Industrial Sees Biggest Price Gains

Crexi, a popular listing website among brokers, investors, landlords and tenants, the price per square foot for industrial pricing increased by 5.4% in September.

According to Crexi users, industrial properties saw the highest price increases in September. However, there was also a noteworthy rise in the number of unpriced listings, which reflects the general uncertainty and repricing patterns in the larger commercial real estate market.

In September, the price per square foot for industrial properties on Crexi’s platform increased by 5.4%, while 20% of the new assets that were added to the site last month had no price listed. September saw an increase in industrial lease rates month over month as well, with average monthly rates per square foot climbing by slightly under 2%.

In a research analyzing the September data, Crexi analysts write, “This surge in unpriced listings aligns with sellers’ understanding of industrial’s sustained success while accepting how shifting market conditions are hurting buyer attitude.” Brokers may believe that delaying the discussion of pricing until later in the negotiation process will enable them to more successfully steer agreements to completion, which is often the case.

Following a 3% increase in August, customers of Crexi saw a slowdown in leasing rates in September, with industrial and special-use property leasing rates rising by 4.3% and retail and office leasing rates falling by 2.3%. Additionally, new merchandise added to Crexi increased by 24% in September. Additionally, search activity increased, particularly in Sun Belt locations, which analysts believe is related to a desire to close deals before further rate increases.

Dallas and San Antonio both witnessed for-sale search increases of 28% and 29%, while Houston had a gain of nearly 30% among tenants looking for space.

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.

1. GDP

Real GDP increased by an annual rate of 2.6%% in Q3 2022, according to the advanced estimate released by the Bureau of Economic Analysis (BEA). The increase follows two consecutive quarterly declines in Q1 and Q2, moderating some concerns that the US economy is already in recession.
Increases in exports, consumer spending, government spending, and nonresidential fixed investment drove the climb in economic output. Meanwhile, private inventory investment and residential fixed investment declined during the quarter.
Notably, the only GDP components that changed directionality from last quarter were nonresidential fixed investment and government spending. Both went from a drag on GDP in Q2 to a driver of GDP in Q3.
The leading driver of increased exports was industrial supplies and materials, including petroleum and other non-durables. Services also increased, mainly travel and financial services. Within consumer spending, an increase in healthcare expenditures was partially offset by a decline in motor vehicle and food and beverage spending.
Nonresidential fixed investment, which went from negative to positive quarter-over-quarter, was driven by equipment spending and intellectual property products while partially offset by a decrease in structures.

2. BEIGE BOOK ANALYSIS

The mid-October release of the Federal Reserve’s Beige Book shows that economic activity expanded modestly across the nation compared to recent weeks. However, conditions varied greatly between industries and districts.
Four of the twelve federal reserve districts reported flat activity while two noted declines—with the latter citing slowing or weak demand in the face of higher interest rates, inflation, and supply issues.
Of the six that reported increased activity, travel and tourism rose sharply, while manufacturing activity held steady or expanded.
Retail spending was reportedly flat across most districts as discretionary spending slowed while demand for services, specifically nonfinancial services, rose.
Rising mortgage rates and elevated house prices continued to weaken single-family starts and sales but helped push up apartment leasing and rents.
Commercial real estate experienced softening in both construction activity and sales as supply and labor shortages continue to slow activity, which higher borrowing costs have only exacerbated.

3. MSCI RCA COMMERCIAL PROPERTY PRICES

Commercial real estate prices climbed by 11.1% year-over-year through September, according to the latest national all-property index released by MSCI RCA. This month’s increase was the weakest annual pace since early 2021.
Price growth has eased in the face of rising financing costs and lower transaction activity. Transaction volume fell 21% year-over-year in the third quarter.
Industrial retains its top spot, with prices growing 18.1% year-over-year, but saw growth dip below 20% for the first time in over a year.
Apartments prices climbed 0.2% from August and registered a 15.9% increase year-over-year.
Retail prices remained fl at month-over-month but climbed 11.8% year-over-year through September from one year ago; still—annual growth in Retail has slowed for seven consecutive months.
Office rates climbed 0.3% month-over-month from August and 6.8% year-over-year.
Price growth in the six major gateway markets tracked by MSCI-RCA fell by 0.5% month-over-month and 3.7% year-over-year. Meanwhile, non-major metros climbed by 0.3% from August to September and 13.7% year-over-year.

4. INDEPENDENT LANDLORD RENTAL PERFORMANCE

On-time collection rates for independently operated residential properties improved by 159 bps between September and October, rising to 81.9%, reaching a 2022 high. According to Chandan Economics’ Independent Landlord Rental Performance Report.
October’s full payment rate is forecast to land at 92.5% by month’s end, representing a year-over-year improvement of 171 bps.
Observing the state of Florida following the impact of Hurricane Ian, the report shows that of the preliminary estimate, 82.2% of independently operated apartments in Florida have successfully paid their October 2022 rents on time. Notably, the on-time payment rate in Florida remains above the national average by 24 bps, despite the storm’s impact.
Gateway markets maintained higher on-time payment rates than units located elsewhere for the tenth consecutive month. October’s on-time payment rate stands at 82.0% in Gateway units and 81.9% in non- Gateway units.
Small Multifamily rental properties (5-49 units) held the highest on-time payment rate of all sub-property types in October, coming in at 83.2%.
Mid-priced rentals ($2,000-$2,499) continue to outperform all other price points, recording an on-time payment rate of 85.8% through October 15th— the highest mark for these (or any) rentals in 2022 to date.

