When interest rates normalize, well-leased and well-maintained real estate will have retained its value.
US real estate fundamentals are easing as rising interest rates weigh on the economy and financial markets. Even though inflation has been on a positive trend over the past two quarters, monetary tightening is slowing economic activity. But, with an unemployment rate of 3.5%, the labor market is historically low and favorable to wage growth. Also, the Fed will continue to maintain a tight monetary policy until inflation in all its forms subsides. This time around, it seems unlikely to see anything like the wave of stimulus-spurred “reopening” the US experienced when COVID-related lockdowns were lifted.
Historically, soft landings have eluded the US central bank, which has failed to stave off recessions after tightening cycles. A slight recession is to be expected at the end of this year or at the beginning of 2024. With the exception of offices, real estate fundamentals should remain relatively buoyant until 2023. Trends rent forecasts for industrial buildings and apartments are trending upwards, which has not been the case during the last four real estate recessions. Rents for all property types have fallen sharply in previous recessions. This supports the idea that when interest rates normalize and transactional liquidity returns, well-leased, well-maintained and well-located properties will likely have held their value relative to those that were not. Until then, patience and vigilance, particularly in terms of asset management, are in order.
Industrial real estate continues to surprise
There are still significant differences between the performance of properties by type. The office and apartment sectors experienced a negative period, while the industrial and retail sectors recorded their strongest quarters of rent growth in over 20 years. For apartment renters, the post-pandemic spike in rates has been painful, especially when combined with rising consumer prices that are hitting decades-long highs. Low- and middle-income renters are spending (or have spent) much of the excess savings accumulated during the pandemic.
Meanwhile, industrial demand continued to surprise even the most skeptical, recording a year of double-digit rental growth and a record vacancy rate, even amid strong construction activity. Despite rising debt costs and the implications for leveraged real estate values, positive secular demand trends, including expanding e-commerce capacity, deteriorating housing affordability and migration of businesses and households to the metros of the Sun Belt, are still intact and remain the drivers of long-term value creation.
The resilience of the labor market, tenant businesses and middle- and upper-income households contrasted with the turmoil in real estate financial markets. When borrowing costs rose in 2022, stock prices of public REITs fell. Compared to public real estate, most unleveraged house price indices are only beginning to turn around.