Data, analysis and insight into the economy and commercial real estate market by Dr. Peter Linneman.
Highlights:
While interest rates have risen, the USA is still flooded with capital and the great re-opening, barring any severe covid variants that might evade the success of current vaccines, will push the economy forward. Proof: real GDP is 3.2% above where it was in 2019. Most American are wealthier due to 2 years of stimulus payments, savings and a rising stock market. Holiday sales where strong and job openings continue to rise. This is 24 months after the close of much of the economy, schools, political division and a current war in Ukraine. Despite these events, the economy continues to rebound.
Rising Interest Rates:
In March, 2022, the Fed raised its key interest rate by 25 bps (basis points), bringing the Federal Funds Rate to the range of .25%-.50%. It seeks to raise it by another 25 to 50 bps in each of the next 6 meetings over 2022. Further, the Fed is to slow its bond purchase (Quantitative Easing) policy. These decisions will be predicated on the current state of the economy but it is anticipated that the Federal Funds Rate will reach a minimum of 1.5% by year’s end.
Result: short term rates may hit 3% by year end and long term rates may rise 100 bps. Yes, the cost of capital is rising but it is still at historic lows and back to levels from 2018-19 when the economy was equally as strong. The extreme media concern is unwarranted. Capital is chasing assets leading to continued value appreciation (decreasing capitalization rates).
Inflation:
The Fed signaled a targeted average of 2% inflation in 2020. Year over year inflation spiked to 6-7% due to world-wide covid generated supply constraints and a jolt in demand as covid risks subsided with vaccine efficacy.
Rate increases may aid in house price reduction but as an effort to decrease overall inflation, it will not solve short term supply chain issues.
Inflation is signaling a healthy increase in demand and GDP growth. Yes, year over year CPI (all goods) was 7.9%, up from 1.7% but the USA is a majority service-sector economy (85%). The service sector inflation rate has been 2.5-3% for the past 30 years and increased by 180 bps as of February 2022. Again, GDP is up 3.2% compared to 2019. Industrial and employment output are down 1%. So prices have spiked due to lack of supply NOT due to an “overheated” GDP.
The USA economy is strong. Temporary inflation should not be an issue save for the temporary pain at the gas pump and food costs.
Housing Market:
The general housing market has experienced 20 years of underproduction. As the U.S. population grows, supply will fit demand in city cores and the suburbs.
There will be a shortage of 490,000 single family homes at the end of 2022. Rapid development will cover this loss by 2024.
Multifamily supply shortages will not be recovered so fast. There is estimated to be an excess of supply of between 1MM and 1.4MM units for the next 4 years. Rents will rise.
As U.S. Employment Strengthens, So Does Real Estate:
While interest rates are increasing, commercial asset classes are still experiencing long term demand, thus increasing their values. As the U.S. job market strengthens, these assets will generate cash flow, tax incentives and a safe haven for capital seeking preservation and healthy returns.
Employment /Vacancy-Occupancy Correlation: (Note: over the long term)
Office: For every 100 bps (1%) increase in U.S. employment, office vacancy rate declines by 43 bps.
Industrial: For every 100 bps (1%) increase in U.S. employment, industrial vacancy rate declines by 72 bps.
Multifamily: For every 100 bps (1%) increase in U.S. employment, multifamily vacancy rate declines by 26 bps.
Retail: For every 100 bps (1%) increase in U.S. employment, retail vacancy rate declines by 26 bps.
Hotel: For every 100 bps (1%) increase in U.S. employment, hotel occupancy rate increases by 52 bps.
Comments