As 2022 begins, it seems hard to believe that we are entering the third year of a once in a century pandemic that has impacted nearly every aspect of our daily lives. From a commercial real estate investment perspective, COVID is still the headline story driving the macro trends that we are likely to see in 2022.
In this article, we are going to discuss the commercial real estate outlook for the coming year. By the end, readers will be aware of the major forces that are expected to shape CRE markets in 2022 and will be able to use this information as an input in their own capital allocation decisions.
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At the outset of 2022, there are four major headlines that are expected to be the driving forces in commercial real estate markets.
Inflation is the gradual rise in the price of goods and services and it is on the move. After more than a decade of relatively minor increases, a variety of factors have combined to send inflation soaring. In fact, the December 2021 inflation reading indicated a rise of 7%, which is the fastest pace since 1982.
What does it mean for investors? It is a good news/bad news scenario. The good news is that commercial real estate assets are one of the safest places to park capital during periods of high inflation because rents and values also tend to rise. But, it also means that the Federal Reserve is likely to increase interest rates, which makes capital more expensive for commercial real estate investors.
Interest Rates Are Going Up
To combat inflation, one of the primary tools in the Federal Reserve’s arsenal is to increase interest rates. Moving into 2022, this will happen in two ways. First, the Federal Reserve will “taper” their quantitative easing program by reducing the amount of bonds they purchase through March 2022, when it hits $0. This will cause long term rates to rise. In fact, the rate on the 10-year US Treasury has already topped 1.9%, which is a multi-year high.
Second, the Federal Reserve has also indicated that they plan three or more hikes of the “fed funds rate” in the coming year in an attempt to tame inflation. These hikes increase short term interest rates.
What does it mean for real estate investors? Again, this means that the cost of capital is likely to rise in the coming year. Existing properties that are financed with variable rate debt may be particularly vulnerable to rate increases because their required debt service will rise, leaving less money available to distribute to investors.
Home Price Affordability
In the most popular housing markets, like Los Angeles, home prices continue to rise, outpacing wage increases and making home ownership less affordable for median wage earners. The most logical solution is to increase density with a slew of new multifamily properties, but rent growth is outpacing wages as well.
What does it mean for commercial real estate investors? There are two major implications. The first is that there will be increased competition for well located existing multifamily properties, and high demand for the development of new ones. The second implication is that individuals will continue to move further from city centers in search of affordability. New commercial development – office space, retail space, self-storage, data centers, etc – will be needed to support this migration. Both present opportunities for investors.
Shortages.. Of Everything
The fourth major headline is that there are shortages of everything, including labor, food, gas, computer chips, and automobiles. This is because COVID safety protocols at factories, at ports, and on ships have created historic supply chain disruptions. The impact to businesses is material and, if prolonged, could impact their ability to pay rent.
So, it is against the backdrop of these headlines that the commercial real estate trends for 2022 take shape.
Commercial Real Estate Trends To Watch in 2022
It can be difficult to predict what is going to happen in the future – especially in a market as dynamic as the commercial real estate industry. But, at the dawn of 2022, there are six trends to keep your eye on in the coming year.
Generally, The Outlook Is Good
Despite the challenges described above, the CRE outlook for 2022 is generally pretty good. In their 2022 outlook, CBRE notes that:
“CBRE is maintaining a positive outlook for the economy and commercial real estate in 2022, despite uncertainty over potential impacts of the COVID omicron variant and other risks. While the new variant will impact the timing of a large-scale return to the office, fiscal and monetary policy remains highly supportive of economic growth….the factors that held back growth in 2021—labor shortages, supply disruptions, inflation and other COVID variants—will ease. Monetary policy will tighten to keep longer-term inflation pressures in check, which may trigger some short-run volatility in the stock market, but it will not be enough to dampen investor demand for real estate.”
The outlook appears to be particularly strong for cities. CBRE goes on to note “A notable trend in the second half of 2022 will be the return of downtowns. As business and tourist travel picks up, we will see a sharp revival in the hotel sector in gateway cities, alongside the already recovering food & beverage sector. This, in turn, will stimulate the return to the office and the fuller recovery of downtown life.”
