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Emerging Opportunities During COVID-19

As the COVID-19 pandemic continues longer than any of us may have predicted, the real estate landscape continues to shift. Some housing trends increase in prominence and some come to a grinding halt, all while new, emerging opportunities for growth present themselves. One door opens as others close, so to speak.  For example, the millennial-led migration from cities to suburbs has only gained momentum. Conversely, multifamily developers and managers have shifted strategies to attract new residents by promoting health and wellness movements rather than property amenities.

“Times of great change always present significant opportunities,” said Urban Land Institute (ULI) Global CEO W. Ed Walter during the recent ULI virtual fall conference. “In the near term, our suburbs will benefit from new growth spurred by shifting demographics and changes to living and working patterns resulting from the COVID-19 crisis.”

Earlier this month ULI published its Emerging Trends in Real Estate 2021 report, referencing insight from over 1,500 leaders in the real estate industry. Some of the following trends are on the rise during the COVID-19 pandemic:

  1. Smaller office footprints
    • Online meeting services such as Zoom and GoToMeeting have made working from home (WFH) easier and more efficient than ever. Businesses are realizing they can cut costs by reducing their office footprint with employees working remotely. According to the report, over 90 percent of real estate professionals expect companies to adopt at least a part-time WFH policy.
  2. Suburban migration
    • As previously mentioned, suburban migration, especially among Millennials, was a popular trend before the pandemic. Now, the desire for low-density living is higher than ever. As a result, the south has seen a large influx of growth from movers longing for the greater housing affordability the region has to offer.
  3. Retail vacancy
    • Over 80 percent of ULI survey respondents believe the pandemic has only accelerated a shift in the retail sector that was already emerging due to online competition. For example, large department stores like Macy’s experienced disastrous sales in March after closing stores for almost two weeks and reportedly losing the “majority” of its sales.
  4. State/local fiscal issues
    • The loss of revenue across the board is expected to cause a wake of fiscal challenges for state and local communities over the next few years. Real taxes, the main source of revenue for local governments, will likely fall due to a drop as hotels and retail centers lose value. Furthermore, pandemic concerns create a snowball effect by encouraging consumers to shop online even more while actively avoiding spending money in-person at retail stores, restaurants, or other local businesses.
  5. Safety and sanitation concerns
    • If anything positive has resulted from COVID-19 it is health, safety, and sanitation practices. Businesses around the world are (re)enforcing sanitation practices by requiring customers to wear facemasks, providing free hand sanitizer at common contact locations in-store, limiting maximum occupancy, and implementing social distancing efforts where a line or queue may form.

Click here for the ULI Emerging Trends in Real Estate 2021 report

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Traders Confident of Interest Rate Cut in July

Last week, an unprecedented amount of traders in the fed funds futures market made bets with high expectations of an interest rate cut in the near future.  The high volume of trading came as no surprise as many traders had already expressed confidence in the first quarter that a rate cut was coming. Their confidence only increased after the post-Federal Open Market Committee statement and forecasting materials pointed to a possible rate cut in the coming months.

According to CNBC’s Jeff Cox, “The market now sees a 100% chance of a rate cut at the July 30-31 meeting, up from 85% a week ago and just 15% a month ago. For the full year, the expectation for three cuts is 66% up from 59% a week ago and a mere 4% last month. ”

The record-setting volume of trading was fetched at the end of the week after the central bank concluded its two-day policy meetings. The week’s volume was tracked above 3.5 million contracts, easily topping the best week ever in May 2018 at 1.19 million contracts.

Click here to read the Traders This Week Bet on a Fed Rate Cut in Record-Setting Numbers article in its entirety 

 

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Multifamily in 2019

Despite some reservations before the start of the year, multifamily real estate performed well in 2018. But as we look toward the beginning of the new year, it would prudent of investors and owners to prepare for as the market is expected to shift in a different direction.

