Tag Archives: Commercial Real Estate

How the Housing Shortage Impacts Commercial Real Estate

How the Housing Shortage Impacts Commercial Real Estate ft

It doesn’t take a real estate expert to see that housing prices have been accelerating in recent years. Ten plus years after the Great Recession of 2007-09, residential real estate prices have more than recovered in most areas across the country. In its place, a housing shortage has created a situation where many Americans struggle to afford their rent, let alone to own a home. In fact, a significant portion of the current generation of young Americans have more or less resigned themselves to the fact that home ownership is unrealistic.

 

What is less obvious is how this residential real estate trend has and will continue to impact commercial real estate. It is unlikely that new home construction will be able to keep up with housing demands. Will these developments help or hurt the health of the CRE industry?

 

The Current State of Housing in the US

How the Housing Shortage Impacts Commercial Real Estate 2

Let’s first establish a few key facts. There are approximately 138 million housing units in the United States. About 80 million of these units are occupied by their owners and 43 million are occupied by renters. By most estimations, the US actually has a very healthy ratio of available housing units to individuals or families in need of residence. So what is the problem exactly?

 

The answer lies in the fact that key markets such as California and Austin are being crushed by demand with a limited supply. The problem is that the current supply of housing units does not align with demand when it comes to price or location. This issue is particularly bad for more affordable homes, which cost between $100k-$250k, depending on the market. This creates heightened competition for more affordable homes, which drives up prices and makes these housing units less affordable to buyers and renters. 

 

Ironically, as young adults flee from traditional markets like NYC and San Francisco and turn to hot markets like Pittsburgh and Kansas City, they are bringing big city housing shortage problems with them. For example, Pittsburgh experienced a 16 percent drop in relative housing availability in 2019 vs. 2018.

 

How Residential and Commercial Real Estate Interact

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Based on these trends, one might assume that the commercial real estate rental market would be booming in response. This is not entirely the case. Despite housing prices rising to near-emergency levels, rental rates in 2020 are expected to remain relatively flat. The latest year-over-year numbers put rental rate growth at approximately 1.4 percent nationwide. Again, this is somewhat misleading as some regions have experienced explosive rental hikes while others have actually seen rental rates diminish.

 

Another key factor in this equation is the decision making process of young renters. Millennials and the generations who are growing up behind them have shown a tendency to choose convenience and amenities over square footage and perceived value. This is due to a number of reasons, including their desire to use public transportation and a preference for urban living. 

 

These trends have been favorable for commercial real estate rental units which are focused on offering convenience first and foremost. Well equipped rental units in urban or even “urban suburb” locations continue to see high occupancy rates in 2020. As young adults continue to struggle to afford their own homes, rental properties should remain a safe bet. 

 

Commercial Real Estate Projections in the Coming Years

By all current metrics, our nation’s housing shortage looks to only worsen in the coming years. This is especially true in mid-major markets experiencing a tech boom including Pittsburgh. As for commercial real estate investors in the area, that means that there will be an opportunity to deliver high quality housing at premium prices for young adults who are willing to pay for high level amenities. 

 

For example, young renters are more likely to pay a premium for rental units in so-called “smart buildings”. These types of commercial real estate units are constructed or retrofitted to accommodate desirable features like ultra high speed internet and even 5G when that is released to the public. This is in step with the advantage that CRE has over traditional residential real estate: it can adapt more quickly on a larger scale to new technologies. 

 

The housing market may be in a strange place, but that offers an opportunity to savvy commercial real estate investors. Understanding what young renters want will allow larger rental investments to continue to be profitable for years to come.

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Going Forward

It may be a running gag that millennials can’t afford to buy homes, but that reality is no joke. The wealth of our country might be held disproportionately by older generations, but younger working generations are the key to future CRE success. Where traditional thinking has valued square footage and price first and foremost, young adults today are shifting their focus towards amenities and convenience. This, coupled with the ongoing housing crisis, creates a scenario where well positioned rental properties can dominate the market.

