US Real Estate Market Update July 2022

As per the Q2 GDP numbers released this week, real GDP declined at an annualized rate of 0.9% in the second quarter, following the 1.6% decrease posted in the first quarter. While two consecutive quarters of falling GDP is considered by some to be the technical signal for a recession, the actual state of the US economy is more complex.?

The April to June GDP drop was predominantly driven by declines in business investment and personal expenditures on goods, while the value of U.S. exports and spending on services increased. The component wise breakup of the GDP change shows that business investment and change in inventory were the key contraction factors. A shift in consumer spending away from goods and back toward services, and rising prices cutting into people’s buying power, left many companies with stockpiles of products they are now discounting to unload.

The U.S. economic recovery is following an unusual trajectory, with weakening output but strong job gains. The unemployment rate, a key barometer of economic health, held steady at a low 3.6% for the past four months, and employers continued to hire at a strong pace. The Labor Department said Thursday that new applications for unemployment benefits, a proxy for layoffs, held last week near the highest level of the year, a sign that the tight labor market is loosening.

Most economists surveyed this month by Wall Street Journal expect the economy to grow in the third quarter and in 2022 as a whole, though lately they have lowered their estimates.

The consumer spending continues to provide support to growth. American households still have relatively healthy balance sheets. After the pandemic hit the U.S. economy in early 2020, increased household saving, government stimulus checks and enhanced unemployment benefits boosted household finances. The resulting “excess savings”—the amount above what they would have had there been no pandemic—remains elevated. According to Moody’s Analytics, excess savings totaled $2.5 trillion in May 2022.

The Fed stuck to its established rate hike plan that was outlined in last Fed meeting. As part of an ongoing response, the Federal Reserve raised the overnight lending rate 75 basis points again in late July, following an identical hike in June. Now at a lower target of 2.25%, the metric will likely end the year in the 3-4% range, per stated Fed plans. These actions are having a substantial upward impact on interest rates, ranging from credit card rates to mortgages and debt financing, with broad implications for the economy and real estate.

?Real Estate

Higher interest rates are affecting both tenant and investor demand for commercial real estate. Businesses and households are limiting some investments, which could translate into less space expansion in the near future. Investors, meanwhile, are contending with higher borrowing costs but tight cap rates, constraining deal flow. If the falling trend in investments takes root, it could nudge cap rates higher and narrow the buyer-seller expectations gap, facilitating transaction activity.

The Fed also acknowledged that activity in housing sector has weakened.?

• Contract signings for home purchases, or deals signed but not yet closed, fell 8.6% in June from a month ago, as per National Association of Realtors report. That was well above what economists were predicting, and a 20% drop from last year.
• It was also the slowest pace since September 2011 — except for the first two months of the pandemic.
• Meanwhile, mortgage applications are at their lowest level of activity since February 2000.

During last month, rents rose 14 to 15% nationally year-over-year, with the median listed rent for an available apartment rising above $2,000 a month for the first time. Rents are up more than 20% in several Florida markets (e.g., Orlando, Miami, and Tampa) and over 15% in many markets (e.g., Austin, Phoenix, Nashville).

Yet, even as rents have risen, the cost of owning has increased even more such that gap between the costs of owning and renting has widened.

While builders are completing units at an unusually rapid rate in early 2022 (349,000 units per-year), about 1.2 times the pre-pandemic pace, according to the Joint Center for Housing Studies at Harvard, the occupancy remains resilient. Occupancy rates nationally remain above 95%, consistent across asset quality and location.

Further, past data suggests private real estate exhibits the highest correlation to headline inflation of all major asset classes. Private real estate typically also demonstrates the most favorable risk-adjusted return profile during this period.

Private Real Estate vs. Major Asset Class Classes During the “Great Inflation” (March 1978 - September 1981)

We believe that Multifamily real estate segment will continue to showcase robust return profile in the current inflationary cycle as well.