughout 2021, significantly outperforming the National Index.” Mr. Starr does see the potential for some softness in 2022, suggesting that Tampa’s office sector will be “challenged due to the increase in the amount of space available on the market,” as the pandemic triggered “the largest supply wave in over a decade.” Still, he sees the rising profile of Tampa and its ability to attract re-locating businesses as broadly supportive of the city’s long-term fundamentals, citing that “office investment activity has sharply increased with annual sales volume roughly doubling 2020 levels.”
The US economy has experienced a robust recovery from the initial shock of COVID-19. A pandemic-driven shift in consumption away from services and into goods, boosted by a sweeping stimulus effort, reconditioned our economy well before an off-ramp from the public health crisis was in sight. By Q3 2020, inflation-adjusted GDP shrugged off its worst quarterly performance on record to record its best, a 33.4% annualized growth rate.1 In 2021, the total nominal value of all consumption and production reached $23.0 trillion, a 9.1% increase above 2020’s total and 6.9% above 2019’s total. After adjusting for inflation, the US economy is 3.2% larger than its pre-pandemic peak.2
The foundation of the economy’s rebound has been a swift labor market recovery. At its April 2020 peak, the official unemployment total reached a staggering 23 million people.3 By the start of 2021, the unemployment total had improved to just 10.1 million people out of work.4 Over the past year, this level has come down to 6.5 million people, less than one million above the pre-pandemic level of 5.7 million.5
INFLATION & MONETARY POLICY
One year ago, the market consensus was that the Federal Open Market Committee (FOMC) would not begin a monetary policy tightening cycle until 2023. However, as demand surges in the face of gummed-up supply chains, rampant inflation has emerged at center stage, forcing shifting guidance from policymakers.
After decades of tepid price increases, in January 2022, the Consumer Price Index (CPI) reached 7.5%, a level not seen in 40 years.6 Core-PCE, the Federal Reserve’s preferred inflation gauge that excludes food and energy prices, reached 5.2% in January, prompting the FOMC to be increasingly committed to an interest-rate hike at its March 2022 meeting.7 In just 24 months, policymakers at the Federal Reserve have repositioned themselves from a tighter monetary policy stance into an accommodative one and back to a tightening one. According to the CME Fed Watch Tool, as of February 23rd, future markets are forecasting seven rate hikes by the end of the year — a sizable shift from even just one month earlier, when future markets were forecasting just four rate hikes in 2022. Volatile swings in the medium-term outlook are symptomatic of the rapid shifts in economic activity that categorized the past two years.
In December, Fed officials looked on cautiously at the near-term outlook as Omicron emerged as a roadblock to economic normalcy. After the Delta variant led to declining activity and sluggish job growth in mid-to-late summer 2021, some officials worried that Omicron, a more transmissible variant of COVID compared to previous waves, would hinder the recovery. While a significant wave of US cases followed, the Omicron wave proved to be less deadly and less straining on the US public health system than previous ones. As a result, an increasing number of US states and municipalities are relaxing masking and vaccine restrictions. On February 25th, the CDC introduced a new slate of guidelines that experts say shifts the US into the “endemic phase” of the pandemic. The new guidelines would put more than half of US counties and over 70% of the population in “low” or “medium” risk designations, bolstering the FOMC’s willingness to remove accommodative monetary policies.
Still, a measurable dose of uncertainty overhangs stock markets and the whole macroeconomy. The VIX, a volatility index captured by the Chicago Board Options Exchange, has remained stubbornly elevated since the onset of the pandemic. Despite moderately retracting during the fall of 2021, the annual average for the VIX in 2021 was 19.7, 27.7% above its 2019 average.8
The SVN Vanguard team can help with your office real estate needs. We can help you find the ideal office property for sale or lease. Interested in discussing a sale-leaseback? Contact us.
NATIONAL OVERVIEW SOURCES
- Morning Consult, as of February 26th, 2022.
