Thoughts

September 24, 2021 | 15:18

U.S. Real Estate Revival

Economist

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Sal Guatieri

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

As one would expect, low interest rates and a recovering economy have been a tonic for the U.S. real estate market, both residential and commercial. On the housing front, while existing home sales pulled back 2% to 5.88 million annualized in August, they remain above pre-virus levels. With mortgage rates approaching historic lows and new mortgage applications hitting five-month highs, sales should rebound. The ever-volatile new home sales posted back-to-back gains for the first time this year. Despite worker and material shortages, housing starts bounced 3.9% to above pre-virus levels, and an even larger 5.6% leap in building permits flags further strength. The NAHB homebuilder confidence index steadied in September (despite hurricanes) after descending from November’s record peak, and remains well above long-run norms.

The problem for the housing market is not enough listings to satisfy strong demand. A 2.6-month supply at the current sales rate is less than half the usual inventory, sending median prices zooming at a near 15% yearly rate. Other price measures (Case-Shiller and FHFA) are running even faster. Based on history, soaring home prices could lift CPI rent growth a couple of percentage points by late next year, adding half a percentage point to inflation. In fact, rents are already starting to percolate, with Zillow’s observed rent measure (which controls for changes in unit quality) up 11.5% y/y in August, the most in the six-year history of the survey. While much of the pop reflects year-ago weakness, the two-year annualized rate is also trending the fastest on record at 5.8%.

Meantime, commercial real estate prices have come storming back after sliding 11% during the shutdown, according to Green Street Advisors’ measure. Prices are now 8% above pre-virus levels, and the two-year annualized rate (4.3%) is the highest in 4½ years. The total rate of return (income and appreciation) improved to a decade-high of 3.6% in Q2 (not annualized), according to the National Council of Real Estate Investment Fiduciaries. Capitalization rates remain low.

While location still matters in the pandemic, sectoral differences have widened. Industrial is the top performing sector, by far. It hardly flinched during the shutdowns and is now clocking in with an 8.9% quarterly rate of return, the most since at least 1978. The segment has thrived on strong demand for goods and warehouse expansion to meet the growing demand for online sales logistics.

Next in line is the apartment space (3.6% return) amid rising rent, more jobs, and soaring house prices channeling prospective buyers into leasing. Rents in cities facing an exodus of teleworkers (Boston, San Francisco, New York) are now rebounding as some workers return to the office and vacancy rates fall.

The office sector is also grinding out a recovery (1.4% return), benefitting from long-term leases, though big questions cloud the outlook. Vacant sub-lease space has soared, notably in some major cities. Recurring waves of the pandemic have delayed the return of many office workers, raising the risk that workers might become too cozy operating from home, thus tilting hybrid plans more toward that option.

After hotels, retail has struggled the most in the pandemic, posting a modest 0.9% return in Q2 after five straight quarterly losses. Despite generally robust consumer spending, the sector will likely underperform until COVID-related anxiety eases, allowing the food services, entertainment, and travel industries to more fully recover, and until more workers return to the office. Even then, given the shift toward online sales and telework, physical retail likely won’t return to pre-pandemic levels.

The upshot: The U.S. housing and commercial real estate markets are enjoying a healthy recovery, though big questions surround the longer-term outlook for retail and offices.