Podcast Summary
Commercial Real Estate Market Surges in 2021: The commercial real estate market saw a historic rebound in 2021 with a record $809 billion in transactions, led by multifamily and industrial sectors. Notable returns included a 24% increase in Greenstreet index and record appreciation in self-storage and industrial. Top markets were Dallas, Atlanta, Los Angeles, Phoenix, and Houston.
The commercial real estate market experienced a historic comeback in the second half of 2021, with a total transaction volume of $809 billion, an 88% increase year over year. The dominant sectors were multifamily, accounting for 42% of deal activity, and industrial, accounting for 21%. Notable returns included a 24% increase in the Greenstreet commercial property price index and record appreciation in self-storage (66%) and industrial (41%). The top performing markets were Dallas Fort Worth Metro, Atlanta, Los Angeles, Phoenix, and Houston, with Los Angeles being an exception due to its strong industrial sales. The drivers behind this strong performance were the easing of pandemic restrictions, low interest rates, and a shift towards niche asset classes like industrial and self-storage. Labor and supply shortages also played a role, leading to increased demand and higher prices. The mass exodus from places like California continued, with many investors looking for better opportunities in more affordable markets. Overall, the commercial real estate market showed significant resilience and momentum in 2021.
Factors fueling commercial real estate demand in 2021: Institutional capital, supply chain issues, inflation, and GDP growth drove up demand for commercial real estate in 2021. Labor shortages and supply chain constraints add costs and uncertainty to new projects, requiring careful risk evaluation.
The commercial real estate market experienced significant demand in 2021 due to a perfect storm of macroeconomic factors and market conditions. Institutional capital flows, supply chain issues, inflation, and rapid GDP growth all contributed to increasing demand for commercial real estate. From an investing perspective, labor shortages and supply chain constraints have become important considerations for risk management and new investment opportunities. Assessing a developer's ability to deliver new projects on time is crucial, and evaluating the general contractor's track record in delivering projects and managing labor is essential. These challenges add costs and uncertainty to new development projects, making it important for investors to carefully evaluate potential risks and opportunities.
Labor shortages impact various real estate sectors: Labor shortages can cause delays in construction projects, understaffing in hospitality businesses, and potential tenant failures in retail centers. Industrial service facilities and a hybrid office model offer potential solutions.
Labor shortages can significantly impact various real estate sectors, leading to operational challenges and potential financial risks. Subcontractors in the construction industry, for instance, may leave projects for better-paying opportunities, causing delays. In the hospitality industry, labor shortages can result in understaffed businesses, leading to tenant failures or rent abatements. Retail shopping centers, particularly those with a high concentration of restaurants, are also vulnerable to labor shortages, as tenants rely on low-wage workers to operate. Additionally, the industrial sector presents an opportunity in the form of industrial service facilities that address supply chain constraints. The future of office work is also evolving, with a hybrid model gaining traction, offering flexibility and reducing the need for extensive on-site presence. Overall, understanding the labor situation and the ability of tenants to adapt to changing circumstances is crucial when evaluating real estate deals.
The Shift Towards Remote Work and Hybrid Offices: Remote work is on the rise, with one out of six jobs now remote and 20% of high-paying jobs also remote. The average commute time saved can amount to 6-9 weeks per year, making it a desirable option for many. The office industry is in a state of transition, with some markets seeing higher utilization rates while others lag behind.
The trend towards remote work is here to stay, and the hybrid office model is becoming increasingly popular. The average commute time in the US is over 27 minutes each way, amounting to 6 to 9 weeks per year. With the option to work remotely, many people are unwilling to give up this newfound time. Job postings on LinkedIn now show that one out of six jobs are remote, and 20% of high-paying jobs are also remote. This shift towards remote work is not necessarily a negative sign for the office sector, but rather a sign of change. Some markets, such as Austin, Dallas, and Houston in Texas, are seeing higher office utilization rates, while others are lagging behind. Overall, the office industry is in a state of transition, and it's an exciting time to observe how this transition unfolds.
Shifting towards flexible and shared workspaces like co-working: The future office landscape will prioritize cost-effective, adaptable co-working spaces, particularly in industries with high professional service usage and sunbelt locations, as companies move towards a more hotel-like model with unpredictable demand.
The future office landscape is expected to shift towards more flexible and shared workspaces, such as co-working, due to the increasing trend of hybrid work schedules and the need for cost-effective and adaptable office solutions. This is particularly true for industries with high professional service usage and in sunbelt locations where office utilization rates are lower. Furthermore, the office market is moving towards a more hotel-like model, where demand is more fluid and unpredictable, making co-working an attractive option for companies as they no longer have to manage offices in the traditional way. However, the ongoing inflationary pressure and low cap rates in commercial real estate may pose challenges, but the adaptability and cost-effectiveness of co-working spaces may help mitigate these issues.