- Moody’s Analytics REIS, report found here: https://cre.moodysanalytics.com/insights/cre-trends/q4-2021-office-first-glance/
- https://www.osc.state.ny.us/files/reports/osdc/pdf/report-10-2022.pdf
- Real Capital Analytics; Through Q4 2021
- Real Capital Analytics; Through Q4 2021
- Real Capital Analytics; Through Q4 2021
- Real Capital Analytics; Throughout Q4 2021
- Real Capital Analytics; Throughout Q4 2021
- Real Capital Analytics; Throughout Q4 2021
- Real Capital Analytics; Throughout Q4 2021
- CoStar; Through Q4 2021. Note: Measured across the top-100 markets
- https://knpr.org/knpr/2022-02/northern-nevadas-economic-diversification-helped-soften-impact-pandemic-can-southern
- Bureau of Labor Statistics
- CoStar; Through Q4 2021. Note: Measured across the top-100 markets
- Bureau of Labor Statistics; Through December 2021
- CoStar; Through Q4 2021. Note: Measured across the top-100 markets
- https://www.krem.com/article/money/economy/boomtown-inland-northwest/spokane-county-future-growth/293-6859dcc0-bd63-40ef-8f16-c483fa61c9e1
- US Census Bureau
- CoStar; Through Q4 2021. Note: Measured across the top-100 markets
- CoStar; Through Q4 2021. Note: Measured across the top-100 markets
- CoStar; Through Q4 2021. Note: Measured across the top-100 markets
MACRO ECONOMY SECTION SOURCES
- US Bureau Economic Analysis
- US Bureau Economic Analysis
- US Bureau Labor Statistics
- US Bureau Labor Statistics
- US Bureau Labor Statistics
- US Bureau Labor Statistics
- US Bureau of Economic Analysis
- Chicago Board Options Exchange
THE RETAIL SECTOR was already steeped in transformational shakeout prior to the pandemic, rightsizing to how shopping is done in an increasingly digital economy. In what has already been a decade-long process, most analysts thought it would be a decade more before we started to see a turnaround. Of course, the pandemic has updated those timelines dramatically. SVN® Retail Product Chair Ryan Imbrie, CCIM notes that the retail sector “landed on the unfavorable side of COVID-19’s lopsided impact on commercial real estate.” While industrial properties benefited from the surge in online spending, Imbrie says the pandemic advanced the retail sector’s “long slide” with mounting store closings and rising vacancy.
As the old Winston Churchill quote goes, “If you’re going through hell, keep going.” In 2020, with physical restrictions on retail in place, a significant portion of retailing shifted from in-person to online. E-commerce’s share of retail sales has grown by an average of 0.5 percentage points annually since the start of the millennium, but between Q1 and Q2 2020, it shot up from 11.4% to 15.7%1— quantitative proof that Americans were not only buying toilet paper and DIY arts and crafts during the shutdown. Thankfully for the Retail sector, shoppers returned to the aisles in late 2020 and continued doing so throughout 2021. Through Q4 2021, e-commerce’s share of retail sales has fallen down to 12.9%.2
Overall, monthly retail sales reached their highest level on record in January 2022, coming in at a seasonally adjusted $650 billion for the month.3 The sector “has experienced some bright spots where tenants are thriving as seen in grocery-anchored properties, home improvement, and dollar stores,” remarks Mr. Imbrie. Over the short term, the sector should continue to benefit from an apparent shift away from services and towards the consumption of physical goods that have remained present even as the country has lifted most pandemic-era restrictions.
The Retail sector was often compared to a patient on life support heading into the pandemic, and the shock of the shutdown was widely thought to be a knockout blow. Interventions by the Federal Government, namely the Payroll Protection Program, helped to limit the scale of distress. According to Trepp, levels of distress in the sector continue to improve, though investors remain cautious. Through January 2022, the CMBS delinquency rate has improved to 8% — down from 18% during the pandemic’s crisis peak, though still above the sub-4% level where it was entering 2020.4
Still, for the first time in a long time, having a healthy dose of optimism for the Retail sector feels appropriate. According to OpenTable’s COVID recovery tracking, the US is arriving right back at its pre-pandemic benchmark for restaurant reservations almost two years after the initial shut down. Moreover, after adjusting for inflation, the value of new commercial construction put in place, a broad category that includes most retail and wholesaling activities, has trended downward since 2018. With less new supply entering the Retail sector, the macro task of repositioning existing stock becomes a bit less herculean. Retail may not be out of the woods just yet, but after following Mr. Churchill’s advice, the temperature dial is starting to improve.
