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Member Perspectives: March 2022

Bergstrom Survey – From ’21 to ’22

Real estate performance should have carried a bigger headline during 2021 but there were a few distractions. With so much discussion about viruses, the CDC, global travel limitations, masks, and general anxiety, there was too little space to realize that the real estate market was performing extremely well. Fortunately, many of our Bergstrom Center members have been sharing their views through this survey confirming our personal observations of the market activity. Thank you to everyone who participated.

Throughout the year our respondents’ outlook for the overall real estate market has been quite positive. During the first quarter, almost half of the views were Stable with the other half mostly Strong. As the year unfolded the weight of the responses moved systematically toward Strong with a quarter of the responses being Very Strong.

The single-family housing market has only been addressed for the past two quarters. The year-end outlook is just as strong for housing as it is for commercial property but the path to the current view differed. Housing was viewed as extremely strong during mid-year with 39% of the responses as Strong and 48% as Very Strong. At year-end, the results reversed to 54% Strong and 35% Very Strong. The housing outlook peaked midyear and moved down to a still very positive view while the commercial sector has systematically risen to a similarly positive view.

Overall expectations for the market are very positive and the current activity rate is very high but this bright outlook is not evenly distributed across all sectors. The residential sector, from land to single-family housing to apartments, seems to be bursting at the seams nationwide. This rapid expansion is as intense in Florida as it is anywhere. Industrial properties are likewise appreciating significantly as the growing supply has not yet matched the expanding demand. This pattern was established years ago and has only accelerated since the pandemic.

Throughout the year, respondents clearly indicated that the office and retail sectors are not on the same trajectory as the residential and industrial sectors. It is unclear as to which sector is absolutely the best and which sector is the weakest but the separation between office/retail and residential/industrial is wide.

Office and retail markets were clearly negatively impacted by the response to Covid 19 in a way that other sectors were not. This does not require that these sectors are performing poorly but rather that they have not kept pace with the other sectors. Our survey questions focus on the relative performance among the sectors and offer no insight on absolute performance. In fact, some evidence indicates that office and retail performance has recovered dramatically from the uncertainty of the prior year.

Figure 1 — Source: UF Bergstrom Real Estate Center

A comparison between the top-performing multifamily and industrial sectors yields a subtle yet interesting shift in perspective. Figure 1 reveals a pattern over the past year that indicates a slight shift from industrial expectations to multifamily expectations. Throughout the year, 80% of the respondents selected either multifamily or industrial as the sector with the best outlook. It is the changing split between these two top sectors that is revealing. During the first quarter of 2021, the industrial sector was favored at 49% to 39%. By mid-year, the multifamily sector received more votes than the industrial sector at 47% to 37%. The gap widened slightly during the fourth quarter leaving a very steady shift from favoring industrial to favoring multifamily.

The pattern of growing confidence may not follow the same path for each of the four main sectors, but it is extremely consistent across the major Florida markets. The average outlook rating for each of eight metropolitan areas across the state is shown in Figure 2. The basic pattern of market confidence (upward) is remarkably consistent across the markets. Our group viewed all Florida markets favorably early in the year and confidence continued to grow during the year.

Figure 2 — Source: UF Bergstrom Real Estate Center

Expectations for the coming year’s business followed a similar pattern from neutral to very positive over the past four quarters. Initially, about a third of the respondents expected to see Less business, a third expected business to be the Same as Last Year, and a third expected to see More business in the coming year. This perspective improved significantly during subsequent quarters. The current expectation is that real estate professionals will be significantly busier in the coming year than they were over the past year.

Figure 3 — Source: UF Bergstrom Real Estate Center

As mentioned earlier, the outlook for single-family housing was extremely positive throughout 2021. This expectation continued as we entered 2022. In Figure 3, we see that the overall outlook for housing peaked during the 3rd quarter with almost half of the responses in the Very Strong category. The view remained very positive through the end of the year even though the position shifted slightly toward Strong. Not a single respondent returned a Very Weak or Weak response in the 4th quarter.

The view on home building did not change at all during the second half of the year, as we see in Figure 4. More than 90% of our members believe that home builders are struggling to meet the current demand as demonstrated by the Selling upon Completion and Hot Sales Market domination among the responses. More than two-thirds of the responses were in the Hot Market category indicating that newly built homes can’t quite fulfill the demand. Perhaps improving supply channels will solve this problem.

