According to a recent report by Moody’s Analytics, the rest of 2022 might be the start of an economic rough patch as increasing risk factors boost market volatility. Moody’s states that economic risks and tightening monetary policy could translate into higher cap rates all the way into 2023.
Cap rate forecasts
The report also points out, however, that all is not equal in commercial real estate (CRE) markets, with sectors like hospitality, office and retail already showing signs of an increase in cap rates in response to rising interest rates. Multifamily and industrial cap rates have meanwhile remained steady in the face of uncertainty.
Worth noting is that the existing low cap rates seen in multifamily mean that an overall rise in cap rates will likely cause an increase for the sector. Put another way: “…sectors that have been transacting at very low cap rates have little place to go but up.”
Is a bump up inevitable?
Earlier this year, the National Association of Realtors (NAR) predicted only a modest rise in cap rates in 2022, counterbalanced by upward pressure in CRE prices. NAR notes that sales price growth has been on the up, especially for the industrial and multifamily sectors.
Moody’s Head of CRE Economic Analysis, Kevin Fagan, adds:
“There are strong opinions in the market both ways, that cap rates will go up significantly with rising rates, and others saying that cap rates will go down, and demand and expectations of rent growth will compress risk premiums.”
In a May 2022 interview with Wealth Management, Fagan added that the biggest headwinds currently facing US CRE are a combination of inflation, lower consumer expenditure and the risk of a recession.
Moody’s adds that, given the current economic climate, the chances of 2022 being a recession year have risen to 33%, while 2023 faces an “uncomfortable 50% probability” of a recession setting in.
Taking the long view
Though these predictions certainly add some uncertainty in the coming year, worth bearing in mind is that the outcome of the current volatility is far from set in stone. The way these factors play out in the CRE market remains to be seen.
For now, Moody’s takeaway prediction is that we should “expect to see more volatility in transaction and capital markets before we record pronounced effects on rents and vacancies.”
SOCIAL: Have you seen any movement in cap rates in your area? And what sectors do you think will be most affected?
Growing up in a small town in western Pennsylvania meant that I wasn’t necessarily on the cutting edge of technology. Any new electronics took months if not years to trickle down and even then would usually mean a trip to bigger cities such as Youngstown or Pittsburgh to track down. A great example is the LED watch. It was initially developed in 1971 and became widely available by the mid-1970s. But it wasn’t until Darrell Knight showed up sporting one on his wrist right after Christmas break of 1978 that I actually saw one, live and in person.
The use of technology in real estate seems to follow a similar path, with innovations taking months, if not years, to be integrated into the industry. This month, we are going to discuss some ways, specifically in the area of smart buildings, that technology has finally begun to make a big impact.
While certain sectors, such as medical and clean manufacturing, have been driving advances in clean air filtration and monitoring, the advent of COVID- 19 has placed a spotlight on this topic. The result is a whole ecosystem of products and strategies known as IAQ, or indoor air quality. The most common IAQ technologies revolve around higher-efficiency filters. Humidification and dehumidification systems have also become much more advanced, helping to control dust and mold while maintaining comfort. More advanced systems assist with heat and energy recovery ventilators to offset the increasingly “air- tight” nature of modern construction, as well as UV purifiers to neutralize airborne bacteria and viruses.
Voice-and touch-activated tech
Again, this type of technology received a huge boost in the wake of COVID-19. If you have ever used systems such as Alexa, Siri or Google, you are already well aware of the power and convenience voice-activation can offer. And while touch-activated technologies have been around for decades, the overwhelming popularity of smartphones and apps are leading to more advanced applications. In the commercial real estate sector, it’s no surprise that the hotel sector has taken the lead implementing this type of technology, ranging from speaking to control lights, temperature and entertainment to accessing the room and ordering room service from your smartphone. And don’t look now but many larger commercial property owners are beginning to integrate these same technologies, offering them to their tenants as a standard building amenity.