Transaction volumes in the retail sector surged in 2021, following a trend observed throughout all commercial real estate. According to Real Capital Analytics, deal volume for retail assets reached $76.8 billion last year — an 88% improvement from 2020’s pandemic-muted total and 14.1% better than 2019’s mark.5 While new deal activity in 2021 remained down from 2015’s record peak by $13.5 billion, last year saw the most retail deal volume since 2018.6
As was the case in 2020, the Retail sector was a mixed bag of outcomes across its sub-property types. Big Box Retail assets saw a resurgence as new deal activity rose by 88% to $2.6B — roughly equivalent to 2019’s and 2020’s totals combined.7 Lifestyle/Power Centers also saw a large uptick in 2021, posting $5.8 billion of deal volume, marking its highest total since 2014.8 Mall assets have continued to see deal volumes crater as the maligned product type posted just $1.9 billion of trades last year, declining 51% from 2020.9 Drug store assets saw muted growth in 2021 as deal volume grew year-over-year by just 19%.10 However, Drug Store’s lackluster (by comparison) growth total is a function of the product type’s success in 2020, as it was the only asset type seeing investment growth during the pandemic slowdown.
Cap rates for Retail properties continued to post declines in 2021. Through Q4 2021, cap rates are down 6 bps from Q3 and 20 bps from the same time last year.11 Again, retail sub-types saw dramatically idiosyncratic cap rate movements through 2021. Unsurprisingly, Malls were the only sub-asset type to post rising property yields in 2021, growing 47 bps year-over-year through Q4 2021.12 Grocery-anchored followed next, with the property type posting just 11 bps of cap rate compression last year.13 On the other side of the spectrum are Anchored and Big Box retail assets, which posted cap rate compression totals in 2021 of 42 bps and 49 bps, respectively.14
On the pricing front, retail assets across the board saw improving trading valuations in 2021. The average year-over-year price appreciation for all retail assets through Q4 2021 was 24.7%.15 Moreover, retail assets generally are trading at valuations 19.0% above where they stood pre-pandemic and 18.1% above their previous all-time high (2016).16 The best performing retail sub-types by price appreciation in 2021 were Centers and Unanchored assets, which saw valuations grow by 30.5% and 22.6%, respectively.17
From the coastlines of Florida to the outskirts of the Colorado River, the retail sector in the Sun Belt is cashing in on consumers migrating into the Southern portion of the country. Positive momentum is stretching across state lines and time zones. Nashville closed out 2021 as one of the nation’s top-performing retail markets, posting the third-highest annual rent growth totals (8.4%).18 While Nashville is heralded as the music capital of the country, its tech sector is singing the sweetest tunes of all. Nashville’s expanding tech base is forecast to double the metro’s employment growth rate in the coming years,19 bringing more residents into the area and putting additional upward pressure on available space. Las Vegas, another entertainment industry heavyweight that has cultivated its tech sector, is experiencing a similar trajectory of success. Retail market rents in Sin City finished up 10.0% to close out 2021, the top mark in the country.20
Three of the four largest increases in Retail occupancy last year were found in the Sun Belt — two of which were in Florida.21 Baton Rouge, LA led the entire country with the largest one-year occupancy rate increase.22 Between Q4 2020 and Q4 2021, occupancy rates in
Baton Rouge jumped from 91.4% to an extremely tight 96.8% — an improvement of 5.4 percentage points.23 Moving down the list, Daytona Beach, FL, posted an occupancy rate improvement of 1.9 percentage points, and Fort Myers, FL, rose by 1.4 percentage points.24 Commenting on the Daytona Beach and Ormond Beach area, Carl Lentz of SVN | Alliance Commercial Real Estate Advisors notes that “explosive residential growth and retail traction along the LPGA corridor have been the primary drivers of the momentum.” While warm winters are a consistent selling point throughout the Sunshine State, Daytona’s retail sector has also benefited from its proximity to the region’s booming blend of suburban amenities, a dominating feature of post-pandemic real-estate growth.
Mr. Lentz goes on to mention that “as local and regional retailers continue to see success, many national retailers are paying attention and entering the market.”
The US economy has experienced a robust recovery from the initial shock of COVID-19. A pandemic-driven shift in consumption away from services and into goods, boosted by a sweeping stimulus effort, reconditioned our economy well before an off-ramp from the public health crisis was in sight. By Q3 2020, inflation-adjusted GDP shrugged off its worst quarterly performance on record to record its best, a 33.4% annualized growth rate.1 In 2021, the total nominal value of all consumption and production reached $23.0 trillion, a 9.1% increase above 2020’s total and 6.9% above 2019’s total. After adjusting for inflation, the US economy is 3.2% larger than its pre-pandemic peak.2
The foundation of the economy’s rebound has been a swift labor market recovery. At its April 2020 peak, the official unemployment total reached a staggering 23 million people.3 By the start of 2021, the unemployment total had improved to just 10.1 million people out of work.4 Over the past year, this level has come down to 6.5 million people, less than one million above the pre-pandemic level of 5.7 million.5
One year ago, the market consensus was that the Federal Open Market Committee (FOMC) would not begin a monetary policy tightening cycle until 2023. However, as demand surges in the face of gummed-up supply chains, rampant inflation has emerged at center stage, forcing shifting guidance from policymakers.
