Results from the first-half 2022 WMRE/Marcus & Millichap Investor Sentiment Survey are overwhelmingly positive. The Investor Sentiment Index climbed five points from 165 in the H2 survey to reach 170 – the highest level since 2015.
A number of factors are driving optimism across all sectors of the commercial real estate market. Vacancy rates for apartments, industrial and self-storage are at or near record lows. For other property types that have faced challenges during COVID-19, the outlook in a post-pandemic cycle is turning an important corner. “Vaccination levels are rising and society in general is feeling more confident in the ability to live with COVID-19,” says John Chang, Senior Vice President and National Director of Research and Advisory Services at Marcus & Millichap. “As a result, other property types that aren’t already at record levels, such as retail and hotels, see upside on the horizon as people get out and travel and go to entertainment venues, restaurants and stores.”
The country is also moving toward some resolution of what return-to office plans might look like. Although hybrid work models are still evolving, there is an expectation that companies will increasingly return to the office in the near future. Therefore, demand for office space should deliver gains, adds Chang. “The positive movement in the index reflects all of those dimensions – the positive trends that are already here in some property types and the momentum that is coming in the future in other sectors,” he says.
Investor confidence is reflected in the record high transaction volume that occurred in 2021. Commercial and multifamily sales topped $846 billion last year, significantly higher than the pre-pandemic total of the $600 billion in 2019, according to Real Capital Analytics. Survey results show a healthy appetite to continue acquiring assets in the near term. More than half of survey respondents (54 percent) said they plan to buy property in the next 12 months, a slight uptick compared to 50 percent who planned to increase holdings in the second-half 2021 survey. Relatively few (6 percent) expect a decrease. The typical respondent plans to increase real estate investments by an average 12 percent, which also climbed higher compared to the 9 percent increase anticipated in the second-half 2021 survey.
“The amount of capital coming into commercial real estate is higher than it has ever been as evidenced by the transaction volume of 2021,” says Evan Denner, Executive Vice President and Head of Business at Marcus & Millichap Capital Corp. Consistent with WMRE/ Marcus & Millichap surveys over the past several years, a majority of respondents (61 percent) continue to have an abundance of capital ready to invest. Additionally, a majority of respondents (71 percent) believe commercial real estate offers favorable returns to other investment classes. However, that view is slightly below the first-half 2020 survey, where 74 percent thought commercial real estate offered favorable returns relative to other investment classes. That slight decline could be a reflection of cap rate compression over the past two years, particularly in high-demand sectors such as multifamily, industrial and self-storage, notes Denner.
Inflation, Interest Rates Are Top Concerns
Despite strong optimism on commercial real estate performance, investors and industry participants recognize the possibility of potential headwinds ahead. The top two concerns on the horizon over the next 12 months are rising interest rates and rising inflation, which rated high by 65 percent of respondents followed by rising operating expenses by 49 percent and changes to taxes by 47 percent. Views on top concerns have shifted, compared to the second-half 2021 survey where tax changes were the top concern. On a positive note, concerns related to the modification/elimination of 1031 exchanges have declined from 48 percent to 34 percent in the current survey. Congress appears unlikely to take action on limiting 1031 exchanges as a means to pay for President Biden’s Build Back Better infrastructure plan.
The timing of the survey could have influenced respondent views on top issues. The survey was conducted in the latter half of February, just ahead of Russia’s invasion of Ukraine on Feb. 24. “I suspect that if we did the survey today, the geopolitical issues would be a much graver concern,” notes Denner. Russia’s invasion of Ukraine is driving oil prices higher, which also has a direct correlation on higher inflation. “People are concerned about inflation more from the point of how the Fed will respond,” he adds. The vast majority of respondents (96 percent) do expect interest rates to rise in the coming year. The question is how much rates will move. Forty-one percent predict that rates will increase by 100 basis points or more, 41 percent think rates could rise between 50-99 basis points and 14 percent said rates are likely to rise less than 50 basis points. Three percent of respondents expect no change in rates. “The Federal Reserve is pursuing policies to rein in inflation including raising the overnight lending rate and reducing its balance sheet,” says Denner. At their March meeting, the Fed hiked rates for the first time since 2018 and set the stage for several more increases this year. “If the Fed is unable to get inflation under control, Chairman Jerome Powell has sent clear signals that they will move more aggressively by raising rates more than 25 basis points or hike in-between scheduled meetings.”
