When interest rates normalize, well-leased and well-maintained properties will have retained their value.
U.S. real estate fundamentals are softening as rising interest rates weigh on the economy and financial markets. Even as inflation has trended positive over the past two quarters, monetary tightening is slowing economic activity. But with unemployment at 3.5%, the labor market is historically low and supportive of wage growth. So the Fed will continue to maintain a tight monetary policy until inflation in all its forms subsides. This time around, it seems unlikely that we will see anything resembling the wave of stimulus-stimulated “reopening” that the U.S. experienced when the COVID-related blocking measures were lifted.
Historically, soft landings have eluded the U.S. central bank, which has failed to avoid recessions after tightening cycles. Expect a mild recession to occur late this year or early in 2024. With the exception of offices, real estate fundamentals should remain relatively buoyant through 2023. Projected rental trends for industrial properties and apartments are trending upward, which has not been the case in the last four real estate recessions. Rents for all property types have fallen deeply in previous recessions. This supports the idea that when interest rates normalize and transactional liquidity returns, well-rented, well-maintained, and well-located properties will likely have retained their value relative to those that were not. Until then, patience and vigilance, particularly in the area of asset management, are in order.
INDUSTRIAL REAL ESTATE CONTINUES TO SURPRISE
Significant differences remain in the performance of properties by type. The office and apartment sectors experienced negative times, while the industrial and retail sectors recorded their strongest quarters of rent growth in over 20 years. For apartment renters, the post-pandemic rate spike has been painful, especially when combined with consumer price increases that are at their highest levels in decades. Low- and middle-income renters are spending (or have spent) much of the excess savings accumulated during the pandemic.
Meanwhile, industrial demand has continued to surprise even the most skeptical, recording a year of double-digit rent growth and a record low vacancy rate, even in the face of strong construction activity. Despite rising debt costs and the implications for leveraged real estate values, positive secular demand trends, including expanding e-commerce capacity, deteriorating housing affordability, and business and household migration to Sun Belt metros, remain intact and continue to drive long-term value creation.
The resilience of the labor market, corporate tenants, and middle- and upper-income households contrasted with the turbulence in real estate financial markets. When borrowing costs rose in 2022, public REIT stock prices fell. Relative to public real estate, most unleveraged real estate price indices are only beginning to turn around.
Dags Chen is Managing Director and Head of US Real Estate Research & Strategy at Barings. He is responsible for analyzing and monitoring real estate and capital market fundamentals, trends and valuations in major US real estate sectors and metropolitan areas. Prior to joining Barings in 2022, he worked as Head of Real Estate Research at Ares Management and as Vice President of Strategy and Research at Clarion Partners. Dags Chen holds an M.B.A.
Barings is a global player in the financial services industry with $391 billion in assets under management as of December 31, 2021. Barings builds sustainable partnerships based on its in-house expertise in both traditional assets and alternative investments and aims to provide innovative solutions and quality service.