Despite the pandemic, private real estate sectors experienced spectacular recoveries, including multifamily housing, industrial, and life sciences, according to the Urban Land Institute’s Emerging Trends in Real Estate report. Nonetheless, private real estate investing is affected by the coronavirus. Investment decisions, on the other hand, cannot be put off indefinitely. Higher risk is now the norm, and the cost of planning one’s life around COVID-19 may have begun to outweigh the benefits.
Here are our top ten private real estate investing forecasts for the coming year. We will continue focusing on multifamily housing, preparing our funds for short-term and long-term profitability.
#1: All trends will be affected by inflation, which is an economic threat.
Investors aren’t the only ones concerned about rising inflation. In the opinion of Blackstone’s Jon Gray and Just Capital’s Paul Tudor Jones, this is more than a short-term phenomenon. For the 12 months ending in November, inflation increased by 6.8%, the highest annual increase since 1982. Higher salaries will have a long-term influence on volatility pricing, and the Federal Reserve may miss the opportunity to rein in this trend. If inflation stays high for a long time, it will affect everything in private real estate, from value-added and ground-up development to capital expenditures and cap rates.
A lack of workers and a lack of a supply chain are the root causes of this problem. There is only one way to motivate workers by raising their salaries, which is beneficial for the workers but also inflationary and non-transitory. If you want it, you have to give it up; there’s no going back. That’s why there will be a longer-lasting effect of inflation and the volatility pricing that it generates.
#2: Interest rates are expected to rise.
The current level of inflation predicts an increase in interest rates this year. If inflation is 3% and the yield on a 10-year Treasury note is 1.6 percent, investors anticipate a real return but are losing 1.4 percent. Inflation is way higher than the yield on the 10-year Treasury note. The Federal Reserve (Fed) may begin raising interest rates as early as May or July, a departure from its previous projections of 2023. Inflation-linked interest rates aren’t always negative, and I’m hoping they’ll rise by less than a percentage point slowly. You don’t want to see a massive shift like a whole point, but 2% to 2.5% is better than nothing at all.
#3: Real estate will continue to be affected by COVID, as it alters where we live and work.
COVID-19 sparked a wave of transformation throughout the whole industry. Three, six, or even nine months of unemployment necessitated a new profession. To avoid a return to retail or office sites, they would not take the chance. As a result, many people discovered that they could work from home. In September, a record 4.2 million people left their jobs. The inflationary effects of such severe labor shortages are numerous. If you work in a port, construction site, or fast-food restaurant, you will continue to make more money and won’t decrease. A hybrid work environment may be necessary to attract the most sought-after employees.
#4: The level of appreciation will be lower than last year.
Although we aren’t in a bubble, valuations are above where they should be. Be cautious, use low leverage, and only purchase assets with secure cash flow prospects. Historically, the stock market returned only 8% to 9%, so we’ll likely see lower returns in the future. Investors in private real estate should no longer expect returns of 15% to 20% over the next decade when the risk-free rate of return is zero. The fact that profit expectations will be lower does not imply a downturn.
#5: Continued migration from large cities to low-cost, business-friendly states.
As virtual and hybrid work continues, more people will move to warmer states in the South where housing costs and taxes are lower. Because the job market is tight, companies are more likely to hire remote workers outside our country’s economic centers, also called “gateway cities.” Housing prices are going up in Charlotte, Denver, and Phoenix, all of which are better places to live than Boston, Chicago, Los Angeles, New York City, or San Francisco. This trend will slow down over time as housing costs go up. People are leaving California, which is best for Phoenix because it has a lower income tax and bigger houses. However, the price difference is getting smaller because the rate of rent growth in Phoenix is higher than the rate of rent growth in San Diego. Price distortions will end when prices are more reasonable, but that won’t happen for years.
#6. No changes for those who qualify for Opportunity Zone benefits.
The legislative deadlock has postponed adjustments in capital gains taxes and even marginal tax rates that were expected to be implemented last year. QOZ incentives for private real estate investment will be less likely to be reduced in the next year because of this. Taxes on capital gains accrued after a 10-year holding term are not applied in QOZs. More than $20 billion has been generated in QOZ funds to date, demonstrating a steadfast interest on the part of investors. A year from now, no new rules will be issued by the US Treasury or Internal Revenue Service regarding QOZ. When Congress stops, little can be accomplished because of the gridlock. Republicans will promote tax cuts to boost investment in underserved areas.
#7: Suburban areas will outperform cities in terms of rent growth as multifamily property values rise moderately.
Many investors are still interested in investing in multifamily housing. Rents will continue to rise, and while property values will slightly rise, they will do so at a slower rate than in the previous year. Rising interest rates will put pressure on borrowing costs and cap rates, which in turn affect a company’s equity multiple. Inflation predicts that rents will continue to grow as workers have more money to spend on rent as salaries rise. Suburban growth is supported by the rise of remote and hybrid workplaces.
#8: The rents for multifamily in the NE and MW will be less than those in the SE, SW, and TX.
Last year, we stated that a comeback in urban Class-A multifamily rentals would be impossible due to the outflow of residents. As a result of rising salaries and increased disposable income, rents in both urban and suburban areas will continue to get high. However, growth in suburban rents is expected to continue to surpass that in urban areas. Even if the prices of urban Class-B properties and properties in the suburbs go down, urban Class-A buildings will still not do as well.
#9: Ground-up construction is filling the role of value-add.
Value-added renovations must offer a distinct advantage over competitors to attract private equity investment. With so much money flowing into value-added projects in recent years, their base costs have risen above those of brand-new units in the exact location and quality category. For this reason, achieving the expected returns is challenging because new construction always attracts higher rental rates. We’ve decided to leave the value-added market for the time being since the risk-reward ratio favors new construction in this market situation. We don’t believe it’s a business worth our investment.
# 10 The rate of ground-up development will accelerate.
In 2021 private capital fundraising will outpace 2020 but will be concentrated in multifamily and industrial real estate. Everyone wants to acquire those sectors, whether its core stabilized or new development. Multifamily housing projects also interest lenders. Because development fundamentals are favorable for both equity and debt funding, new construction will expand. Ground-up progress can fetch 10% to 30% over replacement costs, while value-add is at or above. As land and building prices grow, the demand will drive down new development margins. The market will move to value-add. For now, ground-up construction will stay.
Conclusion
The multifamily real estate market pays to be agile and anticipate future changes. Predicting the housing market helps us identify future possibilities, manage cap rates, and remain ahead of the curve. Despite the unknowns, we expect the year 2022 to be the same and will continue to generate profit.
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Come join us! Email me at mark@dolphinpi.us to find out more about our next real estate investment.