However, concerns related to rising inflation and interest rates don’t appear to be weighing heavily on investors’ buysell decisions. The impact of interest rate increases on plans to acquire real estate varies depending on how much rates rise. Predictably, the higher the interest rates, the less likely people are to buy. A majority of respondents, 67 percent or higher, expect no change to buying if rates rise 100 basis points or less. If rates were to rise 150 basis points or more, it would start to have a more material impact on buying strategies. Forty-six percent of respondents said they are likely to buy less if rates increase by 150 basis points. That percentage gets bigger if rates were to rise higher, including 67 percent who are less likely to buy if rates surpass 250 basis points.
Views were mixed on how inflation could impact strategy. Forty percent said that inflation would have no impact on buying decisions, while 27 percent said they were likely to buy more and 33 percent to buy less. On the sell side, nearly half of respondents (51 percent) said inflation would result in no change of strategy, while 23 percent said they were likely to sell more and 26 percent to sell less.
“I thought we would see more movement toward buying more real estate as an inflation hedge than we did,” notes Chang. However, it is important to note that the base of survey respondents reflects existing owners of real estate and industry participants, such as advisors, developers and lenders. What the survey doesn’t capture is whether inflation could attract new money, he says. “As inflation rises, it could bring more capital from other investment classes to real assets like commercial real estate, especially given the pressures from inflation, geopolitical issues and volatility of the stock market in 2022,” he adds.
Demand outweighs supply
Survey results highlight one of the biggest challenges in the current market, which is that there are far fewer sellers in the marketplace than there are buyers. When all respondents were asked their views on whether it is a better time to buy, hold or sell properties, the vast majority was in favor of buying or holding existing assets, while those who said it was a better time to sell were in the minority. “As a result of that imbalance, you’re going to have a competitive bid environment,” says Chang. “Even in a rising interest rate environment, we’re continuing to see some cap rate compression because there is so much momentum to acquire commercial real estate.”
When all respondents were asked whether it is a better time to buy, hold or sell properties across different sectors, most were in favor of buying seniors housing at 48 percent, storage at 42 percent, industrial at 40 percent and apartments at 36 percent. Those property types that rated low for buyer interest were hotels at 32 percent, retail at 20 percent and office at 19 percent. When the same question was asked for those who already own a particular property type, an insider’s view of the market showed a stronger appetite to buy assets in property types across the board. Notably, a far larger percentage of owners said it was a better time to buy seniors housing at 70 percent, industrial at 58 percent and self-storage at 54 percent [Figure 3]. “That disparity shows that people who own assets have their finger on the pulse of what’s happening within property sectors,” says Chang.
For example, the seniors housing market was severely impacted by the pandemic. Owners had to renovate facilities and change operating procedures. In addition, facilities continue to deal with staffing shortages. As a result, the weakest operators are choosing to exit the field, says Todd Lindblom, First Vice President and National Director of the Seniors Housing Division at Marcus & Millichap. “For those that are successfully operating in this space, this is a golden opportunity. We’re seeing the larger regional and national operators expand, because there are facilities in need of capital and more professional management.” Seniors housing investors are also bullish on the outlook for that sector. Three-fourths (76 percent) expect values to rise over the next 12 months with an average increase of 9.0 percent, compared to 7.5 percent in the second-half 2021 survey.
Survey results also show a strong interest in secondary and tertiary markets. Half of respondents believe now is the time to buy in tertiary markets and/ or secondary cities. Likewise, suburban markets are viewed favorably, with 45 percent who think it is a good time to buy in suburban areas of secondary/ tertiary markets and 43 percent see buying opportunities in suburban areas of primary markets. Respondents are less in favor of acquiring assets in primary gateway markets (22 percent), urban areas of primary markets (22 percent) and urban areas of secondary/tertiary markets at 36 percent.
It is worth noting that the percentage of respondents in favor of tertiary and secondary markets has declined, compared to the previous two surveys. In the second-half 2021 survey, those interested in buying in tertiary markets and secondary cities were at 54 percent and 53 percent, respectively. “One of the primary reasons investors have been looking at secondary markets is that they offered a higher yield,” notes Chang. The trend favoring secondary and tertiary markets will continue, partly due to the migration trends and growth occurring in smaller metros. However, the secret is out on those markets and increased competition is resulting in cap rate compression that is making it difficult for some investors to find buying opportunities at the yields they want, he says.
Remote Working Weighs on Office
Migration trends to the suburbs and Southern states is one of the macro trends impacting the outlook for office. People were already moving out of high cost-of-living areas of the Northeast and West Coast, which was benefiting lower cost markets such as Las Vegas, Phoenix, Texas, Florida, Atlanta and Nashville, notes Alan L. Pontius, Senior Vice President and National Director of Office & Industrial and Healthcare at Marcus & Millichap. “That macro trend of migration is going to reshape office,” he says. “At the same time, substantial speculation remains as to exactly how the return to the office is going to manifest and where it will manifest.”