5. INDUSTRIAL SECTOR WOES

Below-expectation earnings from Prologis for the third quarter rattled its share price this week and joined some other signals of relative concern in the Industrial market.
Several indicators, including a decline in the Philadelphia Fed’s Capital Expenditures Index and transaction data from MSCI Real Capital Analytics, indicate a decrease in buying activity within the sector, and Prologis acknowledges that some of their customers have publicly indicated their plans to pause Capex spending.
However, Prologis CFO Tim Arndt states several customers have indicated “an overarching need to increase space as supply chain resiliency remains a top concern.”
Vacancy rates remain at or near all-time lows in much of the country, sitting at just 1.7% in US coastal markets. As a result, space for new facilities has become increasingly scarce.
According to statements by the company, although large customers like Amazon have slowed their buying pace, potentially due to overbuying in previous quarters, they have not given up on previously acquired space.

6. STUDENT HOUSING

Occupancy in Student Housing stands at 96.6%, with assets seeing 4.1% year-over-year rent growth, according to the Fall 2022 Report Card by Yardi Matrix.
The report card tracks housing units across 200 universities and found that preleasing had accelerated faster at schools with higher levels of selectivity and enrollment. Still, schools across the board saw an improvement in occupancy and incomes.
12 of 200 universities experienced double-digit growth in preleasing through September 2022 compared to one year before. Washington State University and the University of Houston topped the list, climbing by 18.9% and 16.4%, respectively.
While enrollment nationwide remains below peak, the number of universities returning to full capacity climbed dramatically in the past year.

7. OFFICE DEMAND

VTS’ latest office demand index (VODI) increased in September, joining several other metrics signaling an uptick in office activity following the Labor Day holiday.
The VODI ticked up from an index reading of 46 to 48 in September. The index level indicates the percentage of office demand relative to a pre-pandemic benchmark.
Similarly, weekly data by Kastle Data systems shows that most office tenants have returned to the office at least part-time. However, overall daily activity remains down by half of 2019 levels.
Notably, after sharp declines throughout the summer, New York City office activity has returned to 52% of pre-pandemic levels.
The VODI remains down 23.3% quarter-over-quarter and 33.3% year-over-year, though the annual comparison is partially due to base effects from a post-vaccine office push in Mid-2021.

8. EXISTING HOME SALES

Existing home sales fell by a seasonally adjusted -1.5% month-over-month, its eighth consecutive month of decline as rising interest rates slow homebuying demand.
Three of the four major regions of the US saw monthly declines, while the West region saw transactions hold steady. First-time buyers accounted for 29% of all home sales in September, holding relatively steady from previous months.
Despite the weaker number of total sales, more than 25% of homes are selling above their listing price due to “limited inventory,” according to NAR Chief Economist Lawrence Yun. The median sales price for an existing home rose to $384,800, up 8.4% from one year ago.
Utilizing data from Realtor.com’s Market Trends Report, the metros with the largest increases in list price growth were Miami (+28.3%), Memphis (+27.3%), and Milwaukee (+27.0%). Phoenix registered the highest increase in the percentage of homes that had prices reduced compared to one year ago (+32.3%), followed by Austin (+27.4%) and Las Vegas (+20.0%).\

9. SUBLEASING ACTIVITY

According to a recent analysis by Trepp, sublease availability has been growing in smaller US cities over the past many months. In light of declining needs for office space among some of the nation’s largest employers, several have taken to subleasing to reduce their footprints and costs.
Trepp’s analysis suggests an inverse relationship between subleasing activity and multifamily rent growth. Metro areas with high living costs, where many residents were lost during the pandemic, generally see higher rates of subleasing activity, notably Los Angeles and Minneapolis. Atlanta is a notable exception, maintaining strong subleasing activity while having more robust multifamily growth relative to other large metros.
Several firms in California, including Meta, Verizon, and 8×8, have or are implementing plans to sublease their office spaces. The trend also appears to be developing in the life sciences space, with Biogen subletting some 18,000 square feet of space in Cambridge, MA.

10. CONSUMER CONFIDENCE

According to the latest release by the Conference Board, consumer confidence decreased in October following consecutive increases in August and September.
The overall index fell from a reading of 107.8 in September to 102.5 in October, while the “present situation” sub-index, which attempts to reduce the respondents’ inclusion of future expectations, fell even sharper.
According to the Conference Board’s analysis of the report, inflation concerns ticked up again in September after several months of gradual reduction. The trend is likely connected to the subsequent gasoline and food prices acceleration over the same period.
Respondents’ vacation plans were also reduced, though interestingly, intentions to purchase a home, an automobile, and other high-priced items rose despite upward pressure on borrowing rates.
The expectations index declined more modestly than the present situation index but remained close to a reading of 80, a level that the index associated with a recession signal.