Commercial Real Estate and US Economic Trends Going into 2020

Commercial Real Estate and US Economic Trends Going into 2020

As with most investor markets and economic issues, commercial real estate is an ever-changing reality. What might look like a safe bet today could lead to huge losses tomorrow. Government regulations, environmental factors, and a looming recession are just a few of the ways that the commercial real estate landscape can change at any moment. Yet seasoned real estate veterans understand that these changes are just a surface disruption of CRE wisdom which generally holds true over time. 

 

With all of this in mind, here is a brief report on the current realities of commercial real estate in the US as well as some insights into the near future.

 

2019 Commercial Real Estate by the Numbers

2019 Commercial Real Estate by the Numbers

The commercial real estate market is currently valued in the ballpark of $1.1 trillion. To put that in perspective, if a trillion dollars represented $10,000, a billion dollars would be $10. Needless to say, there are massive amounts of revenue being generated in the CRE market in 2019. Here are a few other statistics to give a clearer picture of the current state of CRE:

 

  • The commercial real estate industry experienced an estimated growth of 2.2 percent in 2019. This is down from an average of ~4 percent annual growth in the CRE industry over the past five years.
  • Commercial real estate growth has outpaced overall real estate growth, rental rate growth, and leasing growth in 2019. 
  • Seasonalized annual construction values from Q2 2019 are down by about five (5) percent compared to similar estimates from 2018. Newly constructed commercial structures saw the largest value losses over this time period. 
  • Commercial property valuations are on a steady rise beginning with the recovery period in 2009-2010. During this time period, prices have risen the most in the Western United States with the Midwest lagging behind.
  • Rental rates have flattened to a relatively low 1.4 percent year over year growth from 2018 to 2019. This trend is expected to continue with many market indicators pointing towards a stagnant apartment market overall.

 

The State of the US Economy Looking to 2020 and Beyond

A recession is all but unavoidable in the next few years

Before we stare into the proverbial crystal ball, we should first state the obvious: nothing is guaranteed. That being said, here are some likely events in the US economy over the next several years.

 

A recession is all but unavoidable in the next few years

As of the writing of this article, the latest news is that doom and gloom predictions about the next US recession may have been exaggerated. Despite this sudden onset of optimism, the plain truth is that recessions are a part of modern free markets. The most optimistic, realistic view of the situation is that our next recession may not take place in 2020 but in the years to come. Whether the next economic downturn occurs in 2020, 2021, or beyond, it will almost certainly have a material impact on commercial real estate just as it did during the Great Recession of 2008.

 

Climate change will continue to be a major player for the economy and for CRE

Recent scientific studies have predicted that extreme weather events in the United States will rise by approximately 50% by the end of the 21st century. This continues the already observable trend of extreme weather patterns like more frequent and stronger tornadoes, hurricanes, floods, and other natural disasters. This will impact both the overall economy and commercial real estate industries for obvious reasons. Building codes are likely to be updated, insurance costs will rise, and other incidental expenses will almost certainly take a hit. Economists warn that climate change will likely cost the US economy 100’s of billions of dollars by the year 2090.

 

Young adults will continue to struggle financially

Young adults will continue to struggle financially

Last but not least, the population of adults who should be representing the largest buyers in the US economy will continue to be hit by crippling debt, healthcare costs, and stagnant wages. Barring an unlikely dramatic shift in the political and/or economic landscape, the US Debt Crisis will be a huge factor in the economy for the foreseeable future. This has already played a role in lagging rental rates, home ownership, and spending habits. It is difficult to predict how this situation will play out, but younger generations have proven that they are willing to cut costs, something that is not a great sign for economic health.

 

Going Forward

The commercial real estate sector has been reliably strong for nearly 10 years now. After a two year dip in 2008-09, investors have enjoyed solid returns and steady growth. While it is reasonable to expect another downturn at some point in the next few years, it is also reasonable to believe that the US economy will bounce back and investments will continue to pay dividends. It will continue to be important for investors to keep up with the latest CRE trends such as co-working, energy construction projects, infrastructure construction, and much more. The commercial real estate world’s evolution is ongoing, and the only certainty moving forward is change.