The majority of respondents anticipate a shift to hybrid work models, but views are mixed on what those models will look like. More than half (56 percent) predict workers will continue to work from home 1-2 days per week, while 25 percent think work-from-home time will be higher at 3-4 days per week. Those who expect workers to remain home full time or in the office full time are in the minority at 8 percent and 11 percent, respectively. In addition, views on hybrid work models have continued to change over the past year. In the second-half 2021 survey, a bigger percentage thought workers would work from home 1-2 days (61 percent) and a smaller percentage thought people would work from home 3-4 days (18 percent).
Although there is still debate on what hybrid work models might look like in the future, it seems clear that a majority of people want flexibility and the ability to work remotely at least some of the time, Pontius says. At the same time, people recognize the value in working from the office. Younger workers, in particular, want to be in the office to learn, meet people, collaborate and develop their careers. “We will see a hybrid approach over the next couple of years for sure, but at the same time, we’ll see more time in the office as we go forward ,” he adds.
Sentiment on office continues to lag other sectors. Office investors who think it is a good time to buy more of that property dropped to 28 percent, compared to 43 percent in the prior survey. Most respondents (48 percent) said it is a better time to hold, while 24 percent consider it a better to sell. However, industry data shows greater stability in the office market over the past year. Although vacancies ticked higher to 15.8 percent, asking rents held firm and net absorption for the year was positive, according to Marcus & Millichap. A majority of office owners anticipate stable or slightly improving values in the coming year, with an average increase of 2.4 percent expected. Those who think values could decline are in the minority at 16 percent.
Investors Favor Industrial, Apartments and Storage
Industrial, apartments and self-storage are all benefiting from a wave of demand that is resulting in exceptionally low vacancies and strong rent growth. According to Marcus & Millichap, industrial vacancies dropped to 4.0 percent last year, while rents grew by an average of 9.6 percent. “The underlying drivers for industrial remain firmly in place,” Pontius says. E-commerce continues to be a powerful force. In addition, companies are shortening supply chains to bring inventory closer to consumers and reduce risk. Also, current geo-political issues and trade sanctions on Russia could impact supply chains and the desire to maintain larger inventories of goods on hand to ride out any bumpiness in the market, he adds.
Those industrial owners who think it’s a good time to buy assets held firm at 58 percent, while 31 percent consider it a better time to hold and 11 percent to sell. Sixty-nine percent of investors predict that values will rise in the coming year with an average increase of 7.4 percent expected, which is the same amount compared to the prior survey. “Depending on how steep the interest rate curve proves to be, cap rates on premium assets could creep higher, but it won’t correlate on a one-to-one ratio with rental growth remaining a key offset ,” Pontius says.
Apartment vacancies nationally dipped to 2.6 percent at the end of last year, while rent growth was tracking at 15.5 percent, according to Marcus & Millichap. Some of that rent growth reflects pent-up demand, as many owners did not raise rents during the height of the pandemic in 2020. “There was a certain amount of catch up in the market that occurred in 2021,” notes John S. Sebree, Senior Vice President, National Director of the Multi Housing Division at Marcus & Millichap. However, survey respondents remain optimistic on additional increases in valuations. Seven out of 10 respondents expect values to rise in the coming year with an average increase of 8.6 percent, compared to the 6.7 percent increase anticipated in the prior survey.
At the end of the day, there are two big factors driving the performance for apartments —the shortage of housing and the aging millennial generation that is creating new households, notes Sebree. When the pandemic hit in 2020, many marriages were postponed, and some 20-somethings moved home with their parents. Those trends are reversing, which is driving new household formation and more housing demand. Construction is also facing headwinds, with rising costs and material shortages making it more difficult for supply to keep pace with demand. “There is razor thin availability of rental housing, and I would expect very strong rent growth momentum as we contend with the shortages,” Sebree says. More respondents at 43 percent still consider it a better time to buy apartments, while 40 percent think it is a better time to hold and a minority 17 percent said it is better to sell.
Self-storage is another sector that has posted exceptionally strong metrics. Vacancies improved to 6.6 percent, while annual rent growth averaged 8.5 percent at the end of 2021, according to Marcus & Millichap. Two-thirds of storage owners think values will continue to rise in the coming year, with an average increase of 6.4 percent anticipated.
Storage owners continue to view it as a good time to own storage. More than half (54 percent) said it was a better time to buy, while 40 percent believe it is a good time to hold and a minority 6 percent see an opportunity to sell. “Metrics are very strong. Vacancies are at an all-time low and there is strong momentum for rent growth. New development remains limited compared to recent levels though it is ticking up,” says Steven Weinstock, First Vice President and National Director of the Self-Storage Division at Marcus & Millichap. However, it’s a little surprising that more owners did not express interest in selling, he says. “Many self-storage owners have been in the business a long time and have not seen performance and valuations at such a high level, and it could be an opportune time to take some chips off the table,” he adds.