This may seem like something reserved for only big cities such as New York, Chicago and Los Angeles.
In the commercial real estate sector, it’s no surprise that the hotel sector has taken the lead implementing [voice activation] technology, ranging from speaking to control lights, temperature and entertainment to accessing the room and ordering room service from your smartphone.
And these cities certainly began adopting technologies years ago, with the advent of apps such as SpotHero and ParkWhiz, which allow parking operators to maxi- mize their occupancy through digital notification, reservation and even sub- leasing processes. But if you’ve ever parked in the decks at Hopkins airport, you’ve probably seen another, even sim- pler example that uses a small green or red light above each space, allowing potential parkers to quickly differentiate vacant spots from occupied spots
Energy efficient systems
This can fall into two categories:
1) systems that optimize energy via continual monitoring and 2) clean or renewable energy features. The former is the real heavyweight when it comes to smart building design and is mainly based on the autonomic cycle of data analysis tasks (ACODAT) concept. Basically, the HVAC systems have a central processor that continually monitors usage, time of day, outside air temperature, building occupancy and a host of other factors to not only be reactive in running the HVAC system at peak efficiency but also be predictive by learning patterns over days, weeks and months. The latter includes a host of advances in technologies such as heat pumps and geothermal systems as well as solar- and wind-enabled sources.
The most common acknowledgement of building technology is a certification known as Leadership in Energy and Environmental Design (LEED), through the U.S. Green Building Council. A similar certification is known as the Building Research Establishment Environmental Assessment Methodology (BREEAM) rating. Both of these involve achieving points related to set standards that address carbon, energy, water, waste, transportation, materials, health and indoor environmental quality. There are many examples of LEED-certified buildings in Northeast Ohio, including the Maltz Performing Arts Center at Case Western Reserve University, UH Avon Health Center and the Children’s Museum of Cleveland, among hundreds of others.
And there have been many noteworthy projects worldwide, including the following high-achieving facilities.
Developed by Siemens, the build- ing contains a variety of dynamic and artificial intelligence to power its operation. A noteworthy feature is an advanced air volume system that can put the entire building into “green mode,” which is a setting that uses aggregated historical data to optimize humidity, air pressure and temperature. It also has a decontamination mode that raises the temperature to acceler- ate the decay of airborne virus particles.
This was the first building in Toronto to be rated as a LEED Core and Shell Platinum building. It links up Cisco’s business operations and helps to power Cisco’s Internet of Everything (IoE) while also streamlining all building data into a single network.
Arguably the most striking example of the IoE in smart buildings, the Mitie building uses automated alarms, remote systems management, machine learn- ing and data analytics to achieve a 95% accuracy rate for predictive main- tenance calls and a 3% improvement of energy usage by clients.
By the time we hit high school, Darrell Knight’s simple, push-button, red-hued LED watch had been eclipsed by a series of LCD watches that integrated features like alarms (with music, no less), stop watches and the ability to track multiple time zones. And while today’s smart buildings have shown great advances over the last two decades, the pace of technology promises to have an even greater impact on this sector.
Those keeping track of our ongoing Top Tech series will know that this regular blog is aimed at highlighting some of NAI’s key tech partners and the game-changing solutions they bring to the commercial real estate (CRE) space. These are not sponsored blogs, but rather a way for us to share tools, technology, and ideas that are changing CRE for the better and streamlining and improving the services we offer.
This month’s partner is Apollo Energies. Below we discuss their approach to creating carbon-free properties and helping clients hit ambitious Environmental, Social, and Governance (ESG) goals.
What does Apollo Energies do?
The starting point for Apollo’s commercial services is typically an energy audit that helps clients determine the best way to streamline their building’s operations and bump up energy efficiency. Apollo also advises clients on how to meet safety, health, and wellbeing requirements in line with today’s ESG standards.
