Dealmakers and capital providers seemed thrilled with the overall state of the U.S. commercial real estate industry at the ULI/McCoy Symposium on Real Estate Finance, an invitation-only discussion held in early December 2021 in New York City. The event’s namesake is ULI Life Trustee Bowen H. “Buzz” McCoy.
“There were record volumes of activity in 2021—record levels of sales, of prices, of leverage,” says Ken Rosen, chairman of Rosen Consulting Group, a real estate market research firm based in Berkeley, California, who presented at the symposium. “There is so much money out there that everyone is doing well, with a few exceptions.”
Money is once again pouring into commercial real estate from all over the world – perhaps more than ever before. Investors seem willing to pay top dollar – particularly for properties like apartment buildings, warehouses, and data centers that outperformed during the pandemic.
But too much money chasing deals can lead to other problems. Federal officials now say they are likely to raise interest rates three times in 2022 to prevent wages and prices from rising so much that they create the expectation of inflation. The enthusiasm to invest in real estate could also eventually lead to overbuilding. But for now, investors are likely to keep bidding to buy preferred properties like apartment buildings and industrial warehouses.
“I don’t see anything that, on the margin, is going to significantly change the supply of capital and where it is going to go,” says Roy March, CEO of Eastdil Secured, working in the firm’s Santa Monica, California, office.
2021 Sales Volume Tops 2019
Investors are already spending money more quickly than they did before the pandemic to buy properties. They spent $343 billion to buy commercial and multifamily real estate properties in the first three quarters of 2021, according to Real Capital Analytics, based in New York City. That works out to an annualized rate of $412 billion a year — more than the $403 billion they spent in 2019 and the $371 billion they spent in 2018.
Investors continue to raise money to buy new commercial real estate properties. Nontraded real estate investment trusts (REITs) have raised money in 2021 at an annualized rate of $38.5 billion, according to Robert A. Stanger & Co.
“That is several times the average of just $8.0 billion per year over the last 20 years,” says March.
Private-equity, closed-end real estate funds have $367 billion in dry powder ready to invest at the end of 2021. That is down only slightly from 2019, and up from roughly $200 billion in 2012.
There are very few other places that investors can go to earn a dependable yield. Many investors, such as sovereign wealth funds, need to earn a steady yield around 6 percent a year. But sovereign debt issued by countries like Germany or the United Kingdom now often have negative yields. In 2021, economists counted $14 trillion in sovereign bonds from developed nations with negative yields, down from a peak of $18 trillion at the end of 2020. That is an increase from just $3 trillion at the end of 2014.
U.S. Treasury 10-year bonds yielded just 1.4 percent as the Symposium was held. In contrast, investors expect to earn an unlevered return on core real estate investments of 5.6 percent, according to Green Street Advisors. That’s more than triple the “safe rate” provided by Treasury bonds.
“The tone at the Symposium was the most positive I have ever heard,” says Rosen. “This huge availability of capital—they are just looking for opportunities to deploy it… there was no focus on risk.”
However, the U.S. economy still faces potential problems from the spread of the latest variant of the coronavirus. The vaccines have calmed many real estate investors, though if the new variant virus infects enough people to require a new set of shutdowns, that could do even more harm to properties already harmed by the pandemic, like hotels.
“There should be a lot of uncertainty because of the Omicron variant,” says Rosen.
A growing number of economists also worry that rising prices could create an inflationary spiral.
“This inflation is not transitory,” says March. He found a silver lining to the rising cost of construction materials needed to build new commercial and multifamily buildings as developers tend to eventually overbuild. But the high cost of construction may prevent developers from starting some new projects where demand is not high enough to support high rents to pay for expensive materials.
“I believe supply is going to be in check because of these inflationary elements,” says March.
Tale of Two Markets
The real estate experts at the Symposium were confident – though they largely focused on property types that produced steady income during the pandemic. They are much less interested in property types hurt by the pandemic like hotels, malls, and sub-premium office space.,
“Money has been concentrated in the preferred property types like alternative property types, logistics, apartments, and biotech,” says Rosen. These properties were largely fully occupied throughout the crisis with strong rents.
“Market fundamentals have been stronger than people thought they would be—that’s true of multifamily and industrial,” says Rosen “It’s almost a parabolic increase in demand for both industrial and multifamily in Sunbelt and Mountain state places.”
Investors are much less interested in what Rosen calls “stranded” properties, meaning they are not attracting capital. “There was a lot of discussion of the bifurcation of real estate,” he says. “Class B and C malls are stranded… B and C office buildings are stranded… C and D hotels are stranded.”
Some properties are doing well even in property types hurt by the pandemic. New Class-A office buildings are leasing up, even in central business districts largely quieted during the pandemic, for example.
“The new stuff is doing extremely well. People are paying their rent and it’s good leasing despite the fact that it is the highest availability of office space overall in 40 years,” says Rosen. “Companies want space that makes it attractive for employees to come back to the office: the best amenities, [with fewer] health and safety issues.”
Resort hotels are also performing well, even though many convention hotels are still closed. Some Class-A retail malls have seen more customers return to shop as vaccines have become available.
As the recovery from the pandemic is uneven in the face of the omicron variant, federal officials struggle to balance their efforts to support the U.S economy. As the Symposium began December 9, U.S. Federal Reserve officials still had their benchmark interest rate targets set close to zero. But just a few days later, planned rate increases were announced for 2022.
Federal officials seem to have learned the lesson of the last recession, when they acted too slowly and the Global Financial Crisis of 2008 froze the capital markets. But there is some concern that asset bubbles may have already begun to grow.
“There is a bubble in cryptocurrency, a bubble in the stock market, in venture capital, in private equity,” says Rosen. “When we have all that money, it never ends well.”
“Investors with excess capital need as much discipline as investors in the earlier 1980s,” says H. “Buzz” McCoy, president of Buzz McCoy Associates, the sponsor of the Symposium. In this hot economy, investors and deal makers also face temptation from fees and profit participation.
It might not be enough to simply “look for rivers of capital, and stand in the middle of them, as investors have during past real estate booms,” says McCoy. “There is more than a whiff of inflation in the air. A sharp pullback would cause boots to be filled with water.
