Archives for June 2022

The country’s ports are experiencing a reduction in backlogs. But global instability is leading companies to hoard warehouse space.

After more than two years of pandemic-related disruptions the U.S. supply chain is facing new challenges, keeping availability tight in the industrial market.

Although most of the world has shed COVID-19 restrictions (China remains an exception), both domestic and global supply chains continue to be challenged by the looming threat of new variants and the war in Ukraine. These issues have manifested in high fuel costs and unpredictability in freight flows, as well as uncertainty about how and when the global economy will return to some level of stability, says Kelvin Sakai, senior director, supply chain consulting, with commercial real estate services firm CBRE.

In addition, a labor shortage, wage inflation impacting hourly workers and limited warehouse capacity continue to pose challenges for the U.S. logistics sector, according to Los Angeles-based Brewster Smith, senior vice president, supply chain solutions, with Colliers International.

Signs of improvement

To an extent, the availability and flow of goods domestically is beginning to normalize, Smith notes. Vessel backlogs at the ports of Los Angeles and Long Beach, for example, are down roughly 70 percent from January. However, Sakai stresses that the supply chain continues to face shocks in different areas at different times. So, while some industries and businesses are seeing things ease, others are not.

For example, the situation with the backlog at the ports could reverse its current course when the peak season arrives in a few months, especially if contract negotiations between the ports and dockworkers become contentious and fuel prices continue to rise, Sakai warns.

“Supply-chain volatility has, indeed, made life challenging for manufacturers, distributors and consumers, and real estate is just one component of this complex web spanning across the globe,” says Chicago-based Matt Walaszek, director of research with CBRE specializing in industrial and logistics.

Last year set a record for U.S. industrial demand and rent growth, with a momentum that has carried into 2022, he notes. In the first quarter of the year, industrial vacancy averaged just 3.1 percent nationally. Still, Walaszek notes that leasing activity is down slightly from last year—net absorption went down by 10.4 percent compared to the first quarter of 2021, CBRE found. This is partly a function of moderating demand, but it is also due to a comparison to extremely strong statistics in 2021, according to Walaszek. Overall, industrial net absorption in the first quarter was still above a 10-year average.

The pandemic has created what logistics practitioners call an “inventory bullwhip effect,” when products become scarce and organizations tend to panic and over-purchase merchandise to avoid future stock shortages, according to Smith. All of that pent-up demand in the spring/summer of 2021 created more inventory deliveries than U.S. ports and warehouses could handle and escalated demand for warehousing space, he says.

Today, as overall logistics costs rise, they are fueling additional demand for warehouse space as large companies increase inventory stock in anticipation of potential future price increases and supply chain disruptions, according to Walaszek. As a result, there is still a dire shortage of warehouse and distribution space in most U.S. markets, he says.

But while vacancy remains tight, the competition for space isn’t as fierce as it had been last year due to greater economic uncertainty.

“Occupiers are having to pay more to lease space, and finding available space has been extremely difficult in supply-constrained markets,” Walaszek says. (U.S. taking rents for industrial space have risen by 16 percent year-over-year, he notes. Asking rents, according to CBRE, have risen by 11.8 percent, to a record-breaking $8.94 per sq. ft.)

The rent growth has been especially strong around the country’s biggest ports, where industrial availability is very scarce, including the Port of Los Angeles, the Port of Long Beach and the Port of New York/New Jersey, according to Smith. In the Los Angeles market, for example, industrial vacancy is around 0.5 percent. Near the Port of New York/New Jersey it’s at 1.8 percent.

Walaszek’s data shows that rents at properties located in the Inland Empire rose by 74 percent year-over-year, in Los Angeles by 54 percent and in Orange County, Calif. by 39 percent.

In Smith’s view, it will take six to 18 months for the Fed’s interest rate hikes to start easing inflation and bring down fuel costs. When combined with new industrial deliveries, that should moderate growth in industrial rents.

Globally, however, “the supply-chain situation is much more precarious and difficult to predict,” he adds. “The military conflict can create geopolitical tensions in other parts of the world that disrupt supply chains, which is one reason we’re seeing a trend toward manufacturing re-shoring to the U.S., Mexico and South America.”

