To say that the coronavirus has wreaked havoc across the world and has directly affected every corner of the world is a gross understatement. While some commercial and industrial sectors have benefited from this phenomenon (think logistics and cold storage), others continue to reel from the full force of the pandemic. In the process, underwriting operations have also changed.
A logical methodology when examining these changes in how investors view real estate investing is pre-pandemic, pandemic, and now.
Even before the pandemic, it was clear that investors felt strongly that real estate was a low-correlation asset class (versus stocks and bonds) in their portfolios. As a result, institutional investors have increased their exposure to real estate over the past decade. Additionally, major pensions, endowments, and foundations have invested more than 10-15 percent in their real estate allocations. This was reflected in asset prices and demand for commercial real estate. This has expanded far beyond traditional real estate types to include interest in niche areas such as self-storage, cold storage, seniors, students, and medical clinics. Historically, all asset classes have benefited tremendously from $40, especially leveraged real estate. Interest rate environment is declining year by year. The amount a buyer is willing to pay is correlated to the acceptable risk above the risk-free rate. That is the US Treasury. And the attractive return range is from 100 basis points to several hundred basis point spreads. When the pandemic hit, many models literally broke.
First, interest rates have fallen significantly, lowering cap rates and greatly accelerating exit opportunities. In the original property business plan, the owner assumed that it would take him 5 to 7 years to realize a profit, but as the property value increased significantly in a short period of time, he sold it and realized a significant profit. I was able to do.
Another area that has changed significantly is the fundamentals of supply and demand. However, the demand side is larger in terms of rent increases due to remote work. In some coastal markets, where large-scale shifts in immigration were not anticipated, rent growth exploded or evaporated.
Changes in this dual factor have affected the assessment of regions that are particularly attractive for migration: the Mountain West, the Sunbelt, and the South-Southeast. And the last part was the lack of supply in those markets. The combination of an increase in occupancy, as well as a lack of supply, had a significant impact on rents and rent growth.
Unlike at the beginning of the pandemic, the opposite scenario is now unfolding. This means there is no longer strong pressure on immigration. Demand pressures are not as strong in some large cities, where there is currently a magnetic repulsion for workers in tougher employment situations. The second part is that there is a lot of supply because demand is moving towards cities with lower supply constraints. So there were no restrictions on construction in the Texas or Florida markets. This supply is coming online, but there are headwinds to rent growth.
Another factor is insurance in general, where risks have been underestimated over the past decade. Whether it’s global warming or large-scale natural events, insurance prices in coastal areas have increased two to three times over the past two to three years. Therefore, expenses are increasing much faster than revenues, rapidly eroding NOI and bottom line investment returns.
The final and most impactful issue is interest rates moving from zero to closer to 5%. Not only have interest rates increased, but the system-wide strain has led to a massive deleveraging of all financial assets. There is a lot of pressure on most financial institutions not to lend to certain types of real estate. The multifamily lending market is fluid, with loans available from Fannie, Freddie, and many other financial institutions, but the local banking community, which has historically been a major player in this space, is currently sitting on the sidelines. The same goes for offices and retail. Assets are untouchable.
In summary, the CRE industry has gone from a dramatic pre-pandemic response of falling interest rates to a pandemic where interest rates have fallen to rock bottom, rent growth has skyrocketed, and transaction volumes have increased. And today, the opposite situation is reflected. That means low rents or rent growth receding, interest rates rising, insurance premiums rising, and values plummeting.
Based on our conversations with customers, our customers’ attitudes regarding their investment appetite range from wanting to bury their heads in the sand, to being more confident, to thinking this is the best investment opportunity of their lifetime. It varies. From an optimist’s perspective, the data shows a lot of opportunity, but more work is needed to unravel those needles. What is certain is that underwriting activity for all customers has increased sharply in relation to the number of deals investigated compared to closed deals.
Thomas Foley is CEO and co-founder of Archer, a real estate technology company. Foley is a serial fintech entrepreneur whose work has focused on helping investors invest in startups (Xpert Financial), managing startups’ fundraising processes (CapRally), and helping investors invest in alternative assets (Venovate). I have been running a business with For the past four years, Foley has worked as a director in the investment sales team at JLL and he at HFF. He earned his MBA from Wharton’s Executive MBA program in San Francisco and earned a bachelor’s degree in economics from UCLA.