CRE Fundamentals Continue Bounceback
Commercial real estate fundamentals are bouncing back with help from a slower, but still steady economic recovery, reported Wells Fargo Economics, Charlotte, N.C.
“Property prices are climbing at a rapid pace, led by sturdy gains in retail, apartment and industrial properties,” the firm said in its second-quarter Commercial Real Estate Chartbook. “While the hard-hit office and hotel markets face a longer road to recovery, their path of the recovery is coming into better focus.”
The report noted demand for apartments continues to surge, far outpacing completions and pushing the vacancy rate down to its lowest point on record, just 5.3 percent. “Low inventories and declining affordability in the single-family market will support rental apartments for the foreseeable future,” Wells Fargo said. “Early reports of the third quarter show demand has remained strong.”
Retail sector conditions continue to improve. Net absorption jumped to 19 million square feet in the second quarter, the highest level seen since 2018. “While not all [retail] subsectors have fared the same, still-strong consumer demand should support retailers in the months ahead,” the report said.
The office sector’s worst days are likely behind it, Wells Fargo said. Though net absorption declined again during the quarter, it fell by less than in recent quarters. Asking rent growth was flat quarter-over-quarter, a reflection of improving demand fundamentals, and Wells Fargo found some early evidence that leasing gained strength in the third quarter.
“Industrial fundamentals remain extraordinary,” the report said. The sector saw asking rent growth and net absorption records in the quarter and the vacancy rate declined to 5.1 percent. “Demand is set to strengthen further as businesses reconfigure their logistics operations amid ongoing supply chain logjams and the need to build precautionary stocks,” Wells Fargo Economics said.
But hotel occupancy and average daily room rates remain below pre-pandemic levels, the report noted. It noted leisure travel has ramped back up but said the delayed return to office will likely prolong the recovery in business travel.
The recent upturn in commercial property prices and sales has coincided with lower cap rates, the Chartbook said. Property cap rates averaged 6.3 percent across sectors during the quarter. “Cap rates remain incredibly low by historical standards, which makes sense considering the ground-level interest rate environment,” the report said. “Interest rates and cap rates have never been perfectly correlated, as investor risk appetite can vary considerably. That said, cap rates do tend to move in the same direction as long-term interest rates. With economic growth rebounding, inflation rising and the Fed hinting of a forthcoming taper of its asset purchases, medium- and long-term Treasury yields have begun to step higher.”
Wells Fargo said it expects long-term interest rates to rise “only modestly” over the next few years, even if inflation proves persistent. “Cap rates did not fall as quickly as interest rates did at the onset of the pandemic, but the gap with interest rates has narrowed as investors have searched for higher-yielding assets,” the Chartbook said. “Now that long-term interest rates are rising, demand for commercial properties has perked up, reflecting the improved operating environment and some desire to diversify portfolios.”