SUMMARY OF SOURCES

(1) https://www.bea.gov/news/2022/gross-domestic-product-second-quarter-2022-advance-estimate
(2) https://www.federalreserve.gov/monetarypolicy/beigebook202209.htm
(3) fi le:///Users/julynovember/Downloads/2210_RCACPPI_US.pdf
(4) https://www.chandan.com/independentlandlordrentalreport
(5) https://www.globest.com/2022/10/21/heres-what-prologis-really-thinks-about-the-industrial-sector/
(6) https://www.yardi.com/blog/matrix/student-housing-earns-high-marks/34436.html
(7) https://vts.drift.click/october-2022-vodi?utm_medium=email&utm_source=content&utm_campaign=october-2022-vodi&utm_content=subscriber-email&mkt_tok=ODExLVNKUS04MDMAAAGHtHGjJRYdGvxJIG3YEnerr8PFTwcA7NimpD97mPPbxxYy-_0Io2GUFzsv48Rb2_aP3CYo9ZzRnpq6DjPrpvREigBYH2-Fp-xwsSkow_Bff8X
(8) https://www.nar.realtor/newsroom/existing-home-sales-decreased-1-5-in-september
(9) https://www.trepp.com/trepptalk/sublease-availability-growing-in-smaller-us-cities
(10) https://www.conference-board.org/topics/consumer-confidence

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.

In the long run, investors who stay engaged in the market despite market uncertainty may outperform those who stay off the market.

Some CRE investors choose to sit it out when challenges start to pile up. But is it the best course of action?

Less Competition When Making Offers Can Equals Higher Returns in Long Term

John Chang of Marcus & Millichap notes, “It makes perfect sense to be cautious, but on the other hand, a lot of investors stay active or even ramp things up a notch when others are stepping aside.” “The agreements they make in these times frequently produce the best long-term results.”

While One Area May Be In Distress, Other Markets Are Usually Booming

According to Chang, the CRE market is usually “inefficient,” with variations by geography and property type. He claims that while another metro is expanding, one could encounter significant obstacles.

Chang points to the dot-com bubble as a prime example of this. The Bay Area was particularly hard-hit by the recession, but many other markets fared well and kept expanding.

Timing and Adding Value

According to Chang, he also exhorts investors to look for possibilities that add value. According to him, purchasing an asset now that is deemed overvalued by sales comps may be advantageous if doing so will allow the buyer to combine and enhance a number of properties, resulting in a higher return on the portfolio as a whole. According to him, uncertain times might also offer chances to purchase special assets that are rarely traded or to reposition assets.

According to Chang, the optimum moment to switch horses may be during uncertain times.

Consider What the Market Will Look Like In 5 Years

Investors must also consider where the market will be in three to five years. When purchasing properties, Chang advises using loans without prepayment penalties so that the properties can be refinanced if and when interest rates decline.

According to Chang, investors that make purchases during uncertain times frequently have fewer rivals for their business and benefit in the long run. In contrast, investors who “step to the sidelines with the herd” because they are afraid to conduct a deal during an uncertain market typically miss the best investment possibilities the market has to offer. The key to successful real estate investing is to look long-term, take advantage of opportunities, and have an eye on the future.

While some have hailed it as the “worst bill of the year,” others have welcomed it as a long overdue move toward resolving California’s persistent housing shortage.

However, the Affordable Housing and High-Road Jobs Act of 2022 is anticipated to have a significant impact for multifamily developers in the state when it becomes law next summer, regardless of popular sentiment.

The Middle-Class Housing Act and Assembly Bill 2011 were both signed on September 28 by Governor Gavin Newsom. Together, the two new laws will permit the construction of housing on land that local governments presently zone for parking, offices, or retail. In many circumstances, the legislation will also permit the development of homes without California Environmental Quality Act, or CEQA approval. Additionally, prevailing pay, which are union wages, and health benefits must be provided to the employees who construct these new homes.

Charles “C.J.” Higley, a lawyer with the Northern California legal firm Farella Braun + Martel LLP, stated that this may potentially release a great number of properties for residential construction that have historically been reserved, by virtue of zoning, for retail or office development.

The United Brotherhood of Carpenters’ general president, Doug McCarron, stated during the signing ceremony that the law “will help generate millions of urgently needed new homes and protect the workers who will build them.”

According to McCarron, the opportunity to afford the housing they are constructing will be important for workers.

According to Higley, the legislation might also have a significant influence on developers.

In the 20 years that he has been a developer’s representative, he said, this might result in much shorter deadlines and better confidence surrounding project planning, both of which have been recognized as two of the major impediments to building.

It is still unclear if paying prevailing salaries to the construction workers on these sites will be financially feasible. Although there is disagreement among the state’s construction unions about the legislation’s merits, Higley claimed that everyone agrees that the current situation is ineffective.