Growing Optimism for Retail and Hotels
Many areas of retail, including grocery anchored centers and net lease retail, performed very well during COVID-19. The high levels of distress that some had anticipated due to lockdowns did not materialize, and now the sector shows signs of strengthening. “Looking back at the depths of the pandemic, retail didn’t get hit as hard as many people thought it would, and now investors are seeing many different types of opportunities,” says Daniel Taub, Senior Vice President and National Director of the Retail and Net Lease Divisions at Marcus & Millichap.
Vacancy rates improved 50 basis points last year to 5.2 percent, while asking rents increased by 3.3 percent, according to Marcus & Millichap. Forty-three percent of owners think retail values will rise over the next 12 months with an average increase of 3.7 percent expected, which is a notable improvement over the 1.0 percent increase predicted in the second-half 2021 survey. “Retail was definitely impacted by the pandemic,” Taub says. “Retailers that were already in trouble went out of business or closed stores.” However, the shake-out of “zombie” stores that had been hanging on has actually helped put shopping center owners in a better position where they can evolve and innovate, he says.
Growing confidence is reflected in more positive sentiment for buy-sell decisions and expectations for rising valuations. Nearly half of retail investors (44 percent) think it is a better time to hold assets. However, the 35 percent that said it was a better time to buy shows a big improvement over the 17 percent who thought it was a good time to buy in the second-half 2021 survey. Twenty-two percent believe it is a better time to sell.
Hotel investors’ views on the buy-hold sell strategy remained consistent with the second-half 2021 survey. Forty-five percent of respondents consider now a good time to buy, while 46 percent said it is a better time to hold. Those who think it is a good time to sell are in the minority at 9 percent. However, performance within the hotel sector remains choppy, notes Biran Patel, Senior Vice President and National Director of the Hospitality Division at Marcus & Millichap. Hotels have seen a substantive revival in the limited service sector, while full-service hotels are still struggling, especially those located in urban core areas of major metros and those that cater to conventions.
The same general themes driving the return to work also apply to business travel. “When we get to the endemic stage and society says it’s OK to go back to the office and it’s OK to travel again, that is when we’re going to see a bigger recovery in the hotel sector,” Patel says. “We’re starting to approach that corner, and that is influencing sentiment around buy-sell decisions and views on improving valuations.”
More than half of hotel investors (57 percent) think values will rise in the coming year with an average increase in values of 7.3 percent, compared to the 4.8 percent increase expected in the prior survey. The STR and Tourism Economics 2022 U.S. hotel forecast calls for average daily rates (ADR) to surpass pre-pandemic levels this year to reach $134, while revenue per available room (RevPAR) and occupancies are not forecast to reach pre-pandemic levels until 2023. RevPAR is expected to improve to $86 this year and occupancies to 63.8 percent. However, when adjusted for inflation, the full recovery of ADR and RevPAR is not projected until after 2025, according to STR and Tourism Economics.
Confidence in Commercial Real Estate Performance
Despite positive sentiment, there is still some lingering uncertainty in the market. Nearly half of respondents (49 percent) do not believe the worst of the economic downturn is behind us, while 30 percent think the worst is behind us and 21 percent were unsure. That shows a notable shift compared to both of the 2021 surveys, where more survey respondents thought the worst was behind us at 45 percent in the second half and 40 percent in the firsthalf 2021 surveys. Sentiment is more on par with the early days of the pandemic, where half of respondents did not believe the worst of the pandemic was behind us. “That result is surprising, but I think people have been trained to become paranoid,” notes Chang. People thought the pandemic was nearing an end, then the delta variant hit and then came omicron. “So, people may be waiting for the other shoe to drop, and that hesitancy is coloring the survey response there,” he says.
The reality is that there are still uncertainties and risks related to COVID-19, geopolitical issues, inflation and rising interest rates. Despite those headwinds, the U.S. remains on track for positive economic growth in both 2022 and 2023. Contributing to the economic momentum are factors such as strong household formation, high levels of consumer savings and a return to more typical pre-pandemic behavior that will result in people returning to the office and spending on travel, entertainment, dining and shopping.
Combined, those factors are positive for all types of commercial real estate, and the availability of capital and positive performance outlook across almost every property type is likely to continue to drive investor demand to acquire assets, notes Chang. “The perception that there is greater safety in commercial real estate as compared to other asset classes, is going to work in favor of new capital moving into this space, and it will also make it more competitive,” he says. “At the end of the day, commercial real estate is poised to perform very well in 2022 and beyond.”