As the U.S. economy recovered from the COVID-19 pandemic in 2021, certain commercial real estate sectors experienced strong growth. One of the bright spots of the market was single-family rentals (SFR) and build-to-rent (BTR) communities, a burgeoning asset class that experienced historic growth last year. Rent growth for SFR assets was up 14.7% year-over-year in October 2021, according to Yardi Matrix. Additionally, national occupancy was 95% in Q3 2021, as indicated in Arbor Realty Trust’s quarterly SFR report.
Another winning sector in 2021 was multifamily, which had record occupancy of 97.5% and record absorption of more than 673,000 units, a 66% improvement over the previous peak in 2000, according to RealPage. CBRE predicted that multifamily will also have record investment volume in 2021 of $213 billion. The industrial sector, another strong performer in 2021, saw a record 135.1 million square feet absorbed and record low vacancy of 4.3% in Q3 2021 while rents increased 7.1% year-over-year, according to JLL.
In 2022, there are several trends and factors that could bolster commercial real estate investments, including the resurgence of the U.S. economy to pre-pandemic levels, rising inflation, diversification from the stock market, and high liquidity for real estate assets.
The U.S. Economy is Returning to Pre-Pandemic Levels
The economy has improved greatly since the early days of the pandemic in 2020. The U.S. unemployment rate fell to 3.9% in December, the first time it has been under 4% since February 2020 before the pandemic began, and wages are trending upwards as well.
People filing for unemployment benefits also fell dramatically and has nearly returned to pre-pandemic levels, and U.S. gross domestic product (GDP) has had six consecutive quarters of positive growth since Q2 2020. For 2021, GDP increased 5.7%, the fastest annual result since 1984.
Due to rising inflation and interest rates, the economy is expected to slow from 2021’s elevated pace in 2022, but maintain healthy growth overall, according to U.S. News & World Report. With economic growth, demand is anticipated to increase for real estate properties across various sectors, CBRE’s U.S. Real Estate Market Outlook 2022 stated. This increasing demand is expected to lead to more investment across the commercial real estate market.
Inflation is Rising and Commercial Real Estate Can Be a Hedge
Inflation has been rising since last year as the economy rebounded. In December 2021, prices rose 7% year-over-year for nearly all items, the largest increase since June 1982, according to the U.S. Bureau of Labor Statistics.
To combat the threat of rampant inflation, the Federal Reserve has indicated that it would hasten its efforts to end bond purchases, which propped up markets during the pandemic, and it could raise its federal funds rate beginning this year.
While rising rates could mean that mortgage rates may rise, commercial real estate has the ability to be a hedge against inflation, especially multifamily real estate. Inflation reduces the purchasing power of currency as prices for goods and services increase. When inflation rises, it erodes the value of interest payments from fixed investments, according to U.S. Bank.
Real estate can be a hedge against inflation because rents can increase with inflation, which may help properties keep pace with the rise in prices for expenses. The appreciation in value of real estate investments also helps the assets to fend off the erosion caused by inflation. The inflation hedging potential of commercial real estate may result in high demand from investors for properties.
Diversification from the Stock Market
Investors typically diversify their investments to lower risk and strengthen their portfolios for long-term growth. Commercial real estate is an alternative asset, meaning it is less correlated to the stock market. Therefore, when the stock market is experiencing volatility, real estate may outperform public equities.
Due to inflation rising, investors are worried that the securities market will be impacted, and signs have already been pointing to increased volatility. The Nasdaq composite index fell 9% in January, and the S&P 500 and Dow Jones indices also declined sharply during the month. During periods of volatility, investors may focus on alternative assets not affected by the stock market cooling, such as commercial real estate.
Liquidity for Commercial Real Estate Investments is at Record Levels
Private equity funds raised a record $287.8 billion in 2021 for commercial real estate investments from clients, such as pension funds and endowments, an 11% and 57% increase from 2020 and 2019, respectively, according to Bloomberg. The challenge for these private equity funds has been to put all the capital raised to work. There was an expectation for real estate assets to be discounted during the pandemic, but that didn’t occur across all property types, leaving a substantial sum of money on the sidelines.
In addition to the stockpile of private equity capital, lenders are expected to increase their allocations to commercial real estate due to increased deal volume, according to Commercial Observer. With all the available capital raised for real estate deals and more lenders and investors chasing properties, more transactions can potentially occur this year.
Single-Family Rental (SFR) and Build-to-Rent (BTR) Investment Tailwinds for 2022
The growth of the economy is boosting household formation, which typically increases the need for more housing. This trend is also accelerating because millennials, currently the most populous generation in the country, have begun starting families.
Millennials now desire more space for their growing families — especially after experiencing the COVID-19 pandemic. However, weighed down by record student debt and record for-sale home prices, many can’t afford homes. Therefore, they are choosing to rent single-family homes.
The factors driving single-family home demand is why large institutions committed more than $45 billion in 2021 for SFR and BTR assets, an increase from just $3 billion in 2020, according to John Burns Real Estate Consulting. Moreover, Urban Land Institute and PricewaterhouseCoopers’ annual Emerging Trends in Real Estate report noted that in 2022, SFR has stronger prospects for investment and development than most major commercial real estate sectors, including multifamily, office, retail, and hotel.
While the overall commercial real estate market has various tailwinds in 2022, SFR and BTR in particular is an asset class to pay attention to given demographic trends and strong economic conditions.