Earlier this week, Karlin Conklin, a value-add multifamily expert with a transactional volume exceeding $1.3 billion, outlined three primary factors that could shift the multifamily market in the upcoming year including “pressure from volatile financial markets, a growing housing supply, and emerging development risks.”

Interest Rates And Multifamily

With the economy cruising at a comfortable level, The Federal Reserve has had their foot on the break throughout 2018. It raised the federal funds rate to a 2 percent to 2.25 percent during its November meeting, making it the third rate increase of 2018. A fourth and final increase is expected to come during the Fed’s December meeting. But how will this affect multifamily real estate in the coming months?b1da3076093b404ea90f5996c18540df.jpgAccording to Conklin, debt pricing “looms as the largest multifamily market mover in the coming year… And more so than any other investment, real estate class, or multifamily asset, pricing is tied to debt pricing.” Overall, as borrowing becomes more expensive, the more cap rates will have to be adjusted; and as a result, Conklin sees 2019 as more of a buyer’s market with acquisitions being motivated by assets that are “right priced” to account for rising interest rates.

Supply or Demand?

Throughout 2018, operating dynamics were favorable for multifamily real estate. The combination of increasing rents and high occupancies often resulted in operating expense surpluses. Although, that sweet spot did not last forever. In fact, the industry has started to see a decline in demand, and many markets are now over-supplied. Conklin uses Seattle and Boston has prime examples. Over the last five years, the two markets had “red-hot rent growth” and attracted plenty of developers to capitalize on the high demand and low supply.

Fast forward to November 2018. Seattle and Boston are now pushing through multifamily deliveries that ” put the brakes on rent growth to levels between 0% and 1.5% on a year-over-year Q3-2018 basis, according to Zillow. That compares with annualized rent increases from 2015 to 2017 near 7% in Seattle and 5% in Boston and Nashville.”

In summary, it’s important for investors, owners, and developers to realize how new deliveries are, and will, impact asset values in their current and prospective markets as demand and supply begin to invert.

Development Risks

Beyond the macroeconomic factors that consistently dictate multifamily trends, variables such as trade tariffs, labor shortages, and local government regulation will shape the path for multifamily real estate’s near future.

On a national level, trade tariffs on materials such as steel, lumber, and electronic components have bumped the cost of construction line items by more than 10 percent year-over-year. There has been a specific labor shortage in the construction sector due to a rise in labor costs. The National Association of Home Builders reported in a recent survey that 69% of its members were experiencing delays in completing projects on time due to a shortage of qualified workers, while other jobs were lost altogether.

Post-recession rent growth has put housing affordability in the spotlight, and local governments in some markets are responding with affordable set-aside mandates and rent control proposals. For example, many cities in California have seen the number of citizens vying for citywide rent control vastly increase. Fortunately for multifamily investors and professionals, rent control propositions in California have generally been unsuccessful.

Overall, Conklin still sees opportunities for new construction and renovation in 2019, but with a thinner margin of error.

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Click Here if you’d like to read Karlin Conklin’s article in its entirety.

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Marcus & Millichap/NREI Investor Sentiment Survey

Earlier this week, Marcus & Millichap and National Real Estate Investor (NREI) distributed the results of their second-half Investor Sentiment Survey.

Researchers collected data by emailing invitations to participate in this online survey to public and private investors and developers of commercial real estate. Recipients of the survey included Marcus & Millichap clients as well as subscribers of NREI selected from commercial real estate investor, pension fund, and developer business subscribers who provided their email addresses.

The survey was conducted in the third quarter of 2018, with 543 completed surveys received. Survey respondents represent a broad cross-section of industry respondents that include private investors, developers, advisors, lenders, and REITs among others.

The largest percentage of respondents are private investors at 45%. Respondents are invested in a variety of property types with a majority of 66% invested in apartments.

Tax Reform and How it Has Affected Investor Sentiment

After the Tax Cuts & Jobs Act was approved, investor confidence was high and trending upward, but the most recent survey shows that same confidence level has regressed to 150 – the same level as the second half Investor Sentiment Survey of 2017. See Figure 1 for a visual representation.