Source: “Can the U.S. Supply Chain Withstand New Disruptions?“

Real estate economists predict solid performance by U.S. property markets over the next three years, according to the spring 2022 ULI Real Estate Economic Forecast. This is in spite of predictions of rising inflation and slower economic growth as a result of the Russia/Ukraine war and other developments.

While the real estate–related components of the forecast are generally positive, contributing economists downgraded near-term economic growth and predicted significantly higher inflation and interest rates during the forecast period (2022–2024) compared with the prior fall forecast. At the same time, respondents raised forecasts of real estate transaction volumes, unleveraged returns, and rental growth for most property types.

In many ways, 2021 was a remarkable year for many economic and real estate indicators, as the United States recovered from the pandemic-related downturn, aided by stimulus spending and near-zero interest rates. Some of the metrics for that year that posted results that were both well above average and ahead of expectations, include gross domestic product (GDP) growth (5.7 percent), employment growth (6.7 million), real estate transaction volumes ($846 billion), real estate investment trust (REIT) returns (43.2 percent), and NCREIF Property Index returns (17.7 percent).

While these outsized results provide strong momentum in 2022, some pullback from record levels is also to be expected.

The relatively positive findings and predictions in the Spring Survey point to some fundamental attributes of real estate that dampen volatility. Most property types have multiyear leases and cater to local rather than to global demand drivers, both of which insulate the sector from economic volatility and foreign turbulence.

The Real Estate Economic Forecast, produced by the ULI Center for Real Estate Economics and Capital Markets, is based on a survey conducted in March and April of 2022 of 47 economists and analysts at 36 leading real estate organizations. The forecast is based on the median responses gathered in the survey, which reflect a wide range of views both better and worse.

Key Findings for Commercial Real Estate

U.S. real estate transaction volumes are predicted to decline slightly to $800 billion in 2022, after a record high $845 billion in 2021.  Still, transactions will stay well above the long-term average ($427 billion), with forecasts of $725 billion and $750 billion in 2023 and 2024, respectively. Commercial mortgage–backed securities (CMBS) debt availability will remain steady, with the projected issuance of $90 billion to $100 billion of CMBS in 2022–2024, down slightly from $111 billion in year 2021 but above the long-term average of $83 billion.

Commercial real estate prices, as measured by the Real Capital Analytics (RCA) Commercial Property Price Index, are projected to rise by 10.0 percent in 2022, higher than had been projected in the fall, 6.0 percent in 2023, and 5.9 percent in 2024. The index surprised on the upside in 2021, rising by 19.5 percent.

The forecast total return from unleveraged core real estate (NCREIF Property Index or NPI) is 10.0 percent in 2022, up from the 7.0 percent predicted six months ago. Like the CPPI, 2021 returns greatly exceeded expectations, with a total return of 17.7 percent. Total returns are projected to be 8.0 percent in 2023, also up from the prior forecast, and 7.0 percent in 2024.

Returns will vary widely by property type. Average returns over the three-year forecast period will range from 13.9 percent for industrial to 5.4 percent for office, with apartments at 10.3 percent and retail at 5.9 percent. The forecast 20.0 percent return for industrial in 2022 is down from 43.3 percent in 2021, a record for an individual property type and a big driver of overall NPI returns. Forecast returns for equity REITs are 8.0 percent in 2022 and 8.3 percent in 2023, both lower than the prior forecast as well as the long-term average of 12.7 percent. Modest expectations for equity REITs are understandable given the index’s high return of 43.2 percent in 2021 (compared with 27.8 percent forecast last fall).

As the ULI/PwC Emerging Trends in Real Estate© and other publications have noted, the pandemic accelerated many trends that were previously underway. Two of the most prominent trends in U.S. real estate have been heightened demand for industrial space and apartments. The industrial/warehouse sector finished 2021 with an availability rate of 5.2 percent, down from 6.2 percent in 2019 (pre-COVID) and 440 basis points lower than the long-term average of 9.6 percent. Consequently, industrial/warehouse rent growth is forecast to average 5.5 percent over the next three years, compared with the 20-year average of 1.8 percent. Prospects for the apartment sector are similar. The forecast 2022 vacancy rate of 2.5 percent is 160 basis points lower than in 2019 and less than half of the long-term average (5.2 percent). Apartment rent growth is forecast to average 5.3 percent over the 2022–2024 period. For both of these property types, availability or vacancy rates are expected to increase slightly over the forecast period but remain well below long-term averages.