In recent years, there’s been an increasing push for corporate entities to meet sustainability commitments and to be able to show their progress. ESG criteria, which detail the goals these companies must meet, are also being used by investors and the public to evaluate the impact that company has on society and the environment.
With a focus on the ‘E’ of ESG, Apollo aims to help its partners meet the right goals, and lower their own energy spend in a clearly documented and reportable way. Their approach includes evaluating carbon emissions from a company’s operations, reducing carbon tied to power use, and assessing the carbon impact of the enterprise’s supply chains.
They also work with clients to meet benchmarks for Energy Star® certification, identifying their buildings as top performers in energy efficiency and ESG accountability.
The results of this focus and dedication are certainly impressive, and one of the reasons Apollo are a top choice among NAI brokerages across the country. At time of writing, the company has improved some 52 million square feet of building space and saved nearly 7.5 million kilowatt-hours (kWh) of energy across their client base.
There’s no getting around it – the last couple of years have not been kind to the office sector. The way we work and use office space is also changing, leading to what many consider a fundamental shift in how business, and office real estate, operates. While some consider these developments a chance to reevaluate what adds value in office, for others 23the signal is far more bearish.
Recently, Bisnow reported on a study that falls into the second camp, stating that office values are set to drop by $500 billion by 2029. Reasons given for this dramatic downturn included work-from-home and the resulting change in office risk premiums.
Breaking down the office downturn
The study in question, titled: “Work From Home and the Office Real Estate Apocalypse” suggests that 2020’s losses are just the beginning and that the sector should buckle up for a rough few years ahead.
The authors, focusing on data from the New York market, say that office should prepare for a 28% decline in value in the long run. Drivers of the decline include changes in lease revenues, office occupancy, lease renewal rates, and rents. They add that the impacts are much heavier for ‘low quality’ office buildings, and we can expect the ongoing ‘flight to quality’ to buffer the effects for high-end properties.
Another angle on office
It’s a pretty dire set of predictions for the sector, but, as is often the case, there’s some strong disagreement from other analysts. In a recent report, Moody’s Analytics painted a somewhat different picture, stating: “A two-year onslaught of gloomy, sometimes hyperbolic headlines about the future of office and cities could give casual observers the impression that urban areas are on a course to become post-apocalyptic ghost towns… However, doomsday headlines are at odds with empirical office performance.”
Moody’s went on to highlight that many office markets rebounded strongly in 2021, and that office loan delinquencies are still low, despite economic uncertainty.
Interestingly, the Moody’s analysis also points out that the New York market was one of the hardest hit in terms of rent growth, but that rent and occupancy decline is still less than what’s been seen in past cycles. They add that, overall, the evidence for a sustained decline in office occupancy or value is lacking, and that tenants are still signing and honoring lease agreements.
Moody’s takeaway from all of this? In the words of the report: “The office apocalypse is clearly on hold.”
A balanced view
As the above viewpoints show, the future of the office sector is a topic that currently generates a lot of strong opinions. How things play out in the long-term, however, remains to be seen. For our part, we’ll keep a practiced eye on the sector as prospects, and opportunities, continue to unfold.
SOCIAL: What have your own observations been of market trends in the office space this year? And what’s your go-to source when dealing with conflicting market information?
We have experienced, either directly or indirectly, all sorts of changes over the last few years. We are paying more at the pump each time we fill up, we are waiting longer for certain products that may or may not show up and we probably know companies that are desperate to hire workers that simply cannot turn up.
As we continue through a summer of uncertainty, the questions are not just increasing but also getting tougher. Everyone wants answers but few know where to look. This month, I’m going to review some of the most common economic indicators. When viewed collectively, these can provide significant insight.
Gross domestic product (GDP)
This is a basic measure of overall production for the U.S. economy, including the value of all finished goods and services that were produced in a given time period. During times of expansion, the GDP will increase. Real GDP will include the impact of inflation while nominal GDP considers the current market prices. This measure is produced by the Bureau of Economic Analysis, which is a division of the Department of Commerce. It is reported each quarter, generally released within four weeks of the end of the quarter. Most will use the associated change, on a percentage basis, from one quarter to the next. For the most recent quarter as of press time, first quarter 2022, GDP decreased 1.6%.
