Archives for October 2021

Inflation-adjusted household wealth is up 21.4% over pre-COVID levels.

As the US continues to recover from the COVID-19 pandemic, CRE is outperforming, seemingly against all odds. After all, the US economy has yet to fully recover from the global health crisis.

“We’re still in the middle of a global pandemic,” says John Chang, Senior Vice President and Director, Research Services at Marcus & Millichap. “We shut down a big portion of our economy for several months last year. We have a massive labor shortage, and our supply chain logistics are running into all sorts of problems.”

But despite that, CRE appears to be thriving.

“Apartments are doing great. Vacancy rates hit an all-time low, and rents are climbing. Industrial is doing great. Rents are growing, vacancies are falling despite record construction levels,” Chang says. “Self-storage is also doing great with record low vacancy. Retail, particularly anchored neighborhood centers and single-tenant properties, has held up remarkably well. And office is a bit soft…but the sector definitely hasn’t hit crisis mode.”

And while hotels “have had a tough run,” Chang says the average daily rate for some segments is above pre-COVID levels and occupancy rates are also pretty close to where they were pre-COVID. Meanwhile, senior housing’s “bumpy road” will likely lead to consolidation that will strengthen the sector overall.

So how to explain the disconnect? Chang points to inflation-adjusted household wealth, which is up 21.4% over pre-COVID levels. Even excluding stock market gains and only counting owner-occupied real estate and money in bank accounts, household wealth is still up by 15.7% over 18 months ago.

“That’s a big part of why commercial real estate is outperforming,” Chang says. “Despite the pandemic, the economy is growing. People have money in their pockets and they are spending it. There’s enormous housing demand, retail sales are 19% above pre-COVID levels, and savings are way up.”

The greatest economic risk factors are inflation, “which has little negative impact on CRE in the short term,” and supply chain problems, which Chang says are actually a positive for most CRE property types.  Supply chain issues cause building material shortages, he says, and that in turn constrains competition from CRE development.

“Aside from an inflation or supply chain induced recession, which seems unlikely at least for now, the outlook for most CRE sectors remains promising,” Chang says. “With a baseline economic growth forecast of 4% next year and a strong employment market despite labor shortages the one year outlook for most CRE is strong.”

The outlook for a year-plus is “a little murky,” but momentum is favorable. Supply and demand trends remain favorable, and Chang says that’s why many of the most active investors are pricing strong growth into their underwriting, particularly for industrial, self-storage and apartment properties.

Source: “The Simple Reason CRE Is Outperforming Against All Odds“

PwC and ULI’s emerging trends survey found that 82% of respondents consider ESG elements when making operational or investment real estate decisions.

Already grabbing daily headlines in the United States and globally in most every industry, Environmental, Social and Governance (ESG) is expected to play an increasing role in commercial real estate in 2022, according to a trends report issued Thursday by PwC US and the Urban Land Institute.

The report highlighted several evolving trends shaping the real estate industry, including proprietary data and insights from nearly 1,700 leading real estate industry experts.

Chief among its findings was that flexibility, convenience and ultimately real estate’s resilience, can drive property sector function over the next decade. Consumer expectations of traditionally designed spaces have changed, and there will likely be a massive shift in the functionality of homes, offices, shopping centers and healthcare spaces.

Urban landscapes are facing change, as new land uses and updated zoning allows markets to evolve. All these factors remain under the cloud of climate urgency, prompting new ways of standardizing and measuring ESG requirements.

As businesses approach ESG issues in the property sector, it will be imperative to take a holistic approach and create a strong overall strategy—to help create sustainable advantage and value.

82% of Respondents Consider ESG Elements

The Emerging Trends survey found that 82% of respondents consider ESG elements when making operational or investment decisions. A growing consensus sees the property sector as bearing much of the responsibility for climate change and being uniquely positioned to institute helpful improvements to help mitigate impacts and increase resilience to environmental risks.

Dave Pogue, Chief Strategy Officer, RiverRock Real Estate Group, tells GlobeSt that the answer for developers is not in the design phase but rather the decision phase of where to invest/develop. He cited an annual report issued by the international real estate company, Grosvenor Group, ranking the world’s 50 “most important” cities on a series of environmental and social factors, creating a comprehensive risk management tool for their potential long-term investment targets.

“As the Grosvenor Group demonstrated, location is becoming a critical consideration,” Pogue said. “For new or even existing developments in ‘at risk’ areas, there are a number of steps owners/developers can take.

“Many of these were learned after Hurricane Sandy and include placement of critical equipment, and creation of redundancy and backup to both critical equipment and communications protocol.”

Despite industry participation in environmental accreditation programs and broader ESG initiatives, investors have been slow to incorporate environmental risks into underwriting, according to the PwC-ULI report. However, the growing risks of climate-related property damage may induce more investors to follow the example of leading institutional investors in factoring market-level climate risk into decision-making.