Despite the lowered confidence level, many survey participants maintain positive views of tax reform. According to the collected data, 57% of respondents think the economy will grow faster as a result of the new taxes compared to the 68% who held the same view in the first half survey. Furthermore, one-third of respondents expect growth to remain the same and 10% expect slower growth in the future.

The 60% of respondents who said they consider tax reform to be favorable for commercial real estate also reflects a drop compared to the 71% who held the same view at the beginning of the year. See Figure 2 for a visual representation.

John Chang, senior vice president of research services at Marcus & Millichap, expressed uncertainty regarding the effects of tax reform by stating, “Investors are still getting their arms around the new tax law, so it’s still a little too early to anticipate a lot of change resulting from tax reform.”

That said, over 50% of survey respondents do expect tax changes to increase the flow of investment capital and 46% think the new tax laws will raise property values.

Interest Rates

Continually increasing interest rates have become one of the biggest concerns for investors. Approximately 65% of respondents note rising interest rates as their primary concern followed by unforeseen shocks to the economy at 48%. Both political uncertainty and rising operating expenses round out the top investing concerns for respondents at 44%. See Figure 4 for a visual representation.

“The Fed has implied that it will likely raise rates again in December, although whether or not they follow through with that remains to be seen,” says David Shillington, president of Marcus & Millichap Capital Corp. He also noted that there could be some risk to the economy if short-term rates were to rise above the long-term rates, which is often interpreted as a sign of an upcoming recession.

Apartment Outlook

Investors maintain a bullish outlook on apartment performance, but the desire to increase holdings has consistently declined over the past few years. 50% of apartment owners think it is better to hold, while the other half is torn between buying and selling. Although, buying confidence has decreased since hitting a peak in 2010 when over 70% of respondents were eagerly targeting multifamily properties.

The apartment sector has performed well for a number of years now, but investors are becoming concerned about the volume of construction coming into the market. On average, developers are delivering roughly 270,000 new units per year for the past five years.

However, thanks to the robust economy, absorption of new units has been keeping pace with construction. John S. Sebree, first vice president, national director of the National Multi Housing Group at Marcus & Millichap, credits the health absorption rate to significant household formation. In addition, Sebree noted that housing demand is expected to outpace completions on a national level.

The majority of survey respondents have a favorable outlook on apartment performance. Similar to past surveys, 62% of survey responders expect the general value of apartment properties to increase. The average expected value increase is 3.5%, down from the predicted 5% in the first half survey, but still, a very healthy level compared to other property types.

Investor Strategy

Despite indications of caution, survey responders are maintaining their optimism for the economy and real estate performance. 79% of respondents believe strong job growth will continue through 2018 and into 2019.

Most respondents agree real estate continues to offer more favorable returns than other investment classes and that it is better to invest in real estate rather than the stock market. Investors are also well-resources with 56% of respondents claiming they have an abundance of capital to invest.

Overall, investors are becoming more selective at this point of the economic cycle, but remain active and confident in the market.

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*All statistics, figures, and quotes accredited to Marcus & Millichap/NREI Second Half 2018 Commercial Real Estate Investor Outlook

Click here to view the Investor Sentiment Survey Report in its entirety

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Rent Control Battle in California and Beyond

“Certainly there is a housing shortage, so we need to be building housing, but what we are also seeking to address is the crisis of displacement…We’re seeing vulnerable communities — people of color, elderly folks, people with disabilities, single parents, low-income people and the middle class — being pushed out of California and becoming homeless.”

One of the hottest items on California’s November voting ballot is a rent control initiative called Proposition 10. The proposal intends to repeal a 23-year-old state law that tightly limits all forms of rent control within California. The desire for rent control in California has coincided with the rising cost of living throughout the state.

According to The Sacramento Bee, the nonpartisan Legislative Analyst’s Office (LAO) reports “Soaring housing costs have led to a net loss of 1 million citizens who have fled California from 2007 to 2016…and homelessness is higher here than any other place in the nation.”