According to Higley, “The economics of housing development are generally challenging at the moment due to high construction costs, rising interest rates, and diminished rents.” However, if the new CEQA-streamlining benefits and upzoning prove to be enough of an incentive, we believe it could have the potential to spark a major shift in how California approaches housing development.

Whether municipal governments will challenge the bill in court is another unknown. The fact that the new law gives the state government more influence over municipal zoning issues is a big sticking point for many of them. AB 2011 has been dubbed “the worst bill of 2022 for taking away local control” by a group that represents municipal leaders.

Home rule, which Higley referred to as a “sacrosanct principle” in the state of California and grants local governments the final say in what is constructed inside their borders, is at issue.

He stated that our governance style is deeply rooted in the decentralization of decision-making to those closest to the consequences of those decisions. for good reasons. For good reasons. We tend to distrust centralized control for good reasons.

However, the outdated approach permitted other communities to turn down projects for much-needed multifamily housing. The state has reached a “tipping point” as a result of pervasive NIMBYism, even when it is driven by justifiable concerns, according to Higley.

Higley said we now find ourselves in the midst of a serious crisis. Local jurisdictions have so frequently failed to keep pace with California’s expansion over the years. Although it has taken years for the legislature to recognize the severity of the situation, AB 2011 is the clearest sign yet that the state is prepared to disregard the long-standing division of power between the federal government and local governments on matters of land use.

According to one study, the bill might permit multifamily building on more than 100,000 acres in the state’s commercial corridors, which could lead to the construction of up to 2.4 million new homes. Losses in retail sales tax revenues would be offset by gains in tax revenues from residential and mixed-use developments, according to the California web-based platform UrbanFootprint, which sells tools for urban planners. This would result in a net rise in local and state tax revenues.

However, not all local governments will agree with that upbeat analysis. As legal challenges to the new law are brought forth, Higley stated that he anticipates a time of considerable uncertainty.

According to Higley, there is still some doubt regarding the utility of AB 2011 until the courts have spoken. In the interim, we anticipate having numerous discussions with clients about whether their sites meet the requirements and, even if they do, whether the particulars of their projects make AB 2011 a compelling alternative.

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.

While nobody is sure whether Democrats or Republicans will end up with control, it is certain that some officials might attempt to pass some significant legislation.

As the November elections draw near, what chance is there to get anything done when the main issues are winning re-elections and maintaining political power?

The Real Estate Roundtable notes, there are still a few significant “musts,” for Congress.

According to Politico, the National Defense Authorization Act and an omnibus budget bill must be passed by December 16 in that order.

The huge bill that funds the government is known as the omnibus spending bill. Without its passage, certain departments of the government will be unable to operate and will consequently experience a partial (in this case) shutdown. The NDAA is essential because it keeps the lights on at the Pentagon, the numerous military outposts, and the offices of the defense industry.

Several tax proposals are included in the list of things Politico says is likely, “(but no promises)”. Democrats want to bring back the CTC boost for children. Republicans want to reinstate a tax break that gives companies the ability to deduct their research costs right away. Those are just two of the many tax cuts that might be available during the session, along with additional incentives for retirement savings.

The Tax Policy Center notes that there are also a number of provisions from the 2017 Tax Cuts and Jobs Act that are still in effect, such as bonus depreciation for businesses and stiffer restrictions on the deduction of interest expenditures.

The Real Estate Roundtable claims that another tax-related issue is also up for debate. This is significant for the multifamily sector since “Other expired tax provisions include a temporary increase in how low-income housing tax credits (LIHTCs) are allocated to states.

Because politicians don’t bother to pay for them, tax extenders “often move without much opposition,” TPC concluded. But a grand deal with the company tax reforms connected to the CTC and TCJA won’t be cheap. The cost of the CTC in 2021 is estimated by congressional scorekeepers to be about $1.6 trillion over a ten-year period, and the business investment tax breaks will result in a $400 billion decrease in federal revenue. There is still no official estimate for lowering the cap on net interest deductions at this time.

What’s interesting to think about is where does the funding for these prolonged tax breaks come from?

Cap rates are projected to keep rising in Q4; the only question is by how much.

According to NNNetAdvisors, average net lease cap rates increased five basis points to 5.44% in the third quarter, continuing their upward trend after reaching an all-time low in the second quarter.

However, according to the firm’s analysts, cap rates for the industry are still at their lowest point in 12 years and have lagged in responding to changes in the market. In the third quarter, the difference between the 10-year Treasury and medical cap rates fell to 1.5%, a 12-year low, down from 4% from the previous year.

According to NNNetAdvisors experts, the industry is under pressure due to the shrinking gap between the cost of capital and net lease cap rate levels, which is pushing prices higher and reducing sales volume. While institutional buyers try their utmost to either hold put or push pricing as far as they can, exchange purchasers continue to be motivated. Since the present prices for stocks, bonds, and other more liquid investments provide a more risk averse approach and higher short-term returns, many private purchasers with dry powder continue to patiently wait out the net lease market for improved buying conditions.

