What are the Current Challenges and Opportunities for Real Estate?
Commercial Real Estate
Real estate plays an essential role in the U.S. economy. On one hand, investors could argue that the sector appears primed to benefit from market opportunities, however, the sector also faces several challenges going forward. This article explores the current economic climate and discusses what supporting and detracting factors exist for the real estate environment in the U.S. today.
The U.S. economy has been growing steadily since June 2009 in what a 2018 CNN Money feature described as one of the longest-running economic expansions in the country’s history.
To cite just two examples of the strength of the economy as of mid-2018, consider the following charts:
The first, from the U.S. Bureau of Labor Statistics, shows that in the months after the 2007-2009 recession, the unemployment rate for ages 20 years and over had peaked at 9.3% in October 2009. It has since returned to (and dipped below) pre-recession levels at 3.4% through May 2019, representing a 17-year low.
The second example is Consumer Confidence, which is the degree of optimism on the state of the economy, expressed by consumer activities of spending and saving. The chart below shows that U.S. Consumer Confidence reached a 14-year high in March 2018.
This commonly used indicator could represent more good news for the economy because, as Business Insider reported earlier in 2018, consumer spending now accounts for approximately 70% of the entire U.S. economy.
The U.S. economic news has been so positive, in fact, that many investors today worry the economy could be due for a downturn. As this current bull market nears its 10th straight year and could become the longest-running period of economic growth in U.S. history, concerns about a correction may grow.
The combination of these factors has many investors wondering where to place their capital, and whether to focus primarily on attempting to grow their wealth or simply to preserve it. One type of asset that has historically come in and out of favor, depending on the economic climate, is real estate.
Real estate is cyclical and is affected by changes in the stock market. One specific category of real estate that has grown considerably in popularity among investors in recent years is Real Estate Investment Trusts (REITs). REITs are professionally managed organizations that purchase and operate commercial real estate properties to generate both ongoing income and equity appreciation for their investors.
Although they were signed into law only 60 years ago, REITs have already grown to a $1 trillion equity-market capitalization representing almost $3 trillion in real estate assets, as the nationwide REIT association NAREIT has pointed out. As popular as these investment vehicles have become, however, real estate (and thus REITs) in the coming years could face several challenges:
An expanding economy could lead to new business formation and the growth and expansion of existing businesses, all of which can also lead to increased demand for real estate. The converse, however, might also be true: A weakening economy can hamper demand for real estate, which can put downward pressure on the performance of existing commercial properties. This could negatively affect real estate, particularly investors focused in the types of properties, industries, or geographical regions that are most severely harmed in an economic downturn.
As Forbes has written, rising interest rates can signal a strong, growing economy, which often suggests that real estate is expected to continue to perform well. It is important to keep in mind, however, that the U.S. economy has enjoyed historically low interest rates for years, and a sudden or significant spike in rates could slow available capital for commercial real estate development, which could undermine some real estate-based initiatives.
With the proliferation of REITs in recent years, there is an increased likelihood that some of these organizations are being managed by leadership teams that lack sufficient knowledge and experience in real estate, finance, underwriting, and other disciplines necessary to successfully run these complex organizations in the case of a market downturn. In other words, selecting the right management team for an investment in real estate will become increasingly important. Additionally, ensuring an investment in real estate is spread across different geographies and sectors may reduce overexposed risk in any one concentrated sector or location.
