5 Trends to Watch in Commercial Real Estate

Here are five market trends to monitor this week in the context of your real estate portfolio:

1. The 60/40 Portfolio

“There have been some days more recently where I’ve looked at my portfolio and gone ‘oh, crap,’” … unfortunately this sentiment is probably not uncommon these days among retirement-minded investors. The 60-40 portfolio lost 17% last year, its worst performance since at least 1937. To put it simply, bond market and stock market performance tend to be less correlated when inflation and interest rates are low. This was not the case in 2022, and may not be the case for some time. Where to turn? Investors are dumping money into cash and money market funds, but where else? “Others recommend looking beyond stocks and bonds altogether to more complex investments, often ones that are riskier and charge higher fees. Real estate has long been a popular option for individuals with some spare cash.” With respect to real estate, these are broad brush strokes. Investors may find fee loads palatable in the context of net returns (or versus fees charged by financial advisors). While real estate investments entail risk (like all investments) the risk-adjusted potential returns may be appealing as the 60/40 portfolio continues to face headwinds. Private debt-based investments, for example, can offer the downside protection of collateralization and timely fixed-income option. As Howard Marks put it recently, “thanks to the changes over the last year and a half, investors today can get equity-like returns from investments in credit…. And, importantly, these are contractual returns.”

2. Spooky Markets...

“Capital market malaise is crushing everybody.” said one of the country’s largest developers of rental apartments. “We don’t have a recession now, but there’s a lot of uncertainty around the cost of capital” said the CEO of CBRE during a recent earnings call. Scary stuff for real estate investors? Depends! In real estate investing, one man’s handwringing is another man’s jazz hands. These pessimistic quotes come from some of the largest institutional asset managers in the country. Keep in mind that private real estate markets are segmented and highly fragmented. While current capital market conditions mean that certain large-scale projects may no longer pencil, that doesn’t mean there isn’t opportunity in other pockets of real estate markets. In fact, the leeriness of traditional debt capital and tentativeness of institutional operators means potentially more slack for alternative lenders and middle-market operators to pick up. Despite the Fed’s hawkishness over the past 16 months, the economy has actually gotten stronger by key measures in the past few months. Middle-market CRE operators who are able to move more nimbly could benefit from less competition and at least light tailwinds across a number of CRE sectors. By the way, here’s what EquityMultiple Director of IR (and resident cowboy) Daniel Brereton has to say on the topic.

3. The State of Homeownership

Speaking of opportunities for investment and adding value… housing underproduction and un-affordability shifted beyond urban cores during the pandemic. The number of counties across the U.S. experiencing housing underproduction increased 32 percent from 2019 to 2021. Meanwhile, houses have literally never been more expensive.  “A home buyer needed an income of nearly $115,000 to afford the median-priced U.S. home in August [...] up from about $99,000 a year earlier.” That’s 54% above the median household income in the U.S. Multifamily starts are expected to end the year down 6.4% from 2022. Market fundamentals remain strong, houses remain woefully expensive, and supply is inadequate (among a growing set of geographies). Taken altogether, this is a recipe for a broad, durable investment thesis for multifamily operators, alternative lenders who can fill gaps, and individual investors who are able to tap in.

4. Blue Skies Ahead?

Despite how the economy might be feeling to you and me, all signals are pointing to a recovery. Consumer spending has propelled real GDP growth to nearly 5% year-over-year. Along with consumer spending, however, comes the fear of increased inflation. Although the most recent reading saw core CPI growth coming down to to 4.13%, this is still a good distance from the Fed’s target 2%. At this week’s FOMC meeting, the Fed kept rates steady but continued to leave the specter of another rate hike in the wings should inflation remain above the target. Inflation has been the main focus, but it remains to be seen how resilient the rest of the economy is in the face of higher rates. Aside from curbing inflation, rate increase can also impact lending and borrowing which, as we have seen, can dampen real estate projects. Taking a contrarian view and spending dry powder as others pull back can allow cool-headed investors to capitalize.

5. An Assortment of Results

Diving deeper into economic performance, third quarter corporate earnings releases have shown a mixed bag. Tech darlings from the last few years continue to drop while incumbent giants like Google and Microsoft posted strong results. Of note, WeWork, once valued at nearly $47 billion, has allegedly filed for bankruptcy. Several of the high-flying companies in new-tech industries like green energy have tumbled in the public markets, with some dropping over 90% from their peak valuations. New industries and technologies can be exciting, but they often fail to meet the loftiest projections that the media portrays. EquityMultiple believes that expanding beyond the public markets can benefit all portfolios. Owning tangible real estate investments can help investors diversify against the volatility of the stock market.