The availability rate forecast for neighborhood and community centers is 7.9 percent each year from 2022 to 2024, lower than the 2019 rate of 8.5 percent. The office sector will lag behind the other main property types as the pandemic has slowed office reopenings and companies experiment with hybrid strategies. Office vacancy rates will peak at 17.0 percent in 2022 and 2023, before dropping slightly in 2024. The predicted office vacancy rate will exceed its long-term average (14.5 percent) over the entire forecast period. Expected rental growth is modest for retail and office, with three-year rent growth averaging 2.0 percent and 1.4 percent, respectively.

The hotel sector continues to lag pre-pandemic occupancy levels as business and international travel slowly recovers. The national occupancy rate is expected to be 60.0 percent by the end of 2022, climbing to 62.6 percent in 2024. The latter rate is above the long-term average of 60.9 percent but lower than the 2019 level of 65.9 percent. On the positive side, hotel revenue per available room (RevPAR) will average 11.5 percent growth over the next three years, well above the long-term average of 3.5 percent.

The outlook for the single-family-housing sector remains positive, although recent increases in mortgage rates may slow the sector. Economists are forecasting 1.2 million new housing starts in 2022, with 1.25 million new starts in 2023 and 1.1 million in 2024, above the 20-year average of 935,000. Average home prices will increase by 10.0 percent in 2022, then decelerate to closer to the longer-term average of 4.6 percent, with 5.0 percent in 2023, and 4.4 percent in 2024.  Average home prices rose by 17.6 percent in 2021, much higher than 10.9 percent predicted last fall.

Key Findings for Major Economic Indicators

The U.S. GDP is projected to grow by 3.2 percent in 2022, down from 4.0 percent forecast six months ago, as labor shortages, likely slower global growth, and continued supply chain constraints affect U.S. prospects. Continued GDP growth is expected in 2023 and 2024, with forecast increases of 2.3 percent and 2.1 percent, respectively, similar to the long-term average of 1.95 percent.

Economists predict that the economy will generate 4.1 million net new jobs during 2022, which, combined with a gain of 6.7 million in 2021, will make up for and exceed the 9.3 million jobs lost in 2020. Job growth will slow in 2023 and 2024, with increases of 1.9 million and 1.2 million, respectively, both above the long-term average of 1.0 million.

The forecast calls for the U.S. unemployment rate to end 2022 at 3.5 percent, down from 4.0 percent predicted six months ago and from 3.9 percent in 2021. The unemployment rate is predicted to stay flat at 3.5 percent in 2023 and 3.6 percent at year-end 2024, below the long-term average of 5.9 percent, and equal to the pre-pandemic 2019 level of 3.6 percent.

As discussed above, expectations for inflation have risen over the past six months, as the Russia/Ukraine war has added to both inflation and supply chain issues.  Economists forecast that the Consumer Price Index (CPI) will rise by 6.0 percent in 2022, up from 3.0 percent predicted six months ago. Last year’s rise of 7.0 percent was the highest annual rate of increase since 1990. The CPI is expected to rise by 3.0 percent in 2023 and 2.5 percent in 2024, above the 20-year average of 2.4 percent, but a sizable drop from current levels, indicating that survey respondents believe that current inflationary pressures are mostly short-term in nature.

Expectations for long-term interest rates have reversed direction over the past six months. Responding economists raised the expected rate of the 10-year U.S. Treasury (UST) note to 2.7 percent by year-end 2022 from 2.0 percent predicted six months ago.  Rates will rise to 3.0 percent in both 2023 and 2024, close to the long-term rate of 2.9 percent.

The ULI spring survey is predicting slower near-term growth and higher long-term interest rates compared with the prior forecast. The impact of the Russia/Ukraine conflict has contributed to inflationary pressures and reduced growth expectations, but more importantly adds greater uncertainty. As the Federal Reserve recently noted, the economic outlook is “clouded by the uncertainty created by recent geopolitical developments and rising prices.” Despite this uncertainty, real estate economists are predicting that U.S. real estate markets are generally in strong shape and are likely to perform well in terms of fundamentals, capital flows, and investment returns over the next several years.

Source: “Forecast: Positive for U.S. Real Estate Despite Higher Inflation, Interest Rates“

The increase may be seasonal, with prices remaining steadier than they have in the recent past.

