Financial analysts are still reviewing the economic impact of the pandemic and assessing the real estate market is no exception. The state of the real estate market is very important to understanding the big picture of where the economy is and where it is headed. After all, this past year the Omicron variant set back what was to be an almost certain economic recovery to the point where some economists are now pushing back the ETA of the recovery. Of course, much will depend on the trajectory of the virus.
Let us remember that Americans woke up in the last 6 months to some uncharacteristic economic news. The first was the supply chain issues, labor shortages, rising fuel prices, and historic inflation. The most identifiable American symbol of wealth, the automobile, was also in short supply. So were the microchips that drive our modern technologically advanced automobiles and other devices. Yet another setback was the news that more retail establishments would be closing some of their stores, which only added to the decline of retail, certainly putting a damper on brick-and-mortar shopping.
If there was a silver lining in the broader economic picture it was the housing market that defied all odds and remained strong. The economy is often measured by housing starts and overall sales of new houses with its depleted inventory and soaring prices.
A major surprise was that 2021 turned out to be a record year for commercial real estate sales in the U.S., as investors scrambled to capitalize on the new realities of a reshaped economy. Commercial property sales totaled $809 billion in 2021, nearly doubling 2020’s mark and topping 2019’s $600 billion, according to Real Capital Analytics data reported by the Wall Street Journal. None of the predictions as recently as two years ago forecasted such a strong recovery for the commercial real estate industry.
I asked real estate people if they foresaw this amazing year for commercial property and almost to a man they agreed that they did not. “Had I had any inkling, you can be sure that I would have been on the hunt for many properties,” one real estate investor said. “Now, when I am extremely interested, the pickings are extremely slim.”
Amongst the hottest commercial properties on the market were warehouses, apartment houses and properties that could be used for resorts and hotels as the hospitality industry prepared for a major reboot of the industry. There is no question that it requires a leap of faith to believe that tourism will be back to pre-pandemic levels and that hotels will be in high demand. That would require the end of the pandemic and all the restrictions that came along with it. The US and other nations would have to have reason to allow an unrestricted flow of tourists.
By June 2021 apartment building and nonresidential sales reached a 15-year high, the largest sales count since June 2006. Why apartment buildings? Inventory was in short supply and demand was going through the roof. Investors were gobbling up every piece of real estate that had a steady income (rent roll).
Ironically, despite the wide-scale availability of vaccinations, the public has not yet fully bought in to the recovery, so noticeable on the retail scene. Occupancy in Manhattan offices is still largely a shadow of what it was in 2019. Mass transit in big cities is still waiting for passengers to return. At the same time, vehicular traffic is noticeably increased as people would rather drive than take public transportation. In New York, the MTA is adjusting to the new reality with trimmed schedules, cutting back on purchases of new equipment, and raising fares.
A decline in cap rates during the last year has supported commercial property values. Capitalization rate (or “cap rate”) is a real estate valuation measure used to compare different real estate investments. Job growth and rising single-family home prices have increased demand for apartments, leading to lower multifamily vacancy rates in recent months and an increase in building values.
According to a New York Times report, the commercial property market took a big hit at the onset of the pandemic, but sales and prices have recovered for most properties, especially in suburban locations. The consensus view is that commercial property sales will increase in the coming year. Price growth is also projected to moderate from 2021’s pace but remain above the average of the past 20 years. Investors seem to be taking the hint and venturing into acquisitions of commercial property even as the residential market remains extremely dynamic.
One type of commercial real estate that has seen a huge surge in demand is warehouse space. This may be directly related to the explosion of e-commerce where on-line sellers require lots of warehouse space to stock fulfillment items. It has sent prices for purchase and even rentals soaring.
Hershel was desperate for a warehouse in the New York-New Jersey area to service his growing business on Amazon. Initially, he was looking for a large warehouse with a long-term lease. But his father counseled that he should buy the property and finance it. Why? “You’ll never see interest rates this low.” He located a 27,000 square ft. facility in New Jersey which he financed.
Not to be outdone, the housing market overall also soared. Home sales reached the highest level in 15 years, with an estimated 6 million homes sold in 2021.Homeowners saw average home prices skyrocket nearly 20% through the third quarter compared to a year ago, according to the Federal Housing Finance Agency. But at the same time, they were taking advantage of the extremely low interest rates in financing their homes. However, inventory was scarce. People held on to their homes with the uncertain times ahead. Recognizing the opportunity, investors have been buying private homes for investment.
The year began with the lowest interest rates on record, with average rates for a 30-year fixed rate mortgage at 2.65%. But they didn’t last long. By April 1, it had reached a 2021 peak of 3.18%. Rates have fluctuated since, with the 30-year fixed at 3.05% earlier this year, according to Freddie Mac. And we can expect rates to move even higher in the new year.
For now, commercial real estate appears to be one of the best investments to come out of the pandemic.