Retail Sector provides Opportunities for CRE Investors

Retail Sector Recovery Well Underway

• March core retail sales exceeded $468B; up 6.2% from last year and 24% from pre-pandemic
• Even when adjusted for inflation, sales are up 1.1% Y-O-Y and 16% from pre-pandemic
• Although retail job loss was significant, there are already 278K more retail workers than before the pandemic

Retail Performance Stronger than Many Believe

• Despite the ongoing recovery, just 20% of investors said it’s a good time to buy Retail, compared to 19% for Office
• Office vacancies are still over 300 bps higher than before the pandemic while Retail vacancy is only up 40 bps
• Retail foot traffic and rents are higher than pre-pandemic

Investors Aren’t Fully Capitalizing on Existing Opportunities

• Total CRE transactions were 28% higher in 2021 than 2019, but Retail transactions were up only 9.4%
• Retail cap rates haven’t compressed like other properties
• Average MT-Retail cap rates hover around 6.7%, compared to 4.8% for Apartments

*Adjusted for inflation using core PCE
Core retail sales exclude auto and gasoline sales
Sources: Marcus & Millichap Research Services, U.S. Census Bureau, BEA

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Why CRE Investors Need to Keep Their Eyes on the Horizon

CRE Provides Strong Returns Over the Long Run

• Long-term outlooks allow investors to focus on meaningful demographic and macro trends, not on daily noise
• Despite recent volatility, most CRE property types have outperformed the stock market over the last 20 years
• S&P returns since 2000 were 416%; Apartment returns came in at 458%, 461% for Retail, and 848% for Industrial

Trends That Will Drive CRE Performance Over Next 20 Years

• Millennials entering family formation age will place greater focus on single-family homes and the suburbs
• Aging Baby Boomers to drive MOB and Seniors Housing demand; will progressively transfer wealth to children
• Interest rate, economic and public policy cycles will constantly transform the real estate landscape

Key Considerations for Long-Term Investments

• Take note of demographic trends, not all property types and locations will benefit equally
• Actively and periodically trade assets to capitalize on interest rate cycles and maximize ROI opportunities
• Adapt to changing behaviors, technology & public policy

*Sources: Marcus & Millichap Research Services, S&P Global, NCREIF

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Investor Insights from The Fed’s March Meeting Minutes

Fed To Take More Hawkish Approach to Combat Inflation

• Fed could implement 50 bps increases to overnight rates if inflation remains elevated, up from expected 25 bps
• Could raise overnight rates more than 200 bps this year

Balance Sheet Reduction Coming Soon

• After doubling their balance sheet during the pandemic, the Fed will begin reducing Treasury and MBS holdings
• This Quantitative Tightening should push-up longer term interest rates, would reduce risk of yield curve inversion
• Could push 10-Year Treasury above 4% by year-end

Investors Should Remain Vigilant of All the Moving Parts

• Focus on investment strategies that mitigate inflation risk and prepare for a substantial rise in interest rates
• Economic growth fundamentals remain strong, so if a recession occurs, it will be milder than recent ones
• CRE vacancies for most property types remain very low, rent growth is strong, and the investment climate is sound

*As of April 07, 2022
Sources: Marcus & Millichap Research Services, Federal Reserve

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Should Investors Prepare for an Incoming Recession?

Does a Yield Curve Inversion Signal the Next Recession?

• Yield spread between the 2-yr and 10-yr treasuries briefly inverted last week, one signal of a possible recession
• Another indicator, the 3-mnth and 10-yr rate spread, which takes more pressure to invert, has not flipped
• Currently no guarantees of incoming recession

Greater Risk for Yield Curve Inversion Expected

• Fed’s aggressive approach to tackle inflation involves raising interest rates 7 times this year
• Could put upward pressure on short-term rates, increasing interest rate volatility and raise risk of yield curve inversion
• Recession is possibility but should not be primary concern

What Investors Should Consider for Investment Strategies

• Strong economic growth and low unemployment rate will help mitigate impact of a potential recession
• Investors should instead factor rising inflation and interest rate hikes into their investment decisions
• Consider CRE that can raise revenues to mitigate inflation and lock in fixed interest rates for loans

*Through March 31
Sources: Marcus & Millichap Research Services, Federal Reserve

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Affordability Spread Remains Large, Despite Multifamily Rent Escalation

• Home prices climbing, despite a slowdown in buying. For the first time since 2019, the average rate for a 30-year mortgage breached 4 percent in March, then accelerated at an even faster pace, following the Fed’s first interest rate hike in over four years. Higher mortgage rates make houses less affordable, in an environment where elevated prices are already an inhibiting factor.
• Apartment rent gains catching up to home prices. Preliminary estimates for the first quarter of 2022 show a 16.8 percent lift in average effective apartment rents in the United States, slightly faster than the annual price leap for homes. The formidable apartment rent increase is facilitated by extremely tight vacancy, with tenants competing for record-low volumes of available units in markets across the country.
• Single-family rentals not the lead cause of high prices. More REITs and corporations are exploring single-family homes as an alternative investment option. These well-capitalized groups often outbid individuals and private buyers, contributing to rising prices.

Developing Trends

• Interest rate hike expedites mortgage rate ascent. The 30-year mortgage rate has been steadily climbing, and the Fed’s announcement of an increase to the benchmark rate sped up the pace of growth in mid-March.
• Permit activity indicates some additional relief. The single-family sector has been starved for development over the course of the health crisis, as inventories plummeted amid robust buying activity. Builders had a difficult time keeping pace with demand, as material costs soared and labor shortages impeded project timelines.

* 2022 Q1 figures are preliminary estimates
Sources: Marcus & Millichap Research Services; Capital Economics; Freddie Mac; Moody’s Analytics;
Mortgage Bankers Association; National Association of Home Builders; National Association of Realtors; RealPage, Inc.; U.S. Bureau of Labor Statistics; U.S. Census Bureau; Wells Fargo

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Points to Broad-Based Downward Pressure

Preliminary estimate as of 4Q 2021
Leading indicator based on year-over-year change in cap rates for M&M deals under contract and newly listed
Cap rates for sales $1 million and greater; Seniors housing includes skilled nursing

Sources: Marcus & Millichap Research Services, CoStar Group, Inc., Real Capital Analytics, NICMap, MNet