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Mid Summer 2016 Commercial Real Estate Update

Discerning Solid Demand Drivers from Fads in Commercial Real Estate

As economic data suggest the US macro economy is just slowly growing, 1.2% annualized GDP growth for the second quarter of 2016 as a prime example, it is worthy to question the source of sustained demand growth for commercial real estate. Overall, commercial real estate prices are at or near all-time highs according to Real Capital Analytics and occupancies are generally near normal peaks. Thus, it is anticipated that many investors and market participants will begin or have begun to question where commercial real estate is in the proverbial “cycle” and if some form of a downturn is probable for the future. While it is difficult to forecast the future, determining whether present property fundamentals and pricing is a result of solid demand drivers or just potentially fleeting “fads” is highly worthwhile and more important for long-term investment decisions.

Demographic Waves Driving Commercial Real Estate Demand

In real estate, demand trends are ultimately governed by demographics. There are two major demographic waves that will persist for years to come. First, the rising of the Millennials and second, the aging of the population (also known as the Baby Boomer bust). While this is hardly a new topic of conversation in the real estate industry, some of its most primary implications to core demand seem lost during said “cycle” discussions. To illustrate why these discussions must be merged, a simple snapshot of 30-year-olds in America is presented courtesy of data from the US Census Bureau. In 1975, 71% of 30-year-olds had married, had a child, completed schooling, and had moved out of their parents’ house; as of 2015 the number of 30-year-olds meeting all four criteria had fallen to 32%. Further, this trend is worsening and not likely to reverse anytime soon. Now, given that data, consider where a rational person who is unmarried, childless, and potentially in school is going to live when they finally move out of their family home – clearly the answer is in rental housing. Thus, those analyzing the apartment sector without considering the impact of such changing demographics are more likely to see oversupply, when in fact the actual condition for some markets is undersupply.

Demand drivers - apartment buildingsA similar story regarding the aging of America can also be made using Census data which shows that the percentage of the population over 65 will go from less than 14% in 2010 to almost 22% by 2030. Now, consider the prototypical 65-year-old household; it will likely be childless (at least under the age of 18) with just one to two adults with potentially limited income. With a little creative analysis, it is apparent that the prototypical Millennial household (i.e., a single person or two adult individuals with limited income) is actually quite economically similar to the Baby Boomer household. Further, while not identical, both will have somewhat similar demands for real estate. Thus, the ever insatiable demand for multifamily, certain types of retail, and other properties seems far more logical when all sources of demand are considered. In short, apartments are doing well today, in both fundamentals and pricing, because they benefit from solid demand drivers; meaning those not likely to deteriorate in the short term and most likely to persist for the long term.

Finding True Demand Drivers Across Product Types

When analyzing all other sectors such as office, industrial, retail, and hospitality, it is equally important to assess how “solid” the demand drivers are for those sectors’ product. E-commerce appears very “solid” and thus its impacts on retail and industrial are likely to persist as well. For the contrarian example, consider trends in co-working, clustered work spaces, and other trends in office space; they may all end up being a “fad”, as they are not backed by a solid demand driver. Thus, savvy investors do not spend time assessing “cycles”, they spend time discerning true demand drivers from fads. Most, if not all, “bubbles” that burst are fads being discontinued. This includes the housing “bubble” of the 2000’s; the “fad” was mom and pop investors buying multiple houses just to flip, even though they could never live in or afford them as rentals.

To learn more about the current CRE market and economic conditions throughout the US, read the 2016 Market Outlook Reports here.

CRE Market Outlook

[bctt tweet=”Overall, commercial real estate prices are at or near all-time highs #CRE” username=”svnic”]

Finding the Perfect Apartment Building

Investing in Apartments Includes Some Benefits

Apartments are the hottest class of commercial real estate and are likely to continue being hot for a while. Independent of the unique demographic and economic drivers for their success in the current post-Great Recession economy, there are a few basic truths that make them attractive:

  • Housing costs usually move up and apartment rents can be adjusted on a regular basis.
  • Vacant units are easy to re-rent with little or no cost. In fact, tenant security deposits usually pay for cleaning and repairs.
  • Excellent financing with 80 percent leverage is readily available.
  • Relatively easy appreciation through making cosmetic upgrades to increase rents.

…But Apartments Also Include Some Downsides

For many investors, though, apartments have three key problems compared with other classes of commercial real estate. They have tenants that break things, complain and fail to pay rent. Apartments have kitchens that tend to start destructive fires. Finally, they have bathrooms that leak and cause damage to surrounding units. At the same time, many cities heavily regulate apartments and, in many cases, favor tenants over landlords. These problems make apartments challenging and time-consuming to own.

Imagine, for a moment, an apartment building without tenants, kitchens or bathrooms and with little or no government oversight. All that you would have are rooms with furniture, clothing and other items in them. If you have ever owned an apartment building, you know that a building like this one would be a dream to own!

The Solution: Self Storage Facilities

In fact, the perfect apartment building is a self-storage facility. Mini-storage facilities offer a similar ownership experience to apartments but without any of the drawbacks. Because they frequently serve apartment tenants, their performance tracks the apartment industry, as well. Furthermore, modern management systems make them much easier to own than many people realize.

Read more of Solomon Poretsky’s blog posts here.

[bctt tweet=”In fact, the perfect apartment building is a self-storage facility.”]

Mid-year review of apartment market

According to the 2013 mid-year report from US Capital Trends (a division of REAL Capital Analytics) on the apartment market, the commercial real estate apartment market is doing well as of the end of Q2 2013, with strong sales, including fewer distressed properties on the market.

Apartment sales are strong—$17 billion in Q2—but slowing in comparison to the steep rise experienced since Q4 2009. Transaction volume has moderated due in part to interest rate hikes that started in May. Mid/high-rise properties are appreciating at a slightly higher rate than garden properties.

Sales of distressed properties fell below $1 billion for the first time in more than three years. Because of improving prices, lenders have less pressure to liquidate troubled properties. More than a quarter of distressed properties are located in the Southeast (Miami, Atlanta) and in tertiary markets.

Investors are looking to lagging markets “where fundamentals may outperform over the near term” such as Orlando, Northern New Jersey, Minneapolis and Jacksonville. Volume in major metropolitan areas declined by 6% and grew by 12% in non-major markets. Secondary and tertiary markets are experiencing activity spikes whereas primary markets such as Manhattan and Houston have seen flat or declining volumes. A very active area appears to be the Washington, DC suburbs, where activity increased 118% in the first half of 2013, making it second only to Manhattan.

The top apartment buyers buy investment volume are Equity Residential and Avalon Bay Communities. The top apartment brokers (for all types of apartments) are CBRE and HFF.

To read the complete report, including breakdowns by region, selected sales transactions, sales summaries by type, please download the US Capital Trends Apartment 2013 Mid-Year Review.

*All Sperry Van Ness offices are independently owned and operated.