After decades of tepid price increases, in January 2022, the Consumer Price Index (CPI) reached 7.5%, a level not seen in 40 years.6 Core-PCE, the Federal Reserve’s preferred inflation gauge that excludes food and energy prices, reached 5.2% in January, prompting the FOMC to be increasingly committed to an interest-rate hike at its March 2022 meeting.7 In just 24 months, policymakers at the Federal Reserve have repositioned themselves from a tighter monetary policy stance into an accommodative one and back to a tightening one. According to the CME Fed Watch Tool, as of February 23rd, future markets are forecasting seven rate hikes by the end of the year — a sizable shift from even just one month earlier, when future markets were forecasting just four rate hikes in 2022. Volatile swings in the medium-term outlook are symptomatic of the rapid shifts in economic activity that categorized the past two years.
In December, Fed officials looked on cautiously at the near-term outlook as Omicron emerged as a roadblock to economic normalcy. After the Delta variant led to declining activity and sluggish job growth in mid-to-late summer 2021, some officials worried that Omicron, a more transmissible variant of COVID compared to previous waves, would hinder the recovery. While a significant wave of US cases followed, the Omicron wave proved to be less deadly and less straining on the US public health system than previous ones. As a result, an increasing number of US states and municipalities are relaxing masking and vaccine restrictions. On February 25th, the CDC introduced a new slate of guidelines that experts say shifts the US into the “endemic phase” of the pandemic. The new guidelines would put more than half of US counties and over 70% of the population in “low” or “medium” risk designations, bolstering the FOMC’s willingness to remove accommodative monetary policies.
Still, a measurable dose of uncertainty overhangs stock markets and the whole macroeconomy. The VIX, a volatility index captured by the Chicago Board Options Exchange, has remained stubbornly elevated since the onset of the pandemic. Despite moderately retracting during the fall of 2021, the annual average for the VIX in 2021 was 19.7, 27.7% above its 2019 average.8
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NATIONAL OVERVIEW SOURCES
- US Census Bureau
- US Census Bureau
- US Census Bureau
- https://www.trepp.com/hubfs/Trepp%20Retail%20Report%20February%202022.pdf?hsCtaTracking=8cec15d8-2d6d-4a7e-b3be-47518c19f0f8%7C7edd6f4f-a67b-476b-aaec-43ab495ce73c
- Real Capital Analytics; Through Q4 2021
- Real Capital Analytics; Through Q4 2021
- Real Capital Analytics; Through Q4 2021
- Real Capital Analytics; Through Q4 2021
- Real Capital Analytics; Through Q4 2021
- Real Capital Analytics; Through Q4 202
- Real Capital Analytics; Throughout Q4 2021
- Real Capital Analytics; Throughout Q4 2021
- Real Capital Analytics; Throughout Q4 2021
- Real Capital Analytics; Throughout Q4 2021
- Real Capital Analytics; Throughout Q4 2021
- Real Capital Analytics; Throughout Q4 2021
- Real Capital Analytics; Throughout Q4 2021
- CoStar; Through Q4 2021. Note: Measured across the top-100 markets
- https://technologycouncil.com/wp-content/uploads/2021/11/2021-State-of-Middle-TN-Tech.pdf?utm_source=Sailthru&utm_medium=email&utm_campaign=2021.11.22%20NASH&utm_term=NASHtoday%20Subscribers%20-%20MASTER
- CoStar; Through Q4 2021. Note: Measured across the top-100 markets
- CoStar; Through Q4 2021. Note: Measured across the top-100 markets
- CoStar; Through Q4 2021. Note: Measured across the top-100 markets
- CoStar; Through Q4 2021. Note: Measured across the top-100 markets
- CoStar; Through Q4 2021. Note: Measured across the top-100 markets
MACRO ECONOMY SECTION SOURCES
- US Bureau Economic Analysis
- US Bureau Economic Analysis
- US Bureau Labor Statistics
- US Bureau Labor Statistics
- US Bureau Labor Statistics
- US Bureau Labor Statistics
- US Bureau of Economic Analysis
- Chicago Board Options Exchange