The average days on market increased by 8 days to 142 days in the third quarter, while the difference between asking and sales price increased “dramatically” from 2.71% to 4.29% below the asking price.
In Q3, cap rates for restaurants, auto-related businesses, bargain retailers, and pharmacies tended to follow general market trends, increasing either slightly or not at all. In the drugstore industry, cap rates for CVS and Walgreens sites are comparable to those in Q2, while cap rates for Rite Aid sites increased to 7.7%, in accordance with the brand’s historical tendencies. Bank buildings were the only exception to the trend of declining property sales volume, as we saw only top tier properties trade ownership.

According to a study from NNNetAdvisors., ” As we move towards the last quarter of the year, the question seems to be how long will it take for the net lease market to react to rising interest rates.” The report also noted that While many investors search for net lease arrangements where the return and risk profile match their present expectations, other more liquid investment opportunities continue to respond in real time. In Q4, cap rates are anticipated to rise further; the only question is by how much.

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.

The CRE Industry as a whole should be ready to advocate regardless of the election’s outcome.

As the midterm elections approach, observers of the market wonder whether the results will have any bearing on the commercial real estate market.

In a recent analysis by Trepp, Mike Flood of the Mortgage Bankers Association stated that a split Congress with Republicans in charge of the House of Representatives and Democrats still in charge of the Senate is “the most likely outcome.” Additionally, he adds, “it will be difficult to pass significant, serious, industry-changing legislation with a split Congress and two parties with different perspectives.” It would be unusual for Republicans to win enough seats in both houses to override the president’s veto, even if they win both the House and the Senate. As a result, a divided Congress or even one that is controlled by Republicans will probably struggle to adopt significant legislation that would impact our industry.

Flood points out that President Biden will remain in office through 2024 regardless of the results of the midterm elections, and since the President selects the nominees for the regulatory agencies that the CRE finance industry is concerned about, “Democrats will control regulatory agendas regardless of what happens on November 8.”

” Regulators will continue active oversight of the industry no matter who controls Congress,” According to Flood, in order to manage their annual budgets, financial regulators outside of HUD rely more on fees levied against the industry than on funds that have been specifically allocated. Therefore, aside from exercising rigorous oversight, few tools are available to prohibit regulators from pursuing their existing goals, even in a situation where Republicans control all branches of Congress.

States and the federal government may at some point apply Community Reinvestment Act standards to independent mortgage banks and non-banks, which “could bleed over to the commercial and multifamily side of the industry,” according to Flood, who also notes that the MBA has noted that “policymakers are starting to ask questions about private equity ownership of insurance companies, and what-if any-risks may be out there to mitigate” (but is currently focused primarily on the residential market).

Future SEC measures may affect CMBS and CLO issuers as well; according to Flood, “the SEC is focused on what type and whether the industry should have any disclosure requirements in at issuance and ongoing documentation. If securitization is included, such a standard would increase reporting requirements for the industry.”

He adds that the HUD MAP program, competition from the HUD FFB program, big loan limits, statutory loan restrictions, and how to make the MAP guide more effective for lenders and servicers are all problems that “HUD lenders will be looking at both offense and defense.”

Whatever the results of the election, Flood advises that CRE finance professionals be ready to speak up.

Overview

Historically, seasonality has been a predictable characteristic of commercial real estate (CRE) transaction volume, which typically peaks in the fourth quarter of each year before normalizing again to start the next. However, heading into the Q4 2022, the US economy is sending mixed signals about its health.

This year’s transaction cycle could face resistance from two interrelated headwinds: Quantitative Tightening (QT) by the Fed and a potential US recession.

Fourth Quarter Comebacks

Since MSCI Real Capital Analytics (RCA) began tracking Commercial Real Estate volume in 2001, transaction volume, on average, has performed better during the second half of the year compared to the first, both in terms of dollars and total properties. Historically, total sales are on average 19% higher during Q3 and Q4 compared to the first two quarters, while there is a 16% increase in total properties trading hands.

As CRE investment intensified to new highs in 2021, so too did it’s end-of-year uptick. Three of the four major food groups of CRE achieved record-high transaction volume in dollar terms during Q4 2021. Office, the only of the four that did not reach a new record, still experienced its best performing quarter since Q2 2007.

While history suggests that CRE should have the wind at its back entering Q4, weather predictions have been a dicey undertaking in recent years. Recession signals are escalating, with modest warning signs already flashing in the latest real estate data. During August, US commercial property transactions continued to climb, but at the slowest rate so far this year.

The average price increase across the major property types slowed to 14.0% year-over-year in August, 260 basis points lower than July as investors continue to digest the impact of higher rates.

Further, while transaction volume from a dollar volume standpoint has sat close to all-time highs for much of 2022, less properties are changing hands, indicating that price-growth is currently being driven more by supply shortages rather than a demand-spike.

A Cloudy Forecast

As the Federal Reserve began its rate hikes in March in a bid to tame US inflation, many wondered whether a monetary soft landing was possible, where rates are raised just enough to calm prices but not throw the economy into recession. More than a half-year into QT, the US inflation rate remains north of 8% year-over-year, and policymakers have been forced to intensify their efforts — conducting three consecutive 75 basis point increases through September.