Despite the widespread support from community groups like the AIDS Healthcare Foundation, California Teachers Association, California Nurses Association, and many others, the latest poll by the Public Policy Institute of California reports,

“A whopping 60 percent of likely voters say they will vote against Proposition 10, a measure on the Nov. 6 statewide ballot that would repeal the state Costa-Hawkins Rental Housing Act, which strictly limits rent control in cities across California. Repeal would restore broad authority to cities to enact any rent control law they choose.”

According to the LAO’s analysis of Proposition 10, the proposed repeals could result in more harm than good. LAO analysts warned of declined new rental construction, removal of units from the market, and the value of housing possibly dropping. Any of these factors would directly affect local government property tax revenue, which equates to ~$60 billion every year.  Furthermore, enacting new rent control laws would require millions of dollars per year to enforce, and result in a decline in income tax revenue, especially from the newly-affected property owners and investors.

It is important to consider how these restrictive laws and proposals affect citizens, property owners and investors, and a state’s overall economy. And while Proposition 10 is exclusive to California, and rent control laws vary from state to state, the negatives effects outlined in the LAO analysis showcases how impactful the ongoing battle of rent control is from a real estate professional, owner, or investor standpoint.

Click here to learn more about Proposition 10 and rent control.

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Projected Strong Market Performance Despite Higher Interest Rates

 

Despite a tightening cycle resulting from increased interest rates and high supply levels, Yardi Matrix is projecting the multifamily market to remain strong through the 2018 Spring season.

These projections are largely based on the strong growth of the nation’s economic growth, positive demographic drivers, falling unemployment rates, high job growth, and increased consumer confidence levels.

In a recent article for Multifamily Executive, author Mary Salmonsen provides a detailed breakdown of Yardi Matrix’s U.S. Multifamily Outlook for Spring 2018 and highlights the positive takeaways in a tightening cycle.

Click here to read the U.S. Multifamily Outlook for Spring 2018 breakdown in its entirety.

Employment Growth in October

Last week, the Bureau of Labor Statistics (BLS) reported the addition of 261,000 jobs to the U.S. total nonfarm payroll employment during October. The BLS also reported the headline unemployment rate dropped to 4.1 percent – the lowest rate in the past 17 years.

The rebound in employment counteracts the slump in September which can be widely-attributed to Hurricanes Irma and Harvey.

EPIC Asset Management Group

According to the BLS report, employment in the food services and drink places industry spiked in October increasing by +89,000 following September’s decrease of 98,000 due to the hurricanes. The manufacturing sector saw a rise in employment by 24,000 jobs last month while health care added about 22,000 jobs. The professional and business services industry also stayed on pace with its average monthly gain by adding 50,000 jobs to the market.

Other major industries such as mining, construction, retail, government, transportation and warehousing, and information services experienced minimal change during October.

Average hourly earnings for all employees on private nonfarm payrolls only slightly varied in October. But over the last 12 months, average hourly earnings have increased by 63 cents or 2.4 percent.

Click here for the Bureau of Labor Statistics October report in its entirety: www.bls.gov

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How the Recent Election Could Affect the Multifamily Industry

While it’s still early on in the new presidential term, owners and investors are trying to test the waters and understand how the multifamily industry will perform with Donald Trump as president. Every election cycle has an affect on the economy in terms of Gross Domestic Product (GDP), unemployment rate, inflation, and other important economic statistics. Whether Trump’s affect will be positive or negative remains to be seen, but it goes without saying the real estate world will see and feel the consequences of his actions and policies. 

In a recent Forbes Magazine article, KC Sanjay, leading economist and analyst for Axiometrics, sums up how Trump’s emphasis on creating jobs, growing GDP, and tax reform might impact the multifamily/apartment sector. If you’d like the read the two-page article in its entirety, you can click here, or on the link provided below.

 How The Trump Presidency Could Impact The Apartment Market