How a Recession Would Impact Commercial Real Estate

How a Recession Would Impact Commercial Real Estate

When it comes to recessions, it is not a matter of if, but a matter of when. The average American tends to view recessions as massive periods of history such as The Great Depression. In reality, recessions are quite frequent with varying degrees of impact on the individual and on different industries. Based on historical precedence, the US is due for another recession in the coming years. What is more difficult to calculate is the severity and duration of the next recession. 

 

As real estate investors, recession can be viewed as both a scary proposition and also as an opportunity. Today, we will examine past recessions to better understand how investors can prepare for the impact of a future recession on commercial real estate.

 

The Inevitability of the Next US Recession

THE INEVITABILITY OF THE NEXT US RECESSION

While nothing is inevitable beyond death and taxes, a recession is pretty damn close. Beyond the conceptual inevitability of economic ebbs and flows, recent recession indicators have shown that the US is due in coming years. Examples include:

 

Inverted yield curve: In a healthy economy, a long term, 10-year yield is expected to outperform a short term, 3-month treasury rate. In 2019, the 10-year yield dipped below the 3-month yield for the first time in 12 years. The last time this occurred, the 2008 financial crisis was looming around the corner.

 

Unemployment rates belie the reality: One of the strongest pillars of the current US economy is historically low unemployment rates. This is a great sign of stability of the nation’s economy. However, a worrying trend is that 2019 saw huge cuts to employee hours. This is often the first step towards higher unemployment rates, as employers tend to cut hours first, before ultimately having to downsize.

 

New York Federal Reserve recession probability model: The New York Federal Reserve puts out one of the most comprehensive and respected predictive models when it comes to future recessions. According to this model, the likelihood of a recession has approached 40 percent for the first time since 2009. Previous predictions have been accurate with a nearly perfect track record.

 

2008 Great Recession’s Impact on Commercial Real Estate

2008 Great Recession’s Impact on Commercial Real Estate

The residential real estate market gets most of the attention when it comes to the Great Recession of 2008-2009, and for good reason. Foreclosures and purchasing habits took a massive hit during the following years. However, the commercial real estate industry was hit nearly as hard. In fact, the average price of office space has been slower to recover than average rental rates. While office prices in 2017 had recovered to 30 percent above their 2007 highs, rental rates were performing at 60 percent above their 2007 highs.

 

Another grim aspect of the 2008 financial crisis was the impact it had on vacancy rates within commercial real estate. 2010 saw peak vacancy rates at 17.4 percent for office space, 10.1 percent for industrial space, and 10.8 percent for retail space. It is important to note that the impact on CRE markets seems to have been a bit more delayed than within the residential market, potentially accounting for some of the slower recovery noted above.

 

From the years 2007 to 2009, total investments in real estate went from $460 billion to $70 billion. This is one straightforward trend which will likely translate for commercial investment in any coming recessions. The impact may not be so severe, but total investments will almost certainly slow when a future recession hits.

 

How CRE Investors Can Prepare for a Recession

Liquidate assets now to turn investments into cash

With all of this in mind, how exactly can commercial real estate investors prepare for this inevitability? While predicting the future is obviously a fool’s errand, there are two primary strategies that CRE investors can use to stay ahead of the curve.

 

Liquidate assets now to turn investments into cash

The signs of recession are certainly there. Some investors who have seen solid returns on their current CRE investments might want to take a turn-to-cash approach. This essentially takes your skin out of the game until the economy is back on the rise. The fringe benefit of turning current investments into cash is that savvy CRE investors can once again get back into the real estate market when property values hit their lowest points. 

 

Retain real estate assets and weather the storm

Recessions are scary, but as all things, they too will pass in time. Most long-term investors understand that half the battle is staying in the game. All of the figures we have quoted earlier show horrible downturns and also eventual recoveries. In fact, one of the “bad” statistics for CRE was a mere 30% increase in value over a 10 year period. 

 

Going Forward

Recessions are as American as apple pie. They are not to be feared, but they certainly call for some preparation and smart decision making. Commercial real estate is every bit as susceptible to an economy in recession as residential real estate or any other forms of investment. Smart investors will view coming economic downturns as just a part of the greater picture. Just as the CRE market recovered from 2008, so too will it recover from the next recession.