2022 State Of The Commercial Real Estate Market From Redline's Perspective
Updated: Mar 25, 2022
With all of the economic and political developments happening around the country we are always refining and reevaluating our investment strategy here at Redline. With this in mind, we wanted to give everyone a 'behind the scenes" acquisition update on how we are looking at potential new deals considering the current economic climate, competition within our space, and prospects for future investment returns.
Let's take a look at some of the top factors we are looking at in the current environment.
Continued Economic Growth & Rising Interest Rates
The U.S. added 467,000 jobs in January, triple the expected number of 150,000. This huge surprise coupled with suddenly higher revised job growth in November and December, shows that despite a large increase in infections and economic disruptions from the omicron variant, the U.S. economy has robust momentum. We maintain a positive outlook for the economy and commercial real estate in 2022 and have seen this economic growth translate to increased NOIs (Net operating income) at many of properties in our portfolio.
Financial market volatility likely will continue for the next several months, as investors adjust to a new interest rate situation. This volatility should taper somewhat if inflationary pressures ease in the second half of the year, which should happen as the Fed looks to increase interest rates and cool off the red-hot economy. Due to this volatility in the stock market, this has made the real estate investments even more attractive due to the relative stability they provide in comparison.
The January job growth numbers reinforced the Fed’s plan to raise interest rates several times this year, likely beginning in March, along with reducing its balance sheet later in the year. Even with higher interest rates, the U.S. economy should continue to expand thanks to consumer strength and a greater ability to mitigate the impacts of COVID. This, in turn, will support real estate demand as the year progresses.
As interest rates are poised to grow, our investment process will maintain a disciplined approach. In our opinion debt maturity is the biggest risk in the current environment, and we must stay vigilant to mitigate that risk. If leveraging "bridge/floating debt" we account for the projected interest rate increase by purchasing interest rate caps and always analyzing our refinancing options during our hold period.
Large Amounts of Capital Continue to Flow into Commercial Real Estate
Investment activity in commercial real estate boomed back in 2021 from 2020 lows thanks to strong investor appetite and attractive financing options. According to CBRE, “Total investment volume in 2022 is projected to increase 5% -10% over 2021 levels, which is on track to roughly equal pre-pandemic volumes from 2019. Multifamily assets will likely continue to capture the most investor interest increasing 10%-15% over 2021 levels.”
We have seen this competition on the ground with brokers regularly receiving 30+ bids on some assets. This has been frustrating for us as we know our investors would like to place more money in multifamily deals, but it has been very tough to find deals that create a ton of value for the Redline community. Nonetheless, we continue to push forward and are hoping to have another deal under contract soon.
Cap Rates Continue to Trend Lower
As investors continue to deploy capital into multifamily assets because of their relative safety and attractive growth prospects, cap rates continue to compress lower. I can tell you from personal experience that our target markets in the Southeast and Midwest are highly competitive and to get into these markets, an investor must be willing to pay a low cap rate. Although we believe with conviction the potential growth prospects in these markets provide enough justification for the low cap rate going in.
Selma Hepp, PhD, deputy chief economist, CoreLogic, gives a great analysis of the growing rents and falling cap rates in her 2021 year in review analysis, “As the pandemic started, you could see this huge dip in multifamily rents which lasted about the duration of 2020 but has since rebounded. It has rebounded so strong that it’s now outpacing rents for single-family detached or attached. We’ve seen apartment cap rates fall to a new low of 4.5 percent in December 2021. This is a 10 percent decline from the third quarter of 2021, and cap rates were down 10 percent on a year-over-year basis. If you think about what happened in 2020, that’s when they dropped because of the pandemic; but now they’re even lower at 4.5 percent.”
Rents in our target markets are projected to make large growth this year over the historical average which in turn will increase NOIs. According to CBRE, multifamily NOIs nationwide are projected to increase 8% in 2022. The projected NOI growth justifies our view that cap rates will stay low moving forward, as investors are willing to pay for a low going-in yield with the expectation that their cashflow will continue to rise with the growing economy.
Redline's Investment’s Strategy for 2022
As always, real estate investment strategies rely on a balance between risk and reward. Although we traditionally look at B and C class properties, we are looking at Class A assets as well. Class A assets in growing markets present a great risk adjusted return because of the low construction risk and a higher income tenant base. We will continue to focus on these types of assets in quality markets.
Our target markets in the Southeast and Midwest have high net in-migration, attractive quality of living, great climate, and attractive economic prospects which we expect to continue in the coming years. Out target markets are the catalyst for the newer assets to perform with high NOI growth, which translates to higher cash on cash returns to our investors.
While the current economic climate is anything but certain, the current conditions appear favorable for continuing to invest in real estate for the following reasons. Historically, commercial real estate has provided a hedge against inflation; the economy and apartment rents are growing at record pace; and debt is still relatively cheap compared to the historical mean.
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