Figure 4 — Source: UF Bergstrom Real Estate Center

One of our members sent a comment that made us think about how we ask our questions regarding the capital markets. The comment suggested that we reconsider the term used for one of the responses to the two capital questions. The response to be considered is “Excessive.” It was pointed out, quite correctly, that this term seems a little negative and it was suggested that we might change it to something like “Extensive.” We agree and we will probably change this word on the next survey. However, we intended for this response to be an indication that the capital markets are beyond stable and, I guess, a little negative. So, the next two charts will focus on this one response to each of our capital markets questions.

It is interesting to see how the capital markets are responding to such a bright outlook across some of the sectors and all of the Florida markets. Even though several responses fell in the Stable and Growing categories for each question, Figures 5 and 6 highlight only the proportion of responses in the top category which is currently labeled Excessive.

Figure 5 — Source: UF Bergstrom Real Estate Center

During the year following the onset of the pandemic, nationwide commercial real estate sales volume rebounded as we might expect. What might surprise you is that the sales volume during 2021 exceeded every year’s sales volume since 2007. More than $300 billion of property transferred during this past year. This level of transaction is only possible if capital is freely available.

Figure 6 — Source: UF Bergstrom Real Estate Center

The chart in Figure 5 shows the proportion of responses in the Excessive Equity Capital category. Notice that at the beginning of the year exactly 20% of our members viewed the availability of equity as Excessive. The largest response was Stable, followed by Growing and then Excessive. As the year progressed, the concern of excessive equity availability grew dramatically. By 4Q2021, 48% of the responses fell in the Excessive category. This corresponds to the annual rate of commercial sales rising from $162 billion to $310 billion from first quarter to fourth quarter of 2021.

Throughout the year our respondents’ outlook for the overall real estate market has been quite positive.

The pattern of Excessive responses for debt availability is similar but the magnitude is much smaller. For debt, this response went from only 4% during first quarter to 21% during fourth quarter, as seen in Figure 6. Even during the most recent survey, the majority of debt responses fell in the Stable and Growing categories.

We can all hope that the path to the bright future envisioned by our members is paved in equity rather than debt. If these responses accurately describe the current levels of equity and debt availability, investors should be well-positioned to handle most unforeseen shocks. Relatively low debt obligations mean that investors have the liquidity to iron out the bumps on this rise to the investment summit.

Rising Rates and REITs

by Andrei Larion

The anticipated tightening of monetary policy by the Federal Reserve is a topic of primary concern for all financial market participants. Interest rates are a key driver of investment decisions, and investors may be inclined to believe that rising rates will adversely impact returns, including those of publicly-traded REITs. History tells us that the relationship between interest rates and REIT returns is a little more complicated.

Average Annual REIT Return Over Entire Period = 11.1%

Figure 1 — Source: St. Louis Federal Reserve and the National Association of Real Estate Investment Trusts

We identified four periods over the last three decades in which the yields on 10-Year Treasury Bills underwent material and sustained increases. The four periods of our focus are October 1993 through November 1994, October 1998 through January 2000, June 2003 through June 2006, and July 2016 through October 2018. Treasury yields increased by 263 bps, 213 bps, 178 bps, and 165 bps respectively over the past 30 years. Note that these time periods closely coincide with either recessionary periods or expansionary periods.

Weakening economic conditions that lower growth expectations are one of the reasons that interest rates rise. During these rising rate times, we might expect investment returns to suffer from lower-income growth expectations compounded by higher discount rates. This was the case during three of the four identified rising rate periods: 1993, 1998, and 2016. Discount rates might also rise in response to increased inflation. In this instance, REITs might perform well because expected rent increases could outpace the discount effect. This occurred during the mid-2000s interest rate escalation.

From the chart, we see that REITs produced an average annual total return of 11.1% over the entire period. In comparison, REITs delivered zero or negative returns during three of the rising rate periods and delivered an extremely high return of 26% during one of the periods. Our findings suggest that an exclusively negative relationship between interest rates and REIT returns does not exist. Rather, REIT returns since 1990 are dependent on several factors in addition to interest rate changes. Shrewd REIT investors will avoid the trap of focusing on a single input even if that input is interest rates.