JRE - Reading The Real Estate Tea Leaves
2023-03-22 03:40:00 ET
Summary
- Decelerating growth presents near-term challenges - but we believe they could be temporary.
- Seasonality or slowdown? That’s the question real estate investors are asking as they wrestle with valuations in the face of declining growth in most subsectors, especially the short-duration sort.
- Slowdowns in some sectors don’t come as a great surprise. In apartments and storage, for example, the winter months tend to see less demand, and rates often soften to drive occupancy.
By Matthew Wolpert, CFA
Decelerating growth presents near-term challenges - but we believe they could be temporary.
Seasonality or slowdown?
That’s the question real estate investors are asking as they wrestle with valuations in the face of declining growth in most subsectors, especially the short-duration sort. Consider:
- Apartments: Rents fell every month from August 2022 to January 2023, before rising modestly in February. (Year-over-year growth in February was the lowest since April 2021.) 1
- Storage: Since September 2022, the four large public storage REITs have suffered double-digit year-over-year declines in street rates for a 10ft x10ft unit. (In February, rates dropped by 15%.) 2
- Lodging: Wells Fargo reported that foot traffic at hotels (based on cellphone-location data from Placer.ai) slowed in 1Q23 vs. 1Q19, compared with 4Q22 vs. 4Q19. 3 (The Omicron variant is creating easy year-over-year comps in lodging that may be masking a slowdown in demand, so indexing to pre-COVID 2019 may paint a clearer picture.)
- Office: Leasing volume at public-office REITs declined 37% in 4Q22 vs. 4Q21, and 5% between 1Q23 and 4Q22. 4
Other sectors have more idiosyncratic drivers for near-term revenue growth, but most are decelerating from elevated levels in 2022.
Slowdowns in some sectors don’t come as a great surprise. In apartments and storage, for example, the winter months tend to see less demand, and rates often soften to drive occupancy.
Regarding hotels, travel patterns were likely to normalize as COVID-related disruptions eased. Yet, in our view, while the slowdown is normal, the pace is abnormal, and there lies the concern.
We believe rising cap rates are another worry. In the apartment, industrial and office sectors, cap rates are 30-55 bps higher than a year ago. 5 With real Treasury yields highly volatile, Fed policy increasingly uncertain, and lending markets likely to be impacted by recent bank failures, it seems unlikely that cap rates will retreat anytime soon.
In our view, this combination of slowing growth and rising cap rates will likely create headwinds for real estate investors in the near term. But if recent slowdowns prove little more than seasonal trends - and the capital markets manage to stabilize when the Fed reaches its terminal rate - we believe the second half of 2023 could prove an ideal time to deploy capital into real estate.
Notes: (1) Apartment List as of 2/28/23; (2) Truist research as of 2/28/23; (3) Wells Fargo as of 3/6/23; (4) ISI research as of 3/5/23; (5) Real Capital Analytics and Bloomberg as of 3/7/23.
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Reading The Real Estate Tea Leaves