by Rachel L. Richardson
Inflation and CRE
In the first part of this two-part series, we briefly discussed the current inflation trends, the Federal Reserve’s moves to curb inflation, and what this means for Commercial Real Estate (CRE). This included how inflation affects CRE participants (developers, buyers, owners, and tenants) and how the investment timeframe, asset location, and property type are also important considerations.
Of course, to determine a particular property’s market value or its market rental rate, appraisers will consider a host of factors like age and condition, quality and size, location and amenities, as well as facets particular to its property type. Far from this level of detail, the following section covers general trends as they relate to the main CRE categories—multi-family, industrial, office, retail, and hospitality.
Executive Summary
- Multi-family and industrial remain strong performers, whose metrics are expected to soften from their record-setting pace.
- Newer offices with ample amenities continue to thrive; mixed factors in the industry allow for both risk and great potential.
- Retail is expected to remain in a holding pattern, with little construction, but continued demand for experiential shopping.
- The hospitality sector has shown mixed results by area and amenities, but generally strong growth amid headwinds.
Impacts by Property Type
Multi-family continues to exhibit stable metrics across the nation, according to Moody’s Analytics’ Q2 Quarterly economic briefing. Rent growth is stable and above the long-term average, while multi-family vacancies are below their 2019 rates. This is due in part to the number of would-be homebuyers who have been priced out of the single-family market. Describing the above-average rent growth in multi-family properties despite the escalation of household costs, Moody’s Thomas LaSalvia noted the adage, “Rent eats first.” While short-term households are prioritizing rent above other necessities, they will not always be able to bear this cost burden and Moody’s expects the rent increases will moderate and return to more typical levels. This trend appears to have begun, as month-to-month apartment rents fell in August for the first time in nearly two years. Similarly, across what CoStar describes as the “pandemic era boomtowns” (Boise, Idaho; Phoenix, Arizona; Reno, Nevada; Sacramento, California; and Spokane, Washington) the multi-family markets are showing signs of returning to normalcy as net absorption has declined, even to a point of negative absorption in Reno and Sacramento in the first half of 2022.
Industrial, considered a perennial performer, has experienced a boom in the pandemic era as expansion and development in the logistics side grew to meet consumer demand and the rise of e-commerce. “The pandemic compressed 10 years of forecasted e-commerce penetration into three months,” says Adam Roth of NAI Hiffman, in an interview with CPE highlighting logistics amid supply chain challenges. Though Amazon has recently pulled back on expansion, choosing to sublease at least 10 million square feet of warehouse space, Moody’s Analytics anticipates a marginal, comparative slowdown in the industrial sector but with continued, positive metrics overall. Typical lease terms of five to ten years, in a triple net lease structure (where the tenants assume the operating costs), are key factors shaping how well investment in this sector will weather inflation.
The office outlook, on the other hand, becomes more polarized in terms of location and amenities, while external factors make forecasting more uncertain. Cushman & Wakefield executives expect a return to pre-pandemic leasing by the end of 2024 globally, noting an increase in new leases and the U.S. addition of 635,000 office-using jobs in the first half of 2022. Other firms (like JLL, Newmark, and Colliers) posted strong revenue growth in Q2, but are anticipating decreased deal activity, particularly as companies continue to assess their physical footprints. While the return to the office has proven somewhat difficult, given how much traction remote work has gained and the rising costs associated with commuting, many businesses are looking to get employees back into the office and are using various incentives and methods to do so. Many firms tout the workplace as integral to their company culture and are focused on providing the amenities and atmosphere that would entice workers back into the office.
Some types of retail are faring better than others amid the boom of e-commerce, and trends suggest the in-store experience is still sought by many consumers. Grocery-anchored centers fare the best despite online retail’s emergence, with higher-end anchors like Trader Joe’s, Whole Foods, Aldi, Harris Teeter, and Stop & Shop displaying particularly solid revenues and traffic. Moody’s notes a trend away from goods and to services, and a generally flat performance in retail overall; there is not much construction in the pipeline and elevated vacancy rates will likely continue for several years.
Over the summer particularly, the hospitality sector experienced a surge from pent-up pandemic demand, even as it has sustained challenges with staffing shortages. Moody’s Q2 briefing noted average daily rates (ADRs) at record highs by the end of the second quarter, well over pre-pandemic rates, while revenue per available room night (RevPAR) increased by 29.4% from Q2 of the prior year. ADRs have been softening, but activity remains sustained in what is being called ‘Bleisure’ (business + leisure) as people are traveling for work but are willing to pay more for amenities and experiences, combining vacation aspects of the trip while they are out.
Parting Thoughts
While this is just a whirlwind tour of the key sectors in CRE, it highlights some of the elements that factor into CRE as an investment vehicle. Though each property is unique, valuation professionals leverage their knowledge of their local markets, data gathered from comparable properties, and their years of experience in the field, to form opinions of market value or market rental rates—each tailored to the individual properties they appraise. Amid market uncertainties, this data-driven approach to a property or portfolio provides the key to informed asset decisions.