Commercial Real Estate as an Inflation Hedge: Investing in commercial real estate, particularly hotels and multifamily apartments, can provide a hedge against inflation and potentially generate solid returns. Short-term leases and ability to mark to market daily make hotels the most inflation-resilient asset class.
Investing in commercial real estate, particularly in the most inflation-resilient asset classes like hotels and multifamily apartments, can be an effective hedge against inflation. During the 1970s and 1980s, which was a high inflationary period, commercial real estate outperformed the annualized S&P returns by 9%, resulting in a 5% real return. This historic performance gives investors confidence in commercial real estate as a solid hedge during inflationary times. However, not all commercial real estate is equal in its ability to hedge against inflation. The shorter the lease term, the more resilient the asset class. Therefore, hotels, with their short-term leases and ability to mark to market daily, are the most inflation-resilient asset class. On the other hand, long-term net leases on properties like Starbucks or Walgreens, which have been signed years ago, are the least resilient. Asset classes like multifamily apartments and industrial, with their shorter and longer lease terms, respectively, fall somewhere in between. Overall, commercial real estate, especially the most inflation-resilient asset classes, can provide a hedge against inflation and potentially generate solid returns.
Considering lease terms for retail properties in inflationary environment: Retail properties with longer lease terms and rent bumps before renewal make them a good hedge against inflation. Examine rent rolls and schedules for potential impact.
When evaluating commercial real estate as an investment in an inflationary environment, it's important to consider the weighted average lease term for each asset class. For instance, retail properties may have longer lease terms with rent bumps occurring before the lease renewal, making them a good consideration. Overall, commercial real estate is seen as a hedge against inflation. However, it's essential to examine the specifics of each deal, such as rent rolls and rent bump schedules, to fully understand the potential impact of inflation. Additionally, demographic trends and wage inflation in the area can also influence rent growth, creating a symbiotic relationship between the two.
Analyzing market trends and wage growth for informed real estate investment decisions: Understanding market trends and wage growth is vital for making informed real estate investments. Niche asset classes like life sciences, driven by demographic shifts and increased healthcare spending, offer promising investment opportunities.
Understanding market trends and wage growth is crucial for making informed real estate investment decisions. A unit renting for $100 more per month today than it did six months ago doesn't necessarily mean it will rent for $200 more tomorrow, but it does provide proof that the six-month-old lease was behind the market. By analyzing the competition and demographics, investors can gain confidence in their ability to charge higher rents. Niche asset classes, such as life sciences, have been performing well and are expected to continue doing so due to the aging population and increased healthcare spending. With the population aged 65 and older set to increase by over 30% in the next decade, and this demographic spending three times more on healthcare than younger cohorts, life sciences presents a promising investment opportunity.
Life Sciences Sector's Growth Driven by Aging Population and R&D Breakthroughs: $70B invested in US life science companies in 2020, near urban areas with high intellectual capital attractive for investment, and industrial storage facilities also popular choices.
The life sciences sector is experiencing significant growth due to the aging population's desire for healthier, more active lives and the success of research and development in areas like mRNA technology. This trend has led to a surge in private and public capital investment, with $70 billion poured into life science companies in the US in 2020, a 93% increase from 2018. This investment is propelling the sector along an exponential trajectory, with vaccines developed at record speed during the pandemic serving as a testament to its potential. Real estate investors, including private equity and venture capitalists, are taking note and increasing their focus on life sciences. The most attractive areas for investment are near urban environments with high intellectual capital, such as Boston, San Francisco, and New York. Additionally, industrial storage facilities, which offer high yields for investors, are also a popular choice. Overall, the life sciences sector is expected to continue to be a focus for investment in the coming years due to its potential to benefit humanity through the development of cures and treatments.
Investing in niche real estate markets: Identifying and investing in unique real estate markets, like infill land and cannabis facilities, can offer high demand and potential for cap rate compression. Hold properties until convergence with common real estate uses.
Identifying and investing in niche real estate markets, such as infill land and cannabis facilities, can present attractive opportunities with high demand and potential for cap rate compression. Meanwhile, more traditional sectors like multifamily and industrial real estate, while still profitable, require a different approach due to their popularity and higher prices. For niche markets, the strategy is to acquire properties and hold them until the cap rates converge with more common real estate uses. In contrast, for multifamily and industrial sectors, strategies like ground-up developments and focusing on rent growth can still yield profits. However, it's important to acknowledge that these sectors are more expensive and require a different investment approach compared to previous years.