If you were buying lumber, June 13 was a good day with spot prices and futures down to $528 per thousand board feet, the lowest they’ve been since early September 2021. But now they’ve headed back up.

If you’re in construction or development, take a deep breath because the changes aren’t like they were in April 2021, when prices broke the $1,600 mark and left construction industry professionals feeling very broke.

“We are seeing the market’s initial reaction to price cuts since March,” Alex Meyers, Mickey COO, tells GlobeSt.com. “We can assume lumber prices will fluctuate within the $400 to $600 range due to continued demand and a significant backlog of mill orders. As interest rates begin to peak and home building starts slowing, prices would likely start pushing the other direction.”

Part of the current increase is timing. “There is a seasonal buy just before the July 4th holiday,” says Mike Wisnefski, CEO of MaterialsXchange.  “The market corrected down to the new trading levels and many buyers that have an order file of business to cover decided to step in and make a purchase.  In addition, the overall current demand is still solid so buyers holding inventories have been able to draw down the inventory levels and needed to replenish.  I do not think that we had much of a speculative build of inventories though.”

However, at this point, no one could be blamed for a bit of a flinch.

“The difference now, as opposed to a year or two ago, is people are less likely to hit pause or try to wait out market fluctuations,” Micah Solit, senior project manager at Project Management Advisors, tells GlobeSt.com. “Instead, our clients are pricing in uncertainty and risk, whether that’s added contingency or allowances, extended schedules or some other strategy. For example, on wood-frame residential projects, we work with the general contractor, subcontractor and maybe even the lumber fabricator on developing a strategic approach to purchasing the contract for the structure.”

Then there are the tradeoffs that builders can make. For example, Solit says, if there’s enough qualified labor available, “we may factor in more confidence in the quality and capacity for work and be willing to take greater risk on the cost side by waiting on commodity pricing to drop.” But if timing is critical, they might make their lumber buy early “and live with the consequences.”

For now, at least, the potential consequences aren’t anywhere near as bad as they have been.

Source: “Lumber Prices Head Up Again but Without the Jet Propulsion“

JLL adds that inflation is also showing signs of slowing.

Real estate has long enjoyed the reputation as an inflation hedge. According to data and analysis from JLL, even with the spikes in CPI the US has been experiencing, that statement remains true, at least for multifamily. And as pressure builds on the ability to increase rents and allow continued profitable expansion, there’s evidence that the inflation rate has begun to slow.

“The national average rent growth for Class A multi-housing properties has surpassed inflationary growth by 198 basis points from 2010 to the first quarter of 2022,” according to JLL. “In fact, in the first quarter of 2022, national multi-housing rents increased 15 percent year-over-year, as rising inflation translated to significantly higher rents.”

Multifamily housing does have an ability to mark rents to market, increasing them both on an annual basis at renewal time and when there is turnover in units. According to Yardi Matrix, multifamily asking rents hit an all-time high in April of $1,659, with rents up 8.8% in all but one of the top 30 metropolitan areas.

That pricing strength has also enabled growing property values and cap rate compression. Walker & Dunlop’s latest multifamily outlook stated that nearly $290 billion in transactions were logged in 2021, more than double the total from 2020. “Part of the rebound in the multifamily market reflected a return by many renters who had vacated their urban apartments during the height of the pandemic, but vacancy levels were also flattened by the lack of new multifamily completions,” the report noted.

However, JLL’s framing does suggest that there might be limitations. Class A housing may be able to command continued rent growth from consumers with higher incomes. Whether that might be true for Class B or C housing, where consumers are likely to have more constrained financial resources, is far from clear.

Even for Class A, though, there are eventually limits. “The convergence of several trends over the pandemic, namely home buyer affordability issues, rapidly rising wages, population migration trends and a supply and demand imbalance have resulted in a level of rent growth that is unsustainable,” the JLL release quoted Geraldine Guichardo, JLL head of Americas living research and global head of research, hotels, as saying.

And negative leverage has emerged in multifamily, with shrinking returns for buyers despite rent hikes.

JLL is predicting that both inflation and rental growth will start moderating this year and through 2024, with rates eventually dropping below 5%.

Source: “Multifamily Rent Growth Continues to Outpace Inflation“