With overall inflation and growing expenses, how much is enough?
To say that multifamily and industrial sectors are hot is like noticing heat at the equator. Did anyone not already notice?
The National Association of Realtors has been tracking the 12-month sales price changes on various property categories. In March, they were as follows: 14.7% for industrial, multifamily at 10.6%, retail’s 5.1%, and, bringing up the rear, office’s 2.3%. Except for office, the appreciation rates exceeded those of pre-pandemic times.
“As interest rates increase, one natural question that arises is the effect on commercial prices,” wrote Scholastica Gay Cororaton, a research economist at NAR. “Based on the demand and supply conditions in these property markets, there is a greater likelihood that valuations of commercial properties will remain firm, except in the office market which is facing an elevated vacancy rate. The pace of price appreciation in the retail property market could also slow due to reduced consumer spending as inflation erodes purchasing power.”
But conditions going forward are mixed. On the plus side, vacancy rates are low with demand ahead of supply. “As of March 2022, vacancy rates remain low in the multifamily (5%), industrial (4%), and retail (4.5%) properties market, with an elevated vacancy rate only in the office property sector (12.3%),” Cororaton added.
Growing interest rates has a double-edged effect. They will likely drive financing costs higher, including construction, meaning less new product becoming available. Lack of supply will help maintain prices. Also, as Cororaton notes, as mortgage rates also increase atop generally high housing costs, more people are pushed into renting.
At the same time, higher interest rates mean more expensive refinancing and “the most downside risk to demand, rents, and prices in the office and retail property markets.” New York, San Francisco, and Washington, D.C. already are seeing declining rents in those types. In other areas—Florida, Texas, Utah, Idaho, and Arizona—net migration could help offset the negative impact of higher interest rates in office.
But all this raises fundamental questions. CRE has often served as an inflation hedge. But the calculus of considering property price and operational cash flow against inflation gets complicated. What is the realized total value growth of the property on an annual basis, taking growing operational costs into account? Is the inflation level to beat the general CPI number from the government? Would it more accurately be the inflated costs of developing, maintaining, and operating properties? At what point does a 5%, or even 10%, increase in price still provide enough of a hedge for a given portfolio?