Ground up multifamily projects offer attractive spreads: Investing in ground up multifamily projects provides a significant spread between unlevered yield on cost and expected exit cap rates, making it an attractive investment strategy. Value-added acquisitions also offer high returns through renovations, but future rent growth moderation may impact their viability.
In the current market, ground up multifamily projects have an excess spread between the unlevered yield on cost and the expected exit cap rate, making it an attractive investment strategy. The unlevered yield on cost is calculated by dividing the net operating income by the cost of the project. For reasonably trended rents, a 6% stabilized yield on cost is expected. Historically, a 150 basis point spread was sought between the stabilized yield and the exit cap rate, but today, it can be 250 basis points due to lower exit cap rates. While cap rates are expected to moderate and increase, the excess spread provides a buffer. Additionally, value-added acquisitions have returned as a viable strategy, particularly for early 2000 vintage properties. These properties, which have good bones but are unable to achieve their potential rents, can be renovated to yield significant rent increases due to the current market's high rent growth. The return on cost of a unit renovation, which was tapering down to the low teens in the late cycle, can now exceed $165 per monthly rent increase for every $10,000 invested. However, rent growth is expected to moderate in the future, which may impact the viability of the value-added strategy.
Rapid appreciation in multifamily and industrial sectors: Multifamily renovations and ground-up industrial projects offer attractive investment opportunities due to high demand, compressing cap rates, and significant need for new developments in both sectors.
In today's real estate market, both multifamily and industrial sectors are experiencing rapid asset appreciation and decreasing cap rates, leading to high demand for new developments. For multifamily properties, renovating older buildings can bring them close to new class A rents, despite needing to trade at a discount. Industrial properties, on the other hand, have become hard to find for investment due to the compressing cap rates. Instead, ground-up industrial projects are favored due to the outsized spreads and high demand from tenants. Additionally, the US continues to have a significant need for more industrial real estate, making it an attractive investment opportunity for reliable delivery in the short to midterm. Overall, the speed and velocity in these sectors create opportunities for investors in both multifamily renovations and ground-up industrial projects.
Hospitality Industry Surprises with 2021 Recovery: The hospitality industry saw unexpected recovery in 2021, reaching pre-pandemic RevPAR levels in July. Charleston and workcation markets show promise for continued recovery. Secure deals with excess reserves for solid investments, but remain cautious due to uncertainty.
The hospitality industry showed surprising signs of recovery in 2021, with record-breaking RevPAR (Revenue Per Available Room) numbers in July, surpassing pre-pandemic levels. This recovery was a surprise to many, as it was expected that the sector would begin to bounce back in 2023 or even later. The markets showing the most promise for continued recovery are Charleston and regions with growing trends of "workcations" (working remotely followed by a vacation). It's important to note that there is still some uncertainty in the sector, so it's recommended to secure deals with excess operating reserves for a solid investment. Overall, the hospitality industry's strong recovery in 2021 indicates a promising outlook for the sector in 2022. Additionally, when making financial decisions, it's crucial to trust reliable sources, like NerdWallet, which helps individuals find smarter financial products. This can lead to significant benefits, such as increased travel rewards and savings. Don't wait to make smart financial decisions; compare and find smarter credit cards, savings accounts, and more today at nerdwallet.com.
Retail's Resilience Amid Challenges: Despite pandemic impacts, retail offers stability and potential returns through long-term leases and robust debt coverage ratios. Entrepreneurs can find opportunities in seemingly challenging markets.
Despite the negative press and perceived decline of retail, there are opportunities worth exploring. The sector has been impacted by the pandemic, but the narrative around online sales being the only growing story may be overstated. Brick and mortar sales are actually underreported due to a liberal methodology in quantifying online sales. Retail spaces, particularly those with long-term leases and robust debt coverage ratios, can provide stability and potential for returns. The author's personal experience of seeing more for-lease signs in their neighborhood might not be representative of the market as a whole, but it highlights the potential for entrepreneurs to find opportunities in seemingly challenging markets. The author's bullishness on retail in 2022 is based on the resilience of retail assets during the pandemic and the potential for continued recovery in the years ahead.
Retail real estate shows resilience amid pandemic challenges: Despite pandemic-induced collections drop, well-leased retail properties paid mortgages, conducted improvements, and maintained reserves. Stronger tenants remain, retailers open more stores, and retail fundamentals improve, reducing availability to a 10-year low.
