Brant Brown, President & COO, shares insight into the key influences that drove last year’s commercial real estate market into a successful and historic record-breaking year.
The impact of the worldwide pandemic fully materialized in 2021 as several new and unprecedented challenges hit the commercial real estate industry. Successful industry leaders met those demands by responding to market needs, satisfying increasing sector growth, and fulfilling new expectations throughout. Record high rent growth continues as vacancy rates drop to record lows. Amidst many of these shifts, the market continued to boom, and investment interest has well-surpassed expectations.
The NAR established before year-end that 2021 would, and did, reveal itself to be “the strongest year in terms of investment acquisitions, surpassing the peak sales volume of 2006 and the pre-pandemic level.” In this Insider piece, we take a look at the most prevalent drivers affecting the performance of last year’s commercial real estate market that took us all for one historical ride.
1. Multifamily Volume
Multifamily sales volume quickly rebounded starting mid-2021 and finished the year at record highs of $288 billion according to CoStar Group. Investor appetite remains strong for the sector due to operating fundamentals recovering as well with rents in many markets having tremendous growth. The competition for deals has been across both small and large size markets as investors seek yield in a cap rate compression environment. Debt Funds and agency (Fannie Mae and Freddie Mac) financing remained very active at attractive rates until the last quarter when agencies pulled back due to reaching allocation goals for the year.
Year to date through the third quarter multifamily absorption totaled 600,000 units (twice the average absorption of the last 5 years). Delivery of new supply during this period totaled only 270,000 units thus driving down vacancy rates to an all-time low of 4.5% and asking rents up an unprecedented 11.1% nationally. Regionally the sunbelt has seen the strongest rental rate growth with Phoenix, Austin, and Orlando all seeing growth in excess of 20% in many submarkets. These exceptionally strong fundamentals have helped to push historical levels of investment capital into the multifamily sector with $130 billion in sales through the 3rd quarter. The top investment markets are Dallas / Fort Worth, Phoenix, and Atlanta.
2. Industrial Demand
Demand for industrial space, from investors and users alike, has likely never been as strong as it was in 2021. Top tier industrial submarkets are 98-99% leased while tertiary markets are typically 95% or better. Cap rates compressed across all industrial classes and spread between class A and class B tightened as investors sought yield in an ever-tightening marketplace.
Demand due to high online retail sales and supply chain issues caused vacancy to drop to the national all-time low sub 4%. The construction pipeline desperately tried to keep up with demand, but a shortage in supplies caused strings of delays along with active pre-leasing of buildings. This brought about double-digit rent growth in many markets due to competition and a lack of available space. This, in turn, focused on highly attractive fundamentals which drew many new investors into competitive bidding that led to record pricing.
3. Investor Acquisitions
With improving market fundamentals, investor acquisitions of multifamily, office, retail, and industrial properties of at least $2.5 million totaled $523 billion in the first ten months of the year. NAR expects the full-year level of acquisitions to hit nearly $645 billion, surpassing the prior peak level of acquisitions in 2006 of $581 billion.
The concern over rising interest rates and inflation has more investors looking at hard assets as a hedge against inflationary pressures. These compressed cap rates are leading some retail investors to move further out on the risk curve replacing current cash flow for the hope of reversionary upside. Investors are also placing an emphasis on the operator to provide value (Value-add) through repositioning, upgrades, vacancy absorption, cost controls, and a focused approach (deep knowledge and expertise) and streamline operations.
Investors are seeking out experienced operators that can execute a business plan as cap rate compression will not likely bail out poor operators going forward (“when the tide goes out you can see who is swimming naked” – Warren Buffett). Operators that have deep experience in multiple market cycles and rising interest rate environments should provide additional comfort to investors.
4. Cap Rates Trend Down, Interest Rates Rise Up
2021 proved to be a year marked by tremendous interest in both the industrial and multifamily sectors. Demand drivers for these sectors proved to have a very solid footing throughout the year and are expected to remain strong for a while. Given the cap rate compression experienced through the year, it was very apparent there were large amounts of capital chasing too few deals. The trend will likely continue as we move into 2022. There are many factors to consider, but with inflation beginning to take hold there is a view that more capital will be seeking inflation hedge assets such as real estate. Rising interest rates will play a role in potentially tempering rising prices of real estate, but investor demand is expected to remain strong.
Brant Brown
Brant is the President & COO at Westmount Capital Realty, LLC. He has extensive experience safeguarding investor interests and excels in structured finance and accounting, capital markets, real estate investment performance, investor relations, information technology, marketing, and corporate governance and planning. Brant has led the financial analysis and governance for more than $30 billion in institutional real estate and fixed-income investments.
To learn more about Westmount Realty Capital or for additional information, contact us at info@westmountrc.com or find us at https://westmountrc.com/.
This article, and Westmount Realty Capital blogs in general, is intended for informational and educational purposes only, and does not constitute a solicitation or offer by Westmount Realty Capital, LLC to buy or sell any securities, futures, options, foreign exchange or other financial instrument or to provide any investment advice or service. Westmount is not your advisor or agent. Please consult your own experts for advice in these areas. Although Westmount provides information it believes to be accurate, Westmount makes no representations or warranties about the accuracy or completeness of the information contained on this article.
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