From a small northwestern observatory…

I’m regularly asked, “Is now a good time to buy real estate?” Throughout 2022, my pat answer was, “Now is a good time to have already owned real estate.” Indeed, with the possible sector exceptions of hospitality and retail, real estate was a pretty darned good hedge against the stock market doldrums over the past year. As soon as I say that fingers get pointed at the REIT market, which has had mixed results this year. Indeed, some REIT sectors were terribly over-bought, and some specific stocks (I’m looking at single family residential REITs) simply couldn’t deliver funds-from-operations to meet investor expectations. Nonetheless, and overall, having some real assets in your portfolio at the beginning of 2022 was a pretty good thing.

So where do we go from here? Obviously, forecaster expectations need to be taken with huge grains of salt, but to an extent these forecasts often drive the narrative. In other words, in a behaviorist market (which is is, you know), investors tend to be herd followers. So which way is the herd pointing?

On the housing front, over at the National Association of Realtors, Melissa Dittmann Tracey writes “2023 Real Estate Forecast: Market to Regain Normalcy“. By this, she forecasts that actual sales volumes (that is, number of homes sold) will decline by about 7% but with flat prices overall. Two things strike me about this. First, by our research at Greenfield, since World War II, home prices in America have increased on average by about 2% per year above the inflation rate. This is more-or-less baked into the expectations of market participants and, for that matter, even market intermediaries like mortgage lenders. Thus, when faced with 5% inflation, we expect home prices to rise about 7%. Second, though, this is an average over a very long time horizon, with wild fluctuations. Remember the market meltdown in 2010? Remember the market bubble that preceded that melt-down? Now, consider that according to NAR statistics, home prices rose an estimated 9.6% in 2022 (the exact figures are still out), a whopping 16.9% in 2021 and 9.1% in 2020, all during periods of low inflation. NAR estimates that in the year coming, 2024, inflation will be back to “normal” (and most forecasters agree with this) and home prices should get back to a healthy upward trend (NAR forecasts a 5% price rise in 2024). Thus, if they are right, then 2023 could be a good year to shop for bargains.

New home sales are factored into total home sales but are also a driver of land development activity. According to a U.S. Department of Housing and Urban Development report, released in December, new home sales cycled downward starting in early 2020, from a seasonally adjusted rate of just under 1 million per year to a low of about 600,000 in early 2022, with higher construction costs carrying the blame. Notably, the 2020 numbers were well above the intermediate term trend line. However, for most of 2022, this rate seems to stabilize, and this month the National Homebuilders will conduct their annual survey of builder sentiment. We’ll see how that turns out.

Al Brooks, head of commercial real estate at JP Morgan, suggests that “there may be challenges ahead“. Big macro-economic factors are at work, not the least being the obvious geopolitical problems (the War in Ukraine and sanctions against Russia), inflation coming in at 7.75% in October, and rising interest rates. He projects a mild-to-moderate recession this year, affecting all asset classes, with a full recovery spanning years rather than months. Notably, they find that the multifamily sector is doing well, with vacancies at a five-year low of 4.4%. Demand for affordable workforce housing “far outweighs supply.” He also sees good long-term trends in the industrial sector, which follows the growth of e-commerce. Retail is a mixed bag, according to Brooks, depending largely on location and category. For example, groceries and other neighborhood shopping are doing well, but city-center retail has been “slow to bounce back.”

Brooks goes on to note that the future of office buildings is “up in the air.” However, none of the regions in have seen vacancy rates dip below their pre-pandemic levels. He quotes his colleague Anthony Paolone, a JP Morgan senior analyst and co-head of U.S. real estate stock research, as saying, “we think cash flow growth will be challenged in the office sector.”

Conversely, in September, Deloitte released their 2023 commercial real estate outlook. They surveyed 450 CFOs of major commercial real estate owners or investors and found that while there are “near term performance reservations”, long-term optimism remains. North American respondents to the survey listed logistics and warehousing spaces as their top pick for Investment, while Europeans favored surburban offices and Asian-Pacific respondents favored properties tied to the digital economy.

Finally, one of the perennially most interesting sectors is self-storage. In recent years, there has been a fascinating growth in the niches of this market, with facilities specializing in art storage, wine storage, and even classic/collectable car storage. Self-storage in general enjoyed explosive demand during the pandemic as a result of the work-from-home trend. Going into 2022, it was expected that self-storage would stagnate in no small part due to rising costs. However, rents actually increased faster than costs in the past year, and sector prices now stand 65% higher than pre-pandemic levels, with occupancies averaging 95%. Green Street expects a downtrend in new offerings this year, facing continued labor and materials shortages, but new construction is expected to rebound in 2025.

Well, that’s all for now, folks. As always, if you have any questions on these or any other related topics, please let me know.

John A. Kilpatrick, Ph.D. — john@greenfieldadvisors.com