Despite the risks associated with inflation and rising interest rates, the multifamily sector and commercial real estate in general are expected to continue attracting capital in 2022, according to CRE analysts. Industry experts including Tim Savage, a professor with New York University’s Schack Institute of Real Estate; Brian Bailey, subject matter expert on commercial real estate for the Federal Reserve Bank of Atlanta, and Richard Kalvoda, senior executive vice president of Altus Group, provided insights on a recent Reonomy webinar.
While there are some issues to keep an eye on, particularly rising cap rates, the CRE sector will thrive in 2022 and beyond, according to the panelists. Among the macro issues to watch that could impact overall CRE performance are the expected continuation of remote or hybrid work, labor market disruption, Fed policies and inflation.
Multifamily sector outlook
As in 2021, the industrial and multifamily sectors are the most attractive to investors. The multifamily sector gained 10% in total returns on a two-year annualized rate, according to Savage’s analysis, compared to 27% for industrial properties. During the fourth quarter of 2021, multifamily total returns were 7%, industrial returns were 15%, and office and retail total returns were under 2%.
Approximately $213 billion was invested in the multifamily sector in 2021, with a forecast of $234 billion to be invested in the sector in 2022. Multifamily acquisition opportunities will be driven by the Mountain West, Southeast, Arizona, Florida and Texas. In addition, niche strategies should likely dominate investments, especially in affordable housing and the build-to-rent sector.
Cap rates forecast
Cap rates continue to be on a downward trend now, except for central business district office properties where they are flat. In the short term, cap rates are expected to be stable or slightly down.
Savage anticipates slight upward pressure on cap rates driven by rising interest rates and the reversal of the Fed’s asset-buying policy.
Bailey says properties with 75% and especially 85% LTV will need careful monitoring since a move in cap rates for those properties creates a greater default risk for lenders. Properties that are not considered green could be penalized by the industry with increased cap rates of 100 to 200 basis points, he says.
Macroeconomics and CRE
While the consensus is that the Fed will raise the federal funds rate a few times in 2022 and 2023, panelists believe rising interest rates have already been priced into the market. However, rising rates can be a setback to NOI growth, so investors would be wise to do in-depth data analysis to figure out how to continue to drive NOI growth for their properties, says Savage.
The panelists believe inflation is episodic due to lingering pandemic and supply chain issues that are already improving rather than a long-term concern. The consensus among the panelists is that inflation will likely drop by the end of 2022.
Commercial real estate is historically a good hedge against inflation because rent typically outpaces inflation. In addition, inflation can be passed on through rent growth.
Property sectors with a shorter lease duration can be a better hedge against inflation than those with a longer lease, says Savage. Multifamily property is especially appealing because the typical lease duration is one year.
Employment prognosis and office dynamics
One area of concern to the panelists is the future of work. While employment levels have increased over the low rates early in the pandemic, the labor participation rate is anticipated to stay low in 2022 at 62.2%. Bailey pointed out that employment has returned to above pre-pandemic levels in many sectors, including professional and business services, which have a high correlation with office use.
A redefinition of what office space means, especially in CBDs in large cities, is on the horizon and will impact cap rates and NOI for that sector, says Savage.
Generally, supply and demand fundamentals are excellent for commercial real estate for the coming year and beyond, says Kalvoda.