ESG Concerns Will Come to The Forefront
“ESG” is an acronym that stands for Environmental, Social, and Governance. It is a shorthand way of referring to the fact that investors/tenants are beginning to demand more responsibility from their operators/landlords. They want to see technology and initiatives that make properties more energy efficient and they want to see more diversity at all levels of management.
In their report, “The Impact of Social Good on Real Estate” Deloitte cites ESG considerations as a major value driver for commercial real estate investment. Specifically, they say “ESG is therefore here to stay and will increasingly shape and influence real estate valuation, and therefore real estate investment, as investors wish to allocate their commitments under this banner.”
Cost Containment & Operational Efficiency
Rising interest rates and the increasing cost of capital will put pressure on operators to contain costs in order to maintain the same levels of profitability. To accomplish this, they may push certain costs to tenants (like utilities), harness technology tools to run more efficiently, or cut back on non-essential operating costs. In short, the property management function will take center stage to ensure that profitability is maintained and occupancy levels remain high.
Retail Continues to Adapt
Of all of the commercial real estate property types, it can be argued that none has experienced more change than the retail sector. This change has caused many to opine that ecommerce and Amazon have forever damaged the retail landscape. They are wrong.
Retail continues to be more vital than ever, but it is beginning to take a different shape. In their 2022 Retail outlook, CBRE notes that:
“The retail sector is recovering relatively well from the pandemic’s major disruptions. Existing retail space is more efficient, with sales per sq. ft. improving due to few new stores being built and rising retail sales. The mall sector, thought to be in deep peril, is experiencing foot traffic above pre-pandemic levels and reporting double-digit sales growth. Investors, meanwhile, are taking a fresh look at retail’s attractive yields compared with other asset classes. In addition, record levels of venture capital are targeting retail-focused companies.”
Further, existing retail space has emerged as a compelling solution to the “last mile problem.” That is to say that retail stores will continue to convert sales floor space into distribution/logistics space to handle online orders and in store pickups.
Digital Real Estate Will Continue To Grow
Commercial real estate property types that support continued digital transformation efforts – like data centers, cell phone towers, and industrial real estate – will continue to see strong growth. This means high occupancy, healthy capital inflows, and stable cap rates.
Hybrid Work Goes Mainstream
Many employees would like to work from home full time, but many companies would like their staff back in the office. A hybrid work environment appears to be emerging as a happy medium for both groups. This will no doubt have a major impact on the office market as larger companies shift away from massive corporate campuses and towards smaller, regional, satellite offices.
So, What Does This All Mean For Investors?
Identifying trends in the commercial real estate market is one thing, but translating this knowledge into an actionable investment strategy is something else altogether.
Given the continued change, rising mortgage rates, and inflationary pressures, we think it is wise to take a back to the basics approach and to focus on the fundamentals of each new deal. This means strong tenants, conservative growth assumptions, fixed rate debt, growing markets, and excellent locations. When we look at these factors, we believe that it validates our current strategy, which is to invest in high quality, well located, grocery store anchored retail centers. This strategy is further validated by CBRE’s Retail Outlook, which states that “with grocery-based e-commerce expected to grow by more than 20% in 2022 and double by 2025, grocery-anchored centers will remain the gold standard of retail investment.”
Final Thoughts on the 2022 Outlook
For the commercial real estate sector, the headlines at the dawn of 2022 are rising inflation, rising interest rates, continued shortages, supply chain disruptions, and ongoing housing affordability issues.
Against this backdrop, the outlook for commercial real estate assets is generally strong.
Major trends to look out for include: the rise of ESG concerns, proactive cost containment and operational efficiency efforts, the continued adaptation of the retail sector, and more widespread adoption of hybrid work environments.
For investors, all of this change will bring the focus back to the fundamentals of commercial real estate investment. Those properties that are conservatively underwritten, with strong fundamentals stand to benefit the most.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. We leverage our decades of expertise and our available liquidity to find world-class, multi-tenanted assets below intrinsic value. In doing so, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
If you are an Accredited Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or firstname.lastname@example.org for more information.