Reacting to moves by the Fed, as well as escalating global uncertainty stemming from the War in Ukraine and various fiscal conundrums — recession risks have begun to ratchet up in recent weeks. Utilizing a model based on Treasury yields, national financial conditions, and leading economic indicators, the Conference board recently raised its probability of recession to 96% heading into Q4. Markets are increasingly fearing the likelihood that a hard landing will be needed to calm overheating prices, and policymakers appear to agree.

In their latest Summary of Economic Projections released in September, the FOMC forecasts for growth, inflation, and unemployment were all revised in the wrong direction. The average forecast for the annual change in GDP through Q4 2022 fell to 0.2%, a drop from the 1.7% growth forecast at their June meeting. The Fed also projects that, because of higher rates and slowing growth, the unemployment rate will rise modestly by year’s end, while core inflation is expected to remain above the FOMC’s 2.0% target as we turn the page to 2023.

CRE, A Fortress?

While Quantitative Tightening’s adverse effects are visible across rate-sensitive industries, concurrently, real estate market fundamentals continue to fortify CRE’s relative stability. For example, despite a modest slowdown, prices in the Industrial sector posted a far-from-pedestrian 24.7% year-over-year increase in August, supported by large inventories, and continued spending on goods. Apartment properties, which similarly experienced price deceleration in recent months, remain up 17.1% annually and will continue to largely reflect the effects of strong housing demand amid constrained supply.

The Retail and Office sectors are also being supported by a resilient US economy. Despite two consecutive declines in annual GDP to start the year (an unofficial marker of a recession), a combination of steady job growth, low unemployment, and robust consumer spending hasn’t resembled a typical recession. So far, this year’s decline in output reflects a pullback in private and residential investment and government spending, while inflation-adjusted consumer spending remains positive, averaging 1.9% year-over-year during the first half of 2022. Personal spending continued to rise in August (+0.4%), beating most market forecasts despite declines in energy spending amid falling gasoline prices. Meanwhile, retail sales climbed 0.2% between July and August, inventories ticked up, and the recent start to the school year helped push office occupancy levels to a new post-pandemic high.

Future rate hikes could begin to dampen demand if inflation continues to force the Fed’s hand, further pushing down on

price growth. On the other hand, supply and labor issues continue to make new construction projects challenging, which in turn, is providing a floor for property prices. According to July data from the Jobs, Opening, and Labor Turnover Survey (JOTLS), there are currently 375,000 construction job openings through July 2022, up 22k and 28k from the prior month and the same point last year, respectively. Unemployment claims also recently fell below 200,000 per week, which is supporting
prices through both limited labor supply and durable incomes.

The Q3 Real Estate Roundtable Sentiment Index showed continued optimism regarding the underlying fundamentals of real estate, despite some caution about inflation and rising rates in the short term. Other longer-term trends developing in real estate also remain at play. Remote work continues to play a significant role in driving local housing demand— accounting for more than half of all price increases between November 2019 and November 2021, according to recent research by the San Francisco Fed. The work-from-home renaissance appears to be here to stay and will remain an anchor of some of the best markets for Apartment investment. Additionally, the pandemic-era shift in goods consumption appears to have a degree of permanence, which combined with the upcoming holiday shopping season should provide some support to Industrial and Retail in Q4. Meanwhile, a takeoff in Life Sciences is driving new opportunities for the Office sector.

CRE pricing “will probably be impacted” by the Fed’s most recent rate increase, but less so than what is happening on Wall Street.

Recent volatility in the stock market has made commercial real estate even more alluring to investors seeking security in the midst of the mayhem.

According to John Chang of Marcus & Millichap, “I think it gives everyone a little heartburn to watch the S&P 500 tumble by more than 6% in just over a week.” But this trend has been present in the stock market for some time.

The stock market has fallen by 10% over the past month and by 24% from its peak at the start of this year. And while it increased by 27% in 2021, the losses this year have essentially eliminated the gains from that year. According to Marcus & Millichap data, the CRE sector also had significant price increases last year, with industrial leading the way with 17.9%, self-storage coming in at 13.6%, and apartments coming in at 8.1%. Chang claims that even after the stock market reached its peak at the end of 2021, “commercial real estate kept going.”

Self-storage prices rose by 10.5%, industrial costs by 13.7%, and hotel prices by 13.7% in the first half of 2022. The stock market, meanwhile, experienced a 20% decline in the first half of 2022. The catch is that prices are normally set 90 days before a deal closes, so the pricing figures for the second quarter were likely set before the Fed started raising rates significantly.

Chang claims that the September 21 news conference following the Fed’s most recent rate hike “will undoubtedly have an impact” on CRE prices, but that this impact “will be far less severe than what we’re witnessing on Wall Street.”

CRE values typically fluctuate more slowly than stock market values. They also tend to be less spectacular, “he argues,” pointing out that commercial real estate pricing has mainly remained stable over the last 20 years, despite “enormous” quarterly price changes.

The fact that CRE has delivered a compound annual growth rate of 7.8% since 2000, outpacing the S&P at 5.3%, further emphasizes this thesis.
Although it still experiences ups and downs, Chang notes that they are often far more moderate than those seen in the stock market.

