While vaccine rollouts, rising job numbers, and declining COVID-19 cases offer real estate investors great optimism about the future, uncertainties remain.
The national economy is quickly rebounding, and the continuance of quantitative easing is likely to leave interest rates low for the next couple of years. But growth in remote work and migration from high-cost coastal cities is leading to reduced demand for commercial real estate in some parts of the country. Economists also note record federal spending and loose monetary policies might eventually lead to higher taxes and inflation.
But for now, rising vaccine distribution, loosening restrictions, and a return to normalcy across the country are leading to growing economic optimism, explained Ken Rosen, Chairman of the Berkeley Haas Fisher Center for Real Estate and Urban Economics, who spoke recently at a webinar titled Vaccine Optimism, Fiscal Stimulus, and a Path to Economic and Real Estate Market Recovery, sponsored by Bank of the West. One particularly positive sign is that the unemployment rate had fallen to 6 percent as of March 2021, down from nearly 15 percent a year ago, according to the Bureau of Labor Statistics.
Clifford Rooke, Managing Director of Real Estate for Bank of the West, concurred with Rosen about the current outlook. “It has been a tumultuous year, but we’re proud we’ve been able to come through this period in relatively good shape,” he said. “We are now hopefully in a period of renewal.”
The Unwinding of Fed Policy
Still, there are risks on the horizon, Rosen cautioned. While the federal American Rescue Act and CARES Act helped consumers and pumped money into the economy, the national debt grew to another record high of $28.1 trillion in April 2021, according to the Treasury Department. The debt-to-GDP ratio is now forecast to rise to 102 percent by the end of 2021, the Congressional Budget Office (CBO) has predicted.
“We’re going to normalize interest rates and the balance sheet at some point, and that could be a messy unwind,” said Rosen, who also serves as chairman of the Rosen Consulting Group.
One effect of current policy, Rosen said, is that the spending and the extended period of easing could eventually lead to higher taxes, greater inflation, or a slowing rate of spending. While the Fed is unlikely to raise rates until after 2023, normalization could put rates back in the range of 3 to 3.5 percent, he said.
Commercial Property Waits for Demand
The impact of higher rates goes beyond corporate and personal borrowing. Rosen noted a “bifurcated” economy and recovery, not only for consumers but also for property. While life sciences, biotech, single-family homes, retail, and industrial logistics are performing well, hotels, resorts, and high-end condos are not.
One short-term concern is about the demand for commercial property in many markets. In the West last year, the NCREIF Property Index (NPI) noted a 25 percent decline in hotel properties and a 6.5 percent decline for retail. While industrial property is still appreciating, he noted that the value of office buildings and apartments is relative to location. The income component of these properties has fallen dramatically for most hotels and retails but was holding firm for most apartments and office buildings.
A top issue is how quickly people will return to the office. While many companies have cut their footprints in San Francisco with fewer people in the workplace, Rosen believes that eventually 80 to 90 percent of workers will return to the office. Nevertheless, that gap could still present headwinds for commercial property owners.
“We all have to worry about that because if 10 percent of the people cut their footprint, vacancy rates are going up, and the value of office building isn’t going to be good,” he said.
Renters Move Back, but Will They Return?
Still, even a partial return to the office should benefit the sector, Rosen predicted, as the trend of younger people moving in with their parents during the pandemic should soon reverse.
“This is good news for the apartment business,” he said. “It says there’s a backlog of demand. Once people get their jobs back, once the virus is contained, people will be back in their apartment living space.”
In particular, this could benefit central business districts in cities like San Francisco and Los Angeles, which have experienced weak effective rent growth overall and a drop in rents for high-end apartments. One primary driver is the continuing trend of residents moving to more affordable, tax-friendly environments like Florida, Texas, Arizona, and Nevada.
“The high cost of living in coastal California and New York have made people leave for housing costs and tax reasons,” Rosen said. “Don’t expect a lot of people to move back.”
Watch the entire webinar, Vaccine Optimism, Fiscal Stimulus, and a Path to Economic and Real Estate Market Recovery, to learn more.