JF2479: 8 Post-Pandemic Commercial Real Estate Trends | Syndication School with Theo Hicks
In this episode, Theo analyzes the Post-Pandemic Investment report by Marcus & Millichap. Tune in to learn about future, post-pandemic trends for commercial real estate as a whole, as well as each individual asset class.
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Theo Hicks: Hello Best Ever listeners and welcome to the Best Real Estate Investing Advice Ever Show. I’m Theo Hicks and we’re back again for another episode of the Syndication School series, a free resource focused on the how-to’s of apartment syndications. We’re going to break down another commercial real estate report. This time going to Marcus and Millichap. They’ve been releasing a lot of Coronavirus-related special reports every once in a while. In this report, they analyzed the performance of the major commercial real estate asset classes during the pandemic. They did this with the purpose of providing some predictions on future post-pandemic trends for commercial real estate as a whole, as well as for each individual commercial real estate asset class.
The report is called Post Pandemic Investment Trends. If you go to marcusandmillichap.com and go to their research section, it’ll pop up in their Special Reports section. I believe they released this in May, last month. I recommend checking out the full report. There’s a lot of really good graphs with up-to-date information on things like cap rates, asking rents, and vacancy trends. I think some of this data went back to 2001, and that’s on industrial multifamily office and retail. I know this is typically Apartment Syndication School, but today those will be straight up Syndication School. We’ll talk about the commercial real estate industry as a whole and then a few points on some of the other non-multifamily asset classes, just because one asset class has been performing better than multifamily; the rest, obviously, have not. I’ve got eight takeaways that I got from this report that I wanted to go over today.
The first takeaway is that, overall, there is a very strong improved economic outlook. This is mostly reflected by the GDP growth projections, or the GDP increase projected for 2021. They have a low-end forecast and a high-end forecast for 2021, and that is a GDP growth of 5% on the low end and approximately 9% on the high end. They have data going back in this report to 2001. Even if the low-end forecast comes to fruition of 5%, that’ll be the greatest single year GDP increase since at least 2001. That’s how far back their data went. One of the interesting factors as to why they believe GDP is going to increase so much –I don’t think I’ve talked about this on this show before, but I think it might have been mentioned in an interview I’ve done with someone, or maybe Travis and I talked about it on Actively Passive– but there was a massive increase in savings during 2020. In this report, they say that the savings deposits and money market funds increased by 4.3 trillion dollars since February of 2020. Obviously, as things start opening back up, that money will be spent, which will result in the GDP increasing and helping the economy grow. I think it’s something along the lines of retail spending has increased by over 10% recently; I think it might have been the 12 months leading up to March 2021. It’s kind of already happening. That’s why they projected the GDP to improve so much in 2021.
The second point is about cap rates. The point here is cap rates are expected to continue to decrease. With the exception of senior housing and office space, where cap rates are expected to remain the same, cap rates are expected to decrease across all other commercial real estate asset classes. This is a continued decrease, because they have been decreasing for a while now. They expect the housing and office to not continue to decrease, to kind of stop and stabilize. They expect all other asset classes, industrial, multifamily, retail, etc, to decrease. The asset classes with the greatest anticipated decreases in cap rates were self-storage and hospitality.
Hospitality is an interesting one. We talked about this, I think maybe in the last Syndication School, how a lot of demand for hospitality right now with the expectation that obviously, it’s not doing very well because of the pandemic, but that is going to bounce back very strongly as things open up. It was just a temporary dip and that investors were looking for steep discounts, didn’t get those discounts, and then obviously, once it returns they’ll make a lot of money on those investments. Compressing cap rate is an indication of an increase in demand. A strong demand for self-storage, strong demand for hospitality, also a demand for the other asset classes like industrial, multifamily, and retail.
Theo Hicks: Number three is that the commercial real estate yields are still greater than other alternative low-risk investment vehicles. This is just looking at the spread in returns, the spread in yields from the average commercial real estate cap rate, and the 10-year treasury rate, which would be the alternative low-risk investment vehicles. The spread between the 10-year treasury rate and the average commercial real estate cap rate in 2021 – all this data is from March. March 2021 was 460 basis points. Compare this to five years prior, in 2016, it was 390 basis points, and then in 2011, it was 590 basis points, so right kind of in between those two. This means you can get a better return investing in real estate and other alternative low-risk investment vehicles.
Number four – and this is going into the commercial real estate-specific asset classes – there’s a very strong demand for industrial space. The logic here is, in part – or this is not the only reason why, but it is mostly due to stores closing down and more people, especially the older generations, transitioning to online e-commerce, buying stuff online. These warehouses having to increase their stock, buying extra space, larger spaces. There was a record number of deliveries over a 12-month period ending in March. But at the same time, usually, as new stuff comes online, you would expect a decrease in rents and an increase in vacancy rates, because there’s more product. But during the same time, the national industrial vacancy rate only rose 10 basis points, which is 0.1%, while the asking rents increased by 4.6%. A very, very strong increase in demand for industrial space; even though there’s a record number of new deliveries created in a 12-month period, it still wasn’t enough to keep up with demand, something to consider.