Consumer price index (CPI)
This tracks the changes in prices for what is considered a market basket of consumer goods and services. These include items such as energy, food, apparel, education, new vehicles and medical services, among others. As such, it is also the most common measure of inflation. CPI is tracked and produced by the Bureau of Labor Statistics and can be sorted by various base indexes and geography, but the most common is the All Urban Consumers (CPI-U). This index increased 1.0% in May 2022 and 8.6% over the trailing 12 months. The report is produced monthly and is generally available within two weeks after the end of the month.
U.S. unemployment rate This measures the total number of workers currently unemployed as a percentage of the total workforce. It is also tracked and produced by the Bureau of Labor Statistics and, similar to CPI, it can be broken down by job sector, such as Transportation & Warehouse, Construction and Manufacturing, as well as by geography. The unemployment rate for May 2022 was 3.6%. This index is produced monthly and generally available the Friday following the last day of the month.
Consumer spending This tracks consumer spending on goods and services by U.S. residences. It is similar to GDP in a few ways. First, it will increase during times of expansion. Second, it illustrates the change, on a percentage basis, from a previous time period. And finally, it is produced by the Bureau of Economic Analysis, who also produce GDP. This index was up 0.9% in April and 6.3% over the trailing 12 months. It is produced monthly, generally released by the end of the last weekday of the following month.
As we head into a summer of uncertainty, the questions are not just increasing but also getting tougher. Everyone wants answers but few know where to look.
Home sales This measures sales volume and prices of existing single-family homes in the U.S., including condos. It also breaks down the country by geographic regions. As with many of the indicators, a common metric is the percentage change from the prior period. This measure is tracked and produced by the National Association of Realtors (NAR), who publish it monthly. It is typically released on or about the 20th of the following month. For April 2022, home sales decreased 3.4% but the median sale price exceeded $400,000 for the first time ever, coming in at $407,600.
Housing starts This report tracks housing starts, as well as building permits and housing completions, associated with privately owned, single-family homes. Like many of these indexes, the information can be separated on a regional basis and is produced each month. It is produced on a joint basis by the U.S. Census Bureau and the U.S. Department of Housing. For May 2022, there were 1,549,000 housing starts, which was a 14.4% decrease over the starts in April. It is typically released on or about the 15th of the following month. Federal Reserve beige book If anyone has their finger on the pulse of the U.S. economy, it’s the Federal Reserve – or, as discussed next, perhaps they are the pulse. Eight times a year, they publish a compilation of reports collected from each of the 12 regional banks that make up the system. The result is a sampling of information; some is anecdotal, and some is statistical but all of it is insightful. The most recent edition came out June 1, with future editions scheduled for July 13, September 7, October 19 and November 30. Federal Reserve meeting Few events have more impact on the U.S. economy than the regularly scheduled meeting of the Federal Reserve Board. At these meetings, all sorts of decisions are made directly related to monetary policy, including the (in)famous discount or federal funds rate. The most recent meeting in June 2022 sent shockwaves worldwide when the Fed raised interest rates by 0.75%. This is the largest increase since 1994. The Fed meets a total of eight times a year, with the remaining meetings scheduled for July 26 & 27, September 20 & 21, November 1 & 2 and December 13 & 14. The list above is by no means all inclusive, as there are all sorts of other meaningful and insightful indexes, reports and surveys available. The key is to focus in on a group and consistently track it every month. As the old saying goes – the past is history, and the future is a mystery. But indexes and reports can definitely help to make today a present.
Few events have more impact on the U.S. economy than the regularly scheduled meeting of the Federal Reserve Board. At these meetings, all sorts of decisions are made directly related to monetary policy, including the (in)famous discount or federal funds rate.