1. INTEREST RATE HIKE

On September 21st, the FOMC voted to increase the Federal Funds Rate by 75 bps for third consecutive time to fight persistent US inflation. The current Federal Funds Target Rate sits at 3.00%-3.25%—its highest level since January 2008.
Stocks reacted negatively to the news, with the Dow closing 1.7% lower than it started on Thursday, while the Nasdaq Composite fell 1.79%.
In its summary of economic projections, the committee forecasted a half-percentage point rise in unemployment and an effective federal funds rate of 4.6% by the end of 2023.
Notably, central banks across Asia and Europe followed suit on September 22nd with their own string of rate hikes, a signal that global monetary policy is coalescing to tackle what is a global phenomenon.

2. SUMMARY OF ECONOMIC PROJECTIONS

The Federal Reserve’s latest summary of economic projections, released alongside the September policy meetings, reflected a consensus forecast of slowing growth, higher inflation, and a limited increase in unemployment by the end of 2022.
The average forecast for the annual change in GDP through Q4 2022 fell to a dismal 0.2% in their September projection, a drop from the 1.7% growth forecast in June.
The Fed also projects that, as a result of higher rates and slowing growth, the unemployment rate will rise to 3.8% by year’s end, but this is just ten bps above their June forecast.
Both headline and core inflation are expected to remain above the FOMC’s 2.0% target as we turn the page to 2023. The median forecast for headline PCE was 5.4% in the September projections, up from a forecasted 4.2% in June, signaling that the Fed believes that more aggressive action is needed to fight inflation compared to what they thought was required just a few months ago. The median core-PCE projection, which removes food and energy costs, rose to 4.5% from 4.3% in June.

3. LIFE SCIENCES DRIVE OFFICE DEMAND

CommercialEdge’s latest National Office Report, released in September 2022, shows that Life Sciences is increasingly driving office demand even as office vacancies continue to climb.
21.6 million square feet of lab space is currently in development nationally, with the largest projects in Boston, San Diego, and San Francisco. Moreover, the average Life Science facility sits at $645 per square foot, significantly above the average of $258 per square foot for general office buildings.
Large projects planned in Boulder County, Colorado, and Phoenix also signal that the trend has stretched beyond the typical hubs for the sector and into more tertiary markets.
According to BLS data, as of 2021, employment in life science-related positions is highest in Boston (23,900), New York (18,100), and San Francisco (14,200), as defined by CommercialEdge’s scope of the industry.

4. MEDIAN APARTMENT RENTS DECLINE

Property tracking by Zumper shows that the median apartment rent has decreased for the first time in almost two years, with more than half of the markets tracked by the firm showing month-over-month declines in the average one-bedroom rent.
Zumper’s findings are supported by recent data from CoStar and RealPage, which show a ten bps decline in apartment asking rents nationally between July and August (CoStar) and a 0.4% increase in samestore asking rents for new leases between July and August (RealPage).
Some large metros are bucking this trend; however, low supply in some markets amid high demand has limited the flexibility of rent prices. In Seattle, the median one-bedroom is $2,040, up 20.7% year-overyear and 2.0% month-over-month, according to RealPage. Rents in New York City also continue to reach new highs.
Minneapolis, Nashville, Tampa, Orlando, Jacksonville, and El Paso saw declines in asking rents in August.

5. RETURN-TO-OFFICE

Market watchers have long signaled that September would be a telling month for the health of the US office sector. With children returning to schools without the overhanging threat of possible shutdowns and prolonged periods of remote learning, employers are making bigger pushes to get workers back at their desks.
According to Kastle System’s “Back to Work Barometer,” physical office occupancy across the 10 US cities averaged 47.5% of its pre-pandemic benchmark in the week of September 14th. While these data indicate that physical office occupancy remains less than hallway towards a full recovery, they nonetheless represent the highest occupancy rates since March 2020.
Average office physical occupancy rates jumped by a sizable 4.1% across the top 10 markets, reflecting the impact of children starting their school year. New York saw the largest one-week increase, with occupancy rates rising by an encouraging 8.7%. Meanwhile, Austin holds the title as the most recovered office market to-date, with physical occupancy rates rising to 60.5% of their pre-pandemic benchmark.

6. INDEPENDENT LANDLORD RENTAL PERFORMANCE

The on-time collection rate for independently operated residential properties fell by 55 bps between August and September, landing at 81.1%, according to the latest Independent Landlord Rental Performance Report by Chandan Economics.
Gateway markets have maintained higher on-time payment rates than units located elsewhere for nine consecutive months through July 2022, though the gap has been narrowing over the previous three months. The September on-time rate for Gateway markets stands at 82.3%, while non-gateway markets registered an on-time rate of 81.2%.
Analyzing performance trends at different rental price points, units with monthly rents below $1,000 continue to register the lowest average on-time payment rate through September 2022, coming in at 79.6%. Mid-priced rental units perform the strongest, with a September on-time payment rate of 85.4%. High-priced rentals, defined as those charging more than $2,500 sit in the middle, with an on-time payment rate of 84.4% in September.
2-4 Family rentals maintained the highest on-time payment rate of all sub-property types for the sixth consecutive month, arriving at 83.2%.

