CRE Recovery Will Likely Be Bifurcated

CRE performance metrics will likely continue to improve this year, though analysts caution the recovery will remain bifurcated.  Research from Moody’s Analytics shows that while industrial will remain steady and multifamily family rents and vacancies will turn around in the short term, the future of office, retail, and some hotel subtypes is uncertain.

“Within specific sectors there is chatter about repurposing space: flex/R&D industrial space for life-science companies, with office space for hybrid workers; industrial space devoted to data warehousing; with companies like Convene and even WeWork positioning themselves as monetizing what has traditionally been considered a ‘fixed asset’ by finding alternative uses,” the report notes.

While multifamily performance metrics were slightly negative in Q1, “it is quite likely that the worst is over for the multifamily sector,” the report notes. “There is evidence from real-time data points coming in that year-over-year rent growths for new leases are up by over 5%—a tail that will likely wag the dog of the overall market with increasing momentum over the remainder of 2021.”

On the industrial front, quarterly rent growth for warehouse/distribution was positive nationally for every quarter throughout 2020. The national vacancy rate inched up slightly as well and ended 2020 at 10.7%, and Moody’s predicts industrial will post the strongest rent of all asset classes this year, with asking rents predicted to grow by 2.8% and effective rents estimated to increase by 3%.

But in struggling asset classes like office and retail, major rent and price declines are likely in 2021, Moody’s says. This is despite exceptionally strong GDP growth this year and predictions for similar growth in 2022: overall, economic activity is booming, with updated GDP growth estimates posting in the mid-6’s for all of 2021, the best since 1984. Moody’s predicts 2022 will be strong, with GDP growing by 5.3% and reflecting an expansion period stronger than any on record in at least fifty years.

Moody’s predicts vacancies for neighborhood and community shopping centers will hit a record high of 12.3% this year before declining, with asking rents expected to fall 5.2% for the year and effective rents dropping by 6.8%. Within the retail asset class, regional malls have struggled the most, with vacancies hitting 11.4% in the first quarter.

“Despite general malaise, retail represents an ecology going through a major evolution, and a strong economy bolstered by healthy consumer spending will likely produce winners that can take advantage of market disruptions,” the report says. “Warehouse clubs and large retailers that were successfully able to tailor their omni-channel strategies posted exceptionally strong results throughout 2020 and early 2021. It will be interesting to see how other brick-and-mortar retail operators adapt to the changing landscape.”

Hotels will likely undergo a two-pronged recovery: while occupancies grew in the first quarter to 50.8% (compared to 34.6% and the end of 2020), the average daily rate remains well below pre-pandemic levels.  Moody’s analysts suggest the personal travel segment will lead the recovery, while hotels serving business travelers will have a tougher road to recovery.

Against this backdrop, inflation remains a mounting concern for all asset classes—and Moody’s also cautions against relying on the old adage that CRE is a “hedge against inflation.”

“How much appreciation returns should we expect when cap rates have trended to such low levels (and have remained there)? Can we bank on significant income returns for properties outside multifamily and industrial? It is likely that CRE will benefit from the search for higher yield, at a time of low interest rates,” the report goes on. “But how will it fare at a time of rising inflation, when policy measures like the removal of 1031 exchange benefits are being floated by the current administration?”

Source: “CRE Recovery Will Likely Be Bifurcated”