By Meghan Hall
Ten years out from the Great Recession of 2008 and 2009 and by many accounts, the nation’s economic engine is still churning and fundamentals across an array of investment sectors remain stable, or even strong. In the commercial real estate industry, investors are still looking with a keen eye towards the future with discussions circulating how to maximize ROI while still preparing for an eventual—and somewhat inevitable—economic slowdown. For the time being, however, brokerage firm Marcus and Millichap called the national commercial real estate market balanced and indicated the sector will hold steady on a webcast that took place in September.
“Particularly through the early stages of the growth cycle, we saw absorption dramatically outpacing completions, which has been a real positive for most property types,” explained John Chang, Marcus and Millichap’s National Director of Research Services. “Only in the last few years have we begun to notice a more substantive wave of construction…But overall we see supply and demand…mostly balanced on a macro level. Overall, the market is in balance.”’
The basis for a steady commercial real estate sector has grown out of the national economy. Since the beginning of the cycle, some 22 million jobs have been added, 13 million more than the peak of the last market cycle. On top of that, the United State has added jobs continuously for the last 107 months. On average, the United States has added about 200,000 jobs per month, and unemployment hovers at around 3.7 percent. Currently, there are 7.2 million job openings but only about 6 million people looking for work, keeping job growth in check.
“That’s nine years, where we have added jobs every month along the way, and that’s a record,” added Chang, who noted that steady, not rapid, job growth has been the key to enduring stability. “An important characteristic of this cycle has been the steady base of the job growth. It’s really stayed in the Goldie Locks zone. It’s not getting more heated, and we haven’t been too slow. And that’s really helped keep the pace of the overall economy in balance. And that’s been a really positive factor for all commercial real estate sectors.”
Additionally, overall lending in the commercial real estate has also tightened as lenders are careful not to over-leverage, reducing some of the risk typically seen in previous growth cycles. Construction lending has also slowed to a certain degree, minimizing risk of overdevelopment in many markets. However, despite a balanced market at a macro-level, Marcus and Millichap further broke its analysis down to reveal more intricate details on several of commercial real estate’s biggest product types.
Over the past four years, the U.S. multifamily market has delivered approximately 305,000 units annually, and while new construction is elevated by historical standards, housing shortages do exist across the country due to increased household formation. 2019 is on track to see 1.365 million new households come to fruition, while multi- and single-family development will only total around 1.2 million.
“…New construction continued to grow-up, and in the last four years it has kind of stabilized,” said Marcus and Millichap’s National Director of Multifamily, John Sebree. “We are not overbuilding; we’re not even satisfying demand from a number standpoint.”
Additionally, stated Sebree, development is not spread evenly across geographies, nor is it spread evenly across property classes. more than 50 percent of new development is concentrated in ten primary metros, and the majority of new construction is also in the Class A space, rather than in workforce housing.
“That is kind of an astonishing number because…if you look at all of the growth taking place across the country, there are a lot of secondary markets that are growing at a really, really good rate right now, and they’re not nearly seeing as much of that new construction,” said Sebree.
The uneven spread of new construction has disproportionately affected Class A, B and C multifamily properties. While Class A vacancies has remained around 5 percent, Class C vacancy has decreased from 7 percent 3.8 percent, and rents continue to climb. The disparity in new Class B and C rental product and household formation has kicked off nation-wide conversations about state-wide rent control. While historically rent control has been metropolitan-based, Oregon, New York and most recently California have enacted state-wide legislation to cap rental rates.
“As these work force housing tenants are dealing with increased demand — it’s clearly a supply and demand issue — the quick release or quick response from the politicians was putting rent control into place,” said Sebree. “The problem is that it does nothing to equal out the supply and demand issue. Most economists believe that rent control will stymie most new construction moving forward.”
The office market, notes Marcus and Millichap, is perhaps more balanced that its multifamily counterpart. Companies have taken careful measures not to over-lease, contrasting with the years leading up to the dot.com boom and the Great Recession of 2008. Additionally, the way that companies use their spaces has changed drastically, with firms allocated less square footage per employee.
“Office simply went through a very modified dynamic if you go back to the Great Recession, or even starting before that,” stated Alan Pontius, national director of office and industrial. “You have two factors that caused the recovery to be more prolonged, or the pace of expansion to be slower than you might expect: The first item is simply cautiousness, on behalf of companies large and small, only taking space needed. But maybe the bigger factor is the way space is configured. You have a dramatic reduction of the cut-up, highly-cubed private office spaces.”
Companies are now allocated around 125 to 150 square feet of space per employee, as opposed to nearly the 250 square feet of space they had allotted for in the past.
The industrial submarket continues to ride on the coattails of ecommerce and retail sales growth, which have seen positive momentum in recent years thanks to the economy and new technologies. For the first time, Marcus and Millichap notes, industrial properties are now a growth segment and is favored among investors due to exceptional rent growth and the high liquidity of industrial assets.
“Industrial, for a long period of time was viewed as the steady income assets where supply and demand never got too far out of balance, so growth was not characteristic of the industrial sector,” said Pontius. “Rental growth has become increasingly common.”
Industrial properties offer a wide range of investment based on age, composition and locality, and thus far, strong consumer expectations are believed to drive demand into the future. Most new construction has been concentrated in major markets and on big-box distribution spaces.
“The long view on industrial remains extremely favorable,” said Pontius.”
Confidence in the retail space has come a long way from the past year when much of the talk around retail-related real estate revolved around the closure of big-box retailers and the supposed end of brick-and-mortar retail. By many accounts, stated Marcus and Millichap, retail assets are faring well thanks to demand drivers such as increases population growth and disposable income.
“It is very interesting to see from last year to this year,” said Scott Holmes, national director of retail. “Last year there was still some hangover, some talk of a retail-apocalypse…and people were worried about the downside. This year, it is a very different feel. It was not talk about protecting the downside, it was much more about, ‘how do we find growth?’”
Nationwide, construction is at one of its lowest levels in ten years, and barely a quarter of retail construction levels in 2007 and 2008. Vacancy rates generally remain low, especially as retail becomes more experiential, focusing on the five Fs: food, fitness, fashion, furniture and fun.
Additionally, interest single tenant net-lease retail continues to remain strong as investors look for lower-maintenance assets leased long-term to credit tenants. “It feels like a safer, easier place for people to put some of their dollars in the current cycle,” said Holmes. “As a market, net-lease retail has done really well because of that.”