Despite the challenges brought about by the pandemic, retail real estate has shown resilience. Well-leased properties with debt coverage ratios of 2.4x before the pandemic were able to weather a 33% hit on collections and still pay mortgages, conduct tenant improvements, and maintain reserves. The exit of weaker retailers has left stronger tenants in place, and retailers are opening more stores in 2022, reflecting the growing importance of brick-and-mortar locations in the hybrid retail environment. Additionally, retail fundamentals are improving, with all retail asset classes experiencing positive absorption in Q3 2021, reducing overall retail availability to a 10-year low. The retail sector may soon be revalued as more than just a "dinosaur industry" as e-commerce sales continue to grow in brick-and-mortar locations. However, potential risks to the commercial real estate sector include inflation and rising interest rates, which could pose a threat if they get out of control. Overall, the industry is expected to continue growing, and retail may soon be seen as more than just a discounted industry.
Political Risks Threaten Market Progress: Despite a strong economy, political polarization and local decisions pose risks to the market, particularly in commercial real estate. Coordination and consensus are crucial to mitigate negative consequences.
While the economy is strong and showing signs of continued growth, political risks pose a significant threat to the market. The polarization in the political system and inability to work together could derail progress. Additionally, the Federal Reserve's actions, such as tapering liquidity and raising interest rates, will likely impact the market, but any changes are expected to be moderate. The biggest risk, however, comes from local and municipal decisions, particularly around infrastructure and budget deficits. Consensus and coordination are key to avoiding negative market consequences, especially in the commercial real estate industry. The ongoing trend of migration from densely populated areas to secondary markets and smaller cities is expected to continue, driven by remote work opportunities and rethinking living preferences, which were already in place before the pandemic.
People are moving out of densely populated areas due to pandemic: The pandemic has led to a trend of people leaving densely populated states and moving to less populated ones, with California, Illinois, New York, and Connecticut having the largest net outflows. However, there's a shift towards intra-metro migration and an urban renaissance in the multifamily sector.
There has been a significant trend of people moving out of densely populated areas like the Bay Area in California, as shown in the 2021 United Van Lines study, which identified California, Illinois, New York, and Connecticut as states with the largest net outflows. On the other hand, states like Vermont, Florida, the Carolinas, Tennessee, and Idaho experienced the largest inflows. This trend is a result of the pandemic and is expected to continue for several years. However, there are signs of an urban renaissance, particularly in the multifamily sector, with a shift towards intra-metro migration rather than interstate migration. For Crowdstreet specifically, the company distinguishes between advisory services and marketplace offerings. While evaluating a deal, CrowdStreet first considers it as a potential marketplace offering, and the advisory side is seen as a complementary service that strengthens the marketplace and offers investors an alternative path to investing through CrowdStreet.
Discretionary Capital from Advisory Side Boosts Deal Flow: Crowdstreet's investment committee and IWS advisors evaluate deals for fund mandates and diversification, allocating discretionary capital to secure the best opportunities, benefiting both fund and marketplace investors.
Crowdstreet's marketplace not only offers a robust deal flow for investors but also provides an opportunity for discretionary capital from the advisory side of the business. After a deal is approved for the marketplace, it undergoes a rigorous evaluation process by the investment committee and IWS advisors, acting as fiduciaries, to determine if it fits the fund mandates and provides necessary diversification. If the deal passes this second lens, it can be allocated from the discretionary sources of capital. This layer of discretionary capital helps Crowdstreet win deals and bring more investment opportunities to the marketplace, ultimately benefiting both fund and marketplace investors. The marketplace serves as the foundation, and the discretionary capital acts as a catalyst to secure the best possible deals for all parties involved. For more information, feel free to visit Crowdstreet's website or contact their team directly.
Exploring CrowdStreet and Commercial Real Estate Investing with Ian Migliore: CrowdStreet offers a platform for investing in commercial real estate, providing access to deals and education. Ian Migliore encourages reaching out for deal discussions and reading his book for more information.
If you're interested in learning more about CrowdStreet and commercial real estate investing, the best place to start is by creating an account on their website (www.crowdstreet.com). The site offers a wealth of information and education, and the team is dedicated to helping investors understand the industry. Additionally, Ian Migliore encourages reaching out to him on LinkedIn for deal discussions. His book, "The Comprehensive Guide to Commercial Real Estate," is also available on Amazon. For updates and resources, follow The Investors Podcast on your favorite podcast app and visit their website at investorspodcast.com.
