By Victoria Rock
Real estate markets are rising—but not that fast. This presents opportunity to investors.
That’s what people like about real estate: it moves slowly and is not that affected by the daily swings in the markets. Long-term trends can—and will—affect real estate positively or negatively, but despite raucous political and economic news, real estate just continues to offer a safe harbor for clients.
Real estate investment products can offer superior risk-adjusted returns. Lower volatility is another advantage. Given generally low, or even negative, correlations with stocks and bonds, real estate also can also provide diversification.
Market conditions for real estate are positive from a supply-and-demand standpoint; the fundamentals remain positive; and in many ways markets keep improving.
Growth in the U.S. economy is strong, slow and steady, putting up solid quarterly GDP numbers. Unemployment is at historic lows and consumer spending continues to rise. Those factors are very positive for real estate overall, specifically for industrial, multifamily and office.
Supply-and-demand metrics remain key. New supply is historically low, yet people who aren’t in the industry may look around many cities and say, “There are a ton of construction cranes on the skyline and people are building all over the place.” The fact remains that deliveries of new properties are way below historical averages, in all property types. Demand far outpaces supply.
The U.S. Federal Reserve has already increased interest rates four times. Real estate has been largely unaffected. The industry is more impacted by labor and building materials’ costs. Those have ticked up but not necessarily because of inflation, and building continues.
New property development profitability projections remain in the mid-20s. If that ever falls below 20 or 15 percent, it could turn off development. Nothing near that level looms, even a few years out.
However, if inflation does continue to creep up (in conjunction with growing GDP, which is happening now), it could bode well for real estate: rents often rise as demand for space persists. With inflation hedges built in, real estate also can provide steady income potential, in different market climates.
Tenants—in apartments, industrial, offices or retail—are absorbing what new supply is being delivered. In retail, little new supply is being delivered by nature of what is happening, namely the e-commerce revolution; but in the industrial sector, properties cannot be built fast enough to meet mounting demand.
Obsolescence also plays a role. A huge paradigm shift is happening in the way tenants utilize space in industrial, office, retail and multifamily properties. These days commercial tenants do not want buildings with offices, small windows, low ceiling heights and pillars everywhere; they want open floor plans with modern amenities including cafeterias and agile work spaces. The same goes for apartments.
Take a warehouse built in 1990, a 30-year-old property built expecting a 50-year lifespan, that has become functionally or locationally obsolete. This can be caused by inadequate parking ratios, insufficient clear heights, number of doors, number of docks. Some of these properties are no longer fit for what tenants need now.
An additional 7 percent of existing warehouse stock is expected to surpass the obsolescence threshold over the next 5 years: potentially 500 million square feet of space that will have to be redeveloped or turned down and newly developed. There should be huge opportunity there.
To wit, Home Depot, America’s largest home improvement retailer, announced they will invest over $1.5 billion into their e-commerce business. This will include opening 170-plus new “last mile centers,” distribution hubs close enough to consumers to offer one-day delivery. They will also build eight to 10 one-million-square-foot regional logistics and distribution fulfillment centers.
Demographic trends, especially in the U.S., are positive for real estate. Millennials are about to hit their peak spending years’ highest consumption level, which should last the next 20 years and by and large millennials prefer to rent than buy property. Behind them is the even bigger Generation Z cohort. Demand for new U.S. household formation, new job creation and spending have huge demographic support that can counteract other factors.
All told, this may be a good time to invest in real estate.
Victoria Rock is the head of Alternative Products at Legg Mason. Her opinions are not meant to be viewed as investment advice or a solicitation for investment.