Keep Your Eyes On The Horizon.

Marcus and Millichap provide their long-term view of commercial real estate.

To understand the future, it is best to understand the current economic landscape in the context of forward-thinking strategies.

Economy:

Currently there is a shortage of labor and production but not a shortage of demand. As a result, inflation is on the rise and the Federal Reserve has decided to raise rates to tamper demand. The economy is strong but supply chain inefficiencies and the war in Ukraine are driving up prices due to capacity shortages (supply). We must remember, 40% of the economy was shut down for almost two years, dampening supply capacity. With vaccine efficacy, people re-entered the economy and stimulated demand. It will take time to boost capacity to meet this demand and thus in the short term, prices will rise until these inefficiencies are resolved.

The economy is strong for now. Through 2021, Real GDP was 3.2% above where it was in 2019. There are record high job numbers and $2.6T in savings, thus consumers are at retailers spending aggressively for the time being.

It should be noted that low rates inhibit growth by potentially misallocating capital to risk assets, thus creating speculative investing and asset bubbles. Higher rates will better allocate capital and fuel, not dampen growth in the long run. Interest rate increases will not do enough to reduce food and fuel prices greatly for 24 months. As a result, we are in for continued inflation, which if prolonged, will eat into demand which could then turn the tide of rising prices. For now demand is strong and the US economy (85% services industry) is in good shape due to low unemployment.

Housing:

The apartment asset class will thrive in this inflationary environment. The percent of households that can afford a home will be the litmus test for apartment rent growth.

From 2009-2015, 50% of U.S. households had sufficient income to qualify for a mortgage on a medium-priced home. That soon shrank in 2020 to where households had to earn $73,400/year to qualify for a median priced home. 45% of US households could make this benchmark.

As of April, 2022, buyers needed over $113,000 of income to qualify for a mortgage. Now, only 26% of U.S. households can qualify. As interest rates rise this year, that number will be further reduced. The gap between home payments and apartment payments indicate demand for apartments.

In 2022 the average apartment payment is $600 less than a home mortgage payment. Home payment = $2,200 vs. apartment rent = $1,600. Even though apartment rents are up 16% since 2020 (8%/year), it is still cheaper to rent vs. buy.

In short, vacancy rates will remain low, capital will drive up pricing despite rate increases and renting will continue to be the more economical option than buying for the majority of households. The apartment asset class is still a winner for the long run.