Limon Net Lease Group

Research Brief

What the Fed Rate Hike Means for CRE Investors

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What the Fed’s Unexpected Rate Hike Means For CRE Investors

Fed Takes Aggressive Action to Combat Inflation

  • Fed announced 75 bps hike; previously suggested 50 bps
  • Lenders may pass a larger rate to buyers and bake-in another 75 bps increase in July
  • Four more rate hikes are expected in 2022

Housing Market Already Feeling the Impact

  • Average mortgage rates jumped up nearly 50 bps last week to 5.78%
  • Will decrease number of households that can qualify for mortgages
  • Lifts demand for already tight Apartment market; Could translate to greater rent growth pressure

Will Higher Rates Impact CRE Transactions?

  • Some buyers that are dependent on financing may tap out, but enough competition expected to remain
  • Strong rent growth could outweigh higher cost of capital for certain property types and markets

*As of June 16, 2022
Sources: Marcus & Millichap Research Services, Federal Reserve

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Are We In A Housing Market Bubble?

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Housing Supply Shortage Will Support Apartment Demand

Are We Facing Another Housing Bubble?

  • SF home prices up 15% YOY; Up 38% from two years ago
  • Unlike overbuilding and speculation leading up to Financial Crisis, housing has been underbuilt recently
  • Lack of housing units weighs on household formation, creating pent-up demand and driving price growth

Homeownership Becoming Increasingly Unattainable

  • Leading up to the pandemic, about half of households could afford a median priced home
  • Skyrocketing prices have made the same home affordable to roughly 26% of households
  • Rising interest rates could further shrink this number

Apartments Remain an Affordable Alternative

  • Average Apartment rent remains $638 lower than median home payment; rose at half the rate over last 2 years
  • Housing shortage and demographic trends will sustain low vacancies and rising rents
  • Investors can expect aggressive bidding for Apartment properties despite rising interest rates

*Forecast
Forecast using Moody’s June 2022 baseline forecast
SF=Single-Family, MF= Multifamily
Sources: Marcus & Millichap Research Services, U.S. Census Bureau, RealPage, Inc., Moody’s Analytics

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CRE Investment Overview and Outlook

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Commercial Real Estate Investment Hit Record Levels

Favorable Fundamentals Drove Record CRE Transactions

  • Elevated market liquidity, strong property outlooks and inflation resistance drew many investors to CRE properties
  • CRE transactions in 2021 exceeded prior peak by 29%; 1Q 2022 sales activity ahead of prior year
  • Placing downward pressure on cap rates

Aggressive Acquisition Climate Fueling Price Surge

  • Office, MT-Retail and Hotels, which were hard-hit but are starting to recover, saw modest price growth
  • Strong demographic trends and favorable outlooks drove strong price appreciation for Apartment and Self-Storage
  • Record transactions fueled outsized Industrial price gains

Will CRE Transactions Maintain Their Momentum?

  • Strong CRE outlook will continue to support property space demand
  • Stock market volatility may push capital to CRE, sustaining further buyer demand
  • Fast rising interest rates could erode some sales activity

*Pre-Pandemic period: 2019 through 1Q 2022; MT=Multi-Tenant
Includes sales $1 million and greater
Sources: Marcus & Millichap Research Services, Real Capital Analytics, CoStar Group, Inc.

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How the Pandemic Impacted CRE Property Types

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How is CRE Performing two Years into the Pandemic?

Economic Landscape Looks Significantly Different

  • During pandemic onset, millions of jobs were lost, businesses shuttered and uncertainty was widespread
  • Today, inflation remains a concern, but most economic metrics are near or above their pre-pandemic levels

Behavior Changes Benefited Some CRE

  • Greater eCommerce adoption and increase in store inventories pushed Industrial vacancy to a record low
  • After initial softening, rise in household formation is driving Apartment space demand
  • Self-Storage benefited from disruptions to school and work life and changes in living arrangements
  • Necessity Retail thrived during the pandemic while other types, like experiential retailers, are now recovering

Momentum Shifting for Impacted Property Types

  • Hotels suffered a strong initial impact, but rising business and leisure travel could boost summer occupancies
  • Seniors Housing faces lengthy recovery as industry adapts to the new operating climate
  • Office outlook uncertain, should benefit from relaxing restrictions and continued job growth

*Self-Storage includes 1Q data for 2019 and 2020
MT = Multi-tenant: ST = Single-tenant
Sources: Marcus & Millichap Research Services, RealPage, Inc., CoStar Group, Inc., Radius+

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How Supply Chain Issues Impact CRE Investors

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How Supply Chain Disruptions Could Transform CRE

Supply Chains Disturbances Have Far Reaching Impact

  • Supply chain disruptions greatly increased shipping times and costs, impacting availability of materials
  • Cuts into manufacturing outputs, construction and retail inventories
  • Also raises costs of goods, further fueling inflation

Companies Taking Steps to Limit Impact of Disruptions

  • Increasing order quantities and storing excess products in local warehouses provide small, short-term buffers
  • Some manufacturers are reshoring, looking at facilities in the U.S., Mexico or Canada
  • Higher costs of manufacturing locally offset by increasing automation and lower transport costs

The Ripple Effect on Commercial Real Estate

  • Industrial facilities along U.S. ports of entry, like San Diego and San Antonio, have recorded record space demand
  • Shorter and more secure supply chains benefit Retail, support local job creation and boost housing demand
  • Investors should consider how these changes will shape markets, and capitalize with strategic investments

*Transit time for end-to-end ocean freight from China to the U.S.
Sources: Marcus & Millichap Research Services, Freightos

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Will Cap Rates Rise Due to Increasing Interest Rates?

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Will Rising Interest Rates Put Upward Pressure on Cap Rates?

Interest Rates and Cap Rates Not Directly Correlated

  • Some investors think sellers must raise cap rates when interest rates increase in order to draw in enough buyers
  • This has not held up historically, spread between interest and cap rates have varied significantly
  • Yields can vary greatly by property type and market

Many Factors Currently Impacting CRE Yields

  • Elevated liquidity forcing investors to compete for assets, willing to accept lower yields to invest capital
  • Stock market volatility likely to drive investors to stability of CRE, putting downward pressure on cap rates
  • Property types and markets with momentum or value-add opportunity draw new interest, keeping cap rates steady

Investors Need to Consider Future CRE Trends

  • Demographics to reshape CRE; Retiring Baby Boomers and aging Millennials will drive certain property types
  • Paying a premium now could provide opportunity for elevated returns over next few years
  • Upward cap rate momentum in some markets and property types expected, unlikely to be broad-based

*Through May 11
Includes apartment, retail, office, and industrial sales $1 million and greater
Sources: Marcus & Millichap Research Services, CoStar Group, Inc., Real Capital Analytics, Federal Reserve

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