The complexity of the U.S. real estate market
The factors impacting U.S. real estate are extremely multi-faceted – some have developed over the long-term, and some economic factors are shifting rapidly. With this analysis, CONTI Capital seeks to clearly lay out the major influences on the real estate market and give our considered view of what’s in store, given all of the data available to us.
- Target Sun Belt markets boast high in-migration and don’t have enough places to live.
- Obstacles to constructing more supply include a shortage of workers and supply-chain delays.
- Rising interest rates are causing concern in financial markets, but the difference largely lands on the seller’s price.
- Inflation has been driven by rising oil costs and government stimulus during the pandemic.
- CONTI’s strategy positions us well to weather economic headwinds.
A lack of supply amid construction delays
Residential construction slowed significantly during the height of the pandemic, and now the crush of demand is meeting with a huge gap in apartment supply. Even as more apartments and single-family homes are built, we don’t see demand moderating until at least 2024. Depending on the source, the housing shortfall relative to need is in the millions.
Supply-chain bottlenecks are causing delays in delivery of building materials and equipment, delaying construction of new housing. In combination with this, the construction industry has been grappling with a shortage of workers for the past several months. These factors are elongating construction timelines and causing some developers to pull back entirely.
CONTI’s analysis determined that several Sun Belt markets provide the best opportunities for multifamily acquisitions primarily because those markets are seeing big population increases and there simply aren’t enough places for people to live. These markets boast very strong labor markets and an affordable cost of living relative to Gateway markets, drawing a steady stream of professionals.
Homebuying out of reach
The colossal millennial generation is 90 million strong in the U.S., and from ages 26 to 41, they’ve entered their peak homebuying years in the midst of a market offering limited housing opportunities at sky-high prices. Rising mortgage rates are further limiting single-family affordability, and many hopeful homeowners are being pushed out of the market and into renting.
In the crowded housing market, private buyers can be edged out by increasingly prevalent institutional buyers. These investment companies have deep pockets and can afford to offer a builder whatever price they ask. In fact, this has become so rampant that in Texas, 3 out of every 10 homes were purchased by institutional investors that paid cash, according to the National Association of Realtors. Nationally, 13% of homes are snatched up by institutional buyers.
CONTI acquires high-end apartment assets that charge top-of-market rents. These apartments meet the needs of financially comfortable renters who might otherwise have purchased a house but prefer the flexibility of renting. These assets offer quality amenities in proximity to good schools and other benefits. This pool of renters is large and growing, per our analysis.
Increasing interest rates
Inflation hit a multi-decade high in recent months, and the Federal Reserve has resolved to reduce inflation by way of a series of interest rate increases and balance sheet runoff. So far, they’ve raised interest rates by a total of 150 bps, and we expect another 50 bps rate hike in July – although we don’t rule out the possibility of a 75 bps rate hike. We initially forecasted the Fed would raise interest rates by a total of 250 bps in 2022, but given the recent acceleration in the rate of inflation, we now allow for the possibility that interest rates will exceed our forecasts by year-end, thus our below forecast is evolving and subject to change.
Increasing rates have some investors worried that this will negatively impact their bottom line for new investments, but CONTI’s professionals are seeing the impact land on the pricing expectations of sellers rather than buyers to offset the higher costs of debt. In fact, while several competing entities are pulling out of the market and reassessing, CONTI’s Acquisitions team sees this as an opportunity to move decisively on well-positioned deals.
CONTI has accounted for interest rate bumps in its deal underwriting. We will continue to be conservative in our underwriting and monitor the market closely to anticipate further interest rate increases.
Oil and its impact on inflation
Inflation has been driven largely by the rising price of oil, which was exacerbated earlier this year by the war in Ukraine. Another factor, though not as driving, is the fiscal and monetary stimulus the U.S. government injected into the economy during the worst of the financial impact of the COVID-19 pandemic. This stimulus succeeded in the government’s goal of reinvigorating the financial and labor markets, but also spurred along price increases. This, in combination with supply chain snarls, brought inflation to a high not seen since the 1980s.
With no more stimulus coming from the government and oil prices beginning to stabilize, CONTI believes inflation may be at or near its peak and starting to wane, but it will likely remain elevated through 2024. Rate hikes will continue until inflation is under control.
Commercial real estate (CRE) – and privately-owned multifamily, in particular – remains an effective hedge against inflation. One analysis found that, on average, for every 1% increase in the rate of inflation, CRE returns grow by 1.1%.
The possibility of a recession
The start of a Fed rate hiking cycle and market volatility has raised concerns of an imminent recession. It’s significant that the U.S. financial and real estate markets are in a far different place than they were prior to the Global Financial Crisis. In the current environment, well-capitalized banks and strong underlying real estate demand drivers suggest that, if a recession did occur, there’s a good chance it would be relatively shallow and short-lived. That said, CONTI does anticipate economic activity moderating following its rapid recovery in 2021.
Not all recessions are the same – they have a range of causes, different levels of severity and varying recovery time spans. The last deep recession was the Great Recession, which was triggered by a global financial crisis. With U.S. and global financial institutions in far superior shape when compared to 2007-2008, any recession that may be triggered over the next 1-2 years will probably be far shallower as measured in job and output losses.
CONTI believes multifamily real estate within the Sun Belt is particularly well-positioned to weather economic challenges because of its strong fundamentals. Demand will not be quickly quelled in these markets in the near-term. In addition, these markets boast robust labor markets, so residents and businesses there are well-positioned to weather hits to their balance sheets.
CONTI has invested in cutting-edge data analytics tools to successfully identify outperforming investment opportunities. Part of our analytic toolkit is the CONTI Index, a proprietary, data science-based site selection model developed by CONTI Capital to identity the top performing metropolitan areas, submarkets and zip codes for multifamily investment opportunities. The CONTI Index is sharply accurate and is updated rapidly so that the Acquisitions department can screen potential opportunities against supply and demand variables that have been proven to predict property level performance.
We approach our deals from a fundamentally conservative stance to be good stewards of our capital. We closely monitor and anticipate interest rate hikes, and we keep leverage low to minimize risk.
The bottom line
During times of economic uncertainty, we’ve observed a “flight to safety” of investors positioning themselves for capital preservation. U.S. treasury bonds are arguably the lowest-risk investment available, considering the well-regulated financial establishments operating in the country. Meanwhile U.S. apartment income returns outperform treasury bond returns and are historically a reliable hedge against inflation.
The CONTI Team believes the solid market fundamentals, specifically in target Sun Belt markets, and with our data-driven and conservative deal strategy, we are particularly well-positioned to make acquisitions even as interest rates increase and we face economic uncertainty.