First and foremost, the U.S. commercial real estate market has become bifurcated with high growth low tax states substantially outperforming the low growth high tax states. Are you listening Oregon, California and Washington?
The high growth, low tax states continue to experience a tremendous influx of new residents, and their economies are booming (globest.com 1/2/2024).
The high tax, high crime states are experiencing just the opposite, large out migration, poor economies, declining CRE fundamentals and very slow growth (globest.com 1/2/2024).
These trends were in place prior to the pandemic and attendant economic lockdown. Covid exacerbated this and progressive government failure in many urban areas cemented them in place.
New York, Washington D.C., Los Angeles, San Francisco, Portland and Seattle have been decimated by high crime, rampant homelessness and an outmigration of productive residents and companies. This has resulted in increased vacancies, along with declining rents and values (globest.com 1/2/2024).
This value destruction may ultimately present some brave and deep pocketed investors a real opportunity. However, until these markets turn themselves around and finally begin improving the quality of life for residents and workers, investment risk will be high.
We believe commercial real estate investors are best served following the people, money and businesses to red states.
Consonant with this is our belief that the large bid-ask spread that has characterized CRE the last 12 – 18 months could begin narrowing in ‘24.
Since the Fed embarked on its aggressive rate hikes, the bid-ask spread in CRE has “become wider than the Grand Canyon as sellers and buyers cannot agree on a sales price (globest.com 2024).”
This spread may narrow by mid-year if the Fed reduces rates with debt capital priced lower and more readily available. This may provide a healthier foundation for lending and begin to break up the current logjam.
In the interim, investors should consider focusing on those asset types that have historically provided the big rent increases necessary to drive cap rates down and prices up.
Due to abundant new supply arriving on market, future rent increases in the multifamily sector may be muted. Considering this, senior living and self-storage may present better investment opportunities.
Due to the media’s wrongful conflation of senior living and nursing homes during the pandemic, little new supply arrived on market. This shortage was then exacerbated by inflation, with material prices skyrocketing and construction loans climbing into the mid-teens.
However, the inexorability of aging has driven demand for senior housing beyond pre-pandemic levels. Greater demand plus a shortage of supply may drive the big rent increases necessary to push prices up.
We believe this is particularly true of private pay senior living. The elevated nature of these properties and the amenities they provide have historically attracted more affluent residents. With a larger asset base and more discretionary income available to them, they may be able to sustain higher rents once in place. You either spend it on yourself or give it to the kids.
The self-storage scenario is similar in terms of supply and demand. Storage landlords have always benefitted from the NIMBY (not in my backyard) phenomenon. Everyone needs it but no one wants it next door. Historically, this has limited development.
This shortage is exacerbated by community ordinances prohibiting new storage development. Storage adds little value to land by way of improvement. This limits additional tax revenue. Therefore, many municipalities would rather see apartments, single family homes, retail or office built.
Rent increases are also traditionally more easily had in storage than most other CRE types. By comparison, storage rents are very small. An increase of 10% on $100/month is unlikely to make you move. The same cannot be said for housing, retail or office space.
Finally, with no tenants, storage is presumably unlikely to attract regulatory attention from the government.
‘Junk’ doesn’t vote. Therefore, we believe the likelihood of government interference is low. We hope this helps.