7. REMOTE WORK AND HOUSING DEMAND

A new paper by the San Francisco Fed analyzes the relationship between the uptick in remote work and housing demand and found that the shift to remote work may account for more than half of overall homeprice increases between November 2019 and November 2021.
The share of work done from home, either full or hybrid, has stabilized around 30% as of August 2022, up from 5% in 2019 and 60% in Spring 2020. Still, levels differ significantly across metros, and data shows that cities with more remote work before the pandemic saw larger increases in remote work during the pandemic.
Breaking cities down into tiers, based on their level of remote work, price growth was essentially uniform across all tiers before the pandemic. However, by late 2020, cities with a higher share of remote work saw significantly higher home price increases than those with less, with the divergence expanding in 2021.

8. LABOR MARKET DISENGAGEMENTS

Despite rising economic headwinds and growing recessionary concerns, the US labor market remains exceptionally tight, with nearly two job openings available for every one person looking for work. A
significant reason why demand for labor is outpacing supply is that less Americans are participating in the labor force. While the labor force participation rate has risen by 0.7 percentage points in the past year, it remains down by another 1.0 percentage points from where it entered the pandemic.
A recent Chandan Economics analysis of the Census Bureau’s August 2022 Current Population Survey explored the reasons why out-of-work Americans are choosing not to look for jobs. According to the findings, two factors are keeping a growing number of people out of the job market: family responsibilities and schooling/training.
Family responsibilities was the primary reason why 18.8% of out-of-work Americans had not looked for new employment in recent weeks— up from just 12.1% in 2020. The uptick is likely due to a surge in family formations following the initial stages of the pandemic.
Similarly, 15.1% gave the reason of attending school or enrolling in a training— up from 8.8% two years ago.

9. MSCI RCA COMMERCIAL PROPERTY PRICE INDEX

Commercial real estate prices climbed by 14.0% year-over-year through August, according to the latest national all-property index released by MSCI RCA. This month’s increase was the slowest annual pace of 2022, while the index rose just 40 basis points month-over-month.
Each of the four major sectors saw modest price growth deceleration in August. Industrial retains its top spot, with prices growing 24.7% year-over-year. Industrial also charted the most significant monthly increase, climbing by 1.5%.
The Apartment index rose 17.1% year-over-year but experienced its sixth consecutive month of slowing growth. Apartment prices climbed by ten bps between July and August.
The Retail index rose 16.0% year-over-year but, like Apartments, saw its sixth consecutive month of slowing growth. Retail prices are up 80 bps from July.
Suburban Office posted a 6.6% year-over-year increase and saw its fourth consecutive month of slowing price growth. The CBD Office index rose 7.7% year-over-year and ten bps between July and August.
Price growth in Gateway markets climbed 7.6% year over year while price growth in non-major metros rose by 16.3% year-over-year.

10. GLOBAL SUPPLY CHAINS

According to the New York Federal Reserve’s Global Supply Chain Pressure Index, supply chain conditions have made significant progress towards normalization in recent months, though they are still far from pre-pandemic normality.
Supply chain disruptions have proven a significant contributor to inflation both in the US and around the world over the past year, as consumer demand has exceeded the capacity of supply lines to keep up.
The index has a historical average value of zero, with each monthly observation represented as standard deviation from the mean. August 2022’s index value was a 1.47. Before the pandemic, the index had never fallen below -1.57 or risen above 1.56, indicating that today’s conditions still reflect abnormally stressed supply chain conditions.
Nonetheless, the index has improved considerably in 2022. After reaching an all-time high is December 2021 (4.31), the Supply Chain Pressure Index has fallen in six of the past eight months.

SUMMARY OF SOURCES

(1) https://www.federalreserve.gov/newsevents/pressreleases/monetary20220727a.htm\
(2) https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20220921.pdf
(3) https://www.commercialedge.com/blog/national-office-report/
(4) https://www.globest.com/2022/09/28/median-apartment-rent-sees-first-declines-in-nearlytwo-years/?kw=Median%20Apartment%20Rent%20Sees%20First%20Declines%20in%20Nearly%20
Two%20Years&utm_source=email&utm_medium=enl&utm_campaign=nationalamalert&utm_content=20220928&utm_term=rem&enlcmp=nltrplt4
(5) https://www.kastle.com/safety-wellness/getting-america-back-to-work/#workplace-barometer
(6) https://www.chandan.com/_files/ugd/df56fe_8cccce5ce9ac4b67851830309d9d1838.pdf
(7) https://www.frbsf.org/economic-research/publications/economic-letter/2022/september/remotework-and-housing-demand/
(8) https://www.chandan.com/post/diplomas-and-due-dates-are-keeping-americans-out-of-the-laborforce
(9) https://www.msci.com/our-solutions/real-assets/real-capital-analytics
(10) https://www.newyorkfed.org/research/policy/gscpi#/overview