Number five, moving to a multifamily, which may be what you care about the most. This is just a reiteration of things we’ve talked about before… But target secondary and tertiary markets for real estate. Primary markets didn’t fare very well over the last four quarters. Vacancy increased by 80 basis points on average, and the average rent declined by 3.4%. Again, this is on average; some places a lot more than others. When we look at secondary and tertiary markets, vacancy actually went down 10 basis points, and average effective rents grew by 2.2% over that time span. Obviously, this is a trend that was occurring prior to the pandemic, and they kind of just accelerated this trend. So focus on those secondary tertiary markets, also stay away from urban areas and focus more on suburban areas.
Number six, this is focusing on retail space. The trend here is a single-tenant retail space is performing better than multi-tenant retail space, with one exception, of course. The demand for retail space, that at least maintained performance during a pandemic, like discount stores, drugstores, quick service, drive-thru restaurants, are things you should focus on. Those are examples of single-tenant retail space. On the other hand, multi-tenant retail space didn’t perform as well. The only exception would be grocery-anchored shopping centers in growing sub-markets. You’ve got a big grocery store, like I guess here would be a Jewel-Osco, or a fresh market, or a Whole Foods, and then around them or other things. Like where I live, there’s a bunch of other retail stores. As long as it’s in a growing sub-market, that’s still something worthy of investing in.
Number seven is about office space, which is going to continue to be uncertain. I remember when we did our investor outlook Syndication School last week, we said that surveying investors, obviously, no one thought the [unintelligible [12:37] was going to return for office for at least, I’m pretty sure it’s three years. This report reiterates that; there’s a lot of uncertainty because of the unknown of when or how many people are going to return to in-person working, so cap rates really haven’t changed, while cap rates basically everywhere else have compressed. There are some places like medical offices that are in demand. For medical offices, cap rates are compressing. Also, a suburban office base is performing way better than urban office base, for the same reasons why suburban multifamily is performing better than urban multifamily.
During a 12-month period ending in March 2021, the vacancy rates for the suburban offices rose approximately 2/3 as much as compared to urban offices. Obviously, the vacancy did increase, but not as much in the suburbs. The same thing for rents; asking rents fell across the board on average, but much more so in the urban areas, with 6.1%. Whereas office space in suburban areas, the asking rents have dropped by about 0.2%. Almost negligible. If you are going to target office, make sure it’s suburban office-based or medical offices.
Lastly, the buying patterns during the pandemics – this is point number eight – is that the private buyers were responsible for a majority of purchases during the pandemic. While institutions were on hold, in a sense, private buyers were responsible for 55% of the total dollars invested during the 12-month period ending in March of 2021. This is a 300 basis points increase compared to the pre-pandemic private investor volume. Now, this is fairly typical during economic recessions. They said that the same thing happened due to the 2008 recession, where big buyers stepped back and private buyers came in there and were doing most of the investing. Then after the recession subsided and the economy bounced back, went back to normal. Whereas this time, they are predicting that private buyers might not necessarily be the majority of the buying volume, but they’re going to be a higher percentage than they have been in the past as things bounce back, especially in the 1 million dollars to 10-million-dollar purchase range. Maybe one takeaway from here is that if you own property in that range, it might be in more demand than it would have been in the past. Maybe a lot of big buyers aren’t buying those types of properties. Usually, private buyers are buying in that range. The more private buyers in the market, the more in demand your one million dollar to 10 million dollar properties are.
Theo Hicks: I’ll quickly go through these one more time to summarize. We’ve got number one, improved economic outlook with a potential record high GDP growth in 2021. We’ve got, almost across the board, a continued compression of cap rates; exceptions again are going to be senior housing and office space. We’ve got the continued large spread between commercial real estate yields and other alternative low-risk investment vehicles, like the 10-year Treasury rate. Four, you’ve got a strong demand for industrial space, it’s across the board. Five, you’ve got a strong demand for multifamily in secondary and tertiary markets. Six, you’ve got the single-tenant retail space being in more demand than the multi-tenant retail space, with the exception of those grocery-anchored shopping centers in good markets. Number seven, office is going to be uncertain, but if you really need to invest in office, you want to choose the suburban office base over the urban office base, and then also you could focus on medical offices across the board. And lastly, private buyers were responsible for a large chunk, the majority of investment volume during the pandemic. That investment volume might, at a piece of the pie, decrease as institutions come back and will still be strong, so there’ll be a demand for private buyers.
Again, this is a special report by Marcus and Millichap, post-pandemic investment trends for Q2 2021. Check that out. Check out the other Syndication School episodes that we have. We also have documents for those episodes are at syndicationschool.com. Thank you for listening. Have a Best Ever day and we’ll talk to you tomorrow.
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