A Real Economy publication

Real estate industry outlook: Summer 2022

May 10, 2022

Real estate outlook key takeaways

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Rising interest rates are unlikely to deter investment in U.S. real estate.

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Fundraising and debt markets will keep the cost of capital affordable.

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Many property sectors continue to show strong fundamentals.

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Real estate Economics

Real estate set to remain strong despite interest rate bumps 

Amid rising costs for energy, food, and other staples, the Federal Reserve has moved to temper inflation. The central bank boosted interest rates 0.25% in March, and another 0.5% in May, the opening salvos in what are expected to be several incremental increases in lending rates expected throughout 2022. 

Real estate fund managers are concerned with how the rate increases will affect their operations and bottom lines. Fortunately, no one needs to sound the alarm. With the cost of capital remaining low, continued interest in real estate from both domestic and foreign investors, and robust demand in sectors such as housing and industrial, the industry should continue to see positive trends despite the near-term impact of changes to monetary policy.

Domestic and foreign investment interest in real estate nears record highs

 Investors continue to look for opportunities to deploy dry powder toward real estate. As an alternative to stocks and bonds, real estate is commonly viewed as a hedge against inflationary markets, including the current environment, and fundraising efforts across the country have shown strong positive trends, despite the ongoing pandemic and geopolitical landscape.

 

Real estate fundraising at record levels
Real estate chart 1

After a small dip in 2020, U.S. fundraising accelerated in 2021 to a 20-year high of $120 billion, according to Preqin. Funds’ war chests are also at record levels, sitting at $225 billion at year-end, Preqin data shows. 

Now, as interest rates rise, buyers may expand to tertiary markets such as Austin, Charlotte, and Denver as they look to acquire assets that can deliver on their targeted returns. Interest in U.S. real estate is vibrant around the globe, fostered in part by the volatile geopolitical environment. Foreign investors acquired more than $70 billion in U.S. real estate in 2021, more than double the 2020 volume and the highest level since 2018, according to Real Capital Analytics. 

The momentum is not expected to slow. With instability in Europe due to the Russia-Ukraine war and the United States among the leading countries with high rates of vaccination, foreign investors will flock to safety and continue to focus on the United States. A 2021 survey of overseas investors by the Association of Foreign Investors in Real Estate showed 75% of respondents expected to increase their holdings in U.S. real estate in the next three to five years, a trend that will help keep domestic property in high demand.

Real estate dry powder at record levels
Real estate chart 2

Loan rates remain low 

Lending is where the Federal Reserve’s rate boosts may have the most direct impact. Once prospective buyers have raised equity and identified a property, they will often use debt to complete their capital stack. Borrowers taking on short-term and/or floating-rate financing will be most affected. They will want to evaluate their investment strategy and compare floating-rate debt to the cost of locking in a fixed-rate loan or purchasing an interest rate hedge. 

As nervous as investors may be about the costs of financing, the near-term rate increases should not cause a major stir in the commercial mortgage market. In fact, a recent analysis from Real Capital Analytics reflected that the spread between the 10-year Treasury rate and mortgage rates would be more likely to compress as the Fed reduces its balance sheet, rather than result in a substantive increase in commercial mortgage rates.

Thanks to strong fundamentals, real estate sector outlook is solid 

Lastly, with the equity and debt markets remaining stable, many property sectors also continue to show strong fundamentals. Across the four core sectors of multifamily, retail, industrial, and office, cap rates have continued to compress over the last decade due to strong price growth and demand. Even if bond yields rise due to the Federal Reserve’s near-term rate decisions, there is still plenty of room for further compression.

Real Estate cap rates continue to compress
Real estate chart 3

In multifamily, the housing shortage continues to drive up apartment occupancy. The national vacancy rate sits at 4.9%, according to CoStar data; prior to declines in 2021, U.S. multifamily vacancy rates hovered between 6% and 7% for 10 years. Meanwhile, the industrial market has reaped large dividends due to growth in e-commerce and tenants’ demands to increase inventory amid supply chain disruption. The past 12 months have seen net absorption of over 500 million square feet of industrial space, CoStar data shows. By comparison, the average annual industrial absorption over the past decade was only 215 million square feet. 

Even the office sector, beleaguered by pandemic-induced workplace shifts, shows opportunity as coronavirus cases decline and large companies such as Google and Facebook parent Meta reopen their offices. As of March 3, property technology solutions provider, Kastle Systems reported its highest occupancy rate in office buildings (38%) since the start of the pandemic. Despite uncertainty in the sector, U.S. office asset values have grown 10% in the past five years, according to CoStar. Across all the core real estate sectors, demand remains strong and investment prospects should stay favorable. 

 The takeaway 

 Rising interest rates in the current inflationary market will leave investors and consumers across many industries concerned, but for real estate, the impact should be muted. The fundraising and debt markets will keep the cost of capital affordable for future investment. Additionally, the fundamentals across real estate asset types remain strong. At a macro view, the near-term rate boosts will be blips on the radar for real estate owners and operators who can expect business to run as usual.

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