“While the initial and primary focus of Grosvenor Group was concern for issues related to climate change,” Pogue said, “what was perhaps most innovative for the time was the inclusion of a broader range of social and governance factors as well, such as infrastructure, education, and business climate. Today many more investors, especially ones with global portfolios and longer-term investment horizons are actively doing similar evaluations. Some sophisticated investors have created internal resources to address this issue, and all are now aided by a number of governmental and privately-curated databases with both historical averages and predictive modeling.”

Pogue said the past few years “have completely rewritten the standards relating to climate/weather events. The issue of resiliency is becoming one of the most important factors for investors to consider.”

Pogue said the issues of most concern for investors today are those same issues or events that concern the insurance industry.

“Insurability is not just important, it is imperative,” Pogue said. “Commercial insurance rates are already rising in many areas such as New Orleans, Miami, and Houston as the near-term history of weather-related casualties keeps worsening.

“What were 100-and 10-year storm events are occurring much more frequently. Now you can add ice storms in Texas as well as fires and droughts in California to the list of regularly occurring casualties.”

The State of California, for example, has been forced to offer “last resort” insurance for many wineries battered by several years of drought and wildfires that have made many of these properties uninsurable.

MDH Partners Updates ESG Policy: ‘Part of Its DNA’

MDH Partners, an Atlanta-based industrial real estate investment company, updated its ESG policy this week. Its CEO, Jeff Small, tells GlobeSt that he believes his firm’s role as a real estate investment company “goes far beyond those of a financial nature. Investors and their investments also have societal impacts, and we have embraced this view, since ESG principles lie at the very heart of the mission and DNA of our firm.”

Small said the past year has sparked renewed and difficult conversations about sustainability, racial inequality, and the health and safety risks associated with the built environment, further illustrating the real estate community’s obligation to create a more sustainable and equitable future.

“We’re witnessing a paradigm shift and ESG is among the first topics investors ask about these days,” Small said. “We value diversity not as a “check-the-box factor” of what our investors expect of us, but because diversity makes us a stronger organization.

“Having a team in which all members have similar backgrounds and life experiences naturally leads to one kind of thinking. Creativity, however, arises from new perspectives, new ways of viewing our world to brainstorming innovative aspects of an urban industrial redevelopment, all led by new members of our more diverse team.”

Positive Environment, But Challenges Ahead

Byron Carlock, PwC Partner and U.S. real estate practice leader, said in prepared remarks that an abundance of investable capital, low interest rates and a continued demand for many product types has created a positive environment for the industry.

“However, not everything is rosy, and real estate still has its challenges ahead,” Carlock said. “There are rising costs, pending tax reform, and new infrastructure spending that could impact the labor market. There are also various social issues, in which the industry can take a leading role in helping to solve. Some of those include affordable housing, ESG-focused city planning, and neighborhood inclusiveness.

“It’s important that regulators, policy makers and business leaders work together to establish trusted standards that guide responsible behavior in our new post-pandemic reality.”

Source: “A Focused ESG Strategy Can Drive CRE Resiliency“

The lack of available labor has been a larger factor in project delays than the materials.

There’s been a “steady return of demand for projects across most sectors of commercial work,” says a new construction outlook report from JLL for the second half of 2021. But that success brings a problem of “above-average increases in construction costs.”

“Through August, average final construction costs for a commercial project had increased 4.5 percent, and total cost growth by year end is likely to surpass 6 percent,” the report reads. “A similar level of cost escalation, in the range of 4 to 7 percent, is expected into 2022,” though the materials component of the estimate is “the lowest confidence forecast due to the wide range of inputs and global supply chains bucketed into a single category.”

In the 12 months before August 2021, average material prices were up 23%. The up-and-down shifts in material prices are “unprecedented in contemporary history,” the report states. Increases in lumber and steel prices are the largest since at least 1949, according to government data that doesn’t go back further. Aluminum prices have increased the fastest since 1995, plastic since 1976, and copper since 2010.

While materials prices have been high and availability often scarce, the effects of labor on project pricing and timing have also been significant. Wage growth has “kicked into high gear” and the lack of available labor has been a larger factor in project delays than the materials. JLL expects labor conditions to worsen through 2022.

According to JLL analysis of U.S. government data, the unemployment rate in construction was 4.6% in August 2021, with total employment in the field of 7.4 million, which was significantly lower than the overall 5.2% rate.

From August 2020 to August 2021, material costs rose 23.1% and labor wages were up 4.46%. Non-residential construction spending was down 9.5% on an inflation-adjusted basis and residential was up 7.6%.

Those looking for a true rebound in non-residential construction will likely have to wait until the spring or summer of 2022, given the usual slower winter months and uncertainty about the Covid-19 Delta variant.

As for the potential impact of the infrastructure spending bill currently in Congress, “much of the spending, and therefore the cost impacts, will occur in years 2 to 6 after passage rather than right away.”

Source: “Construction Sees No End to High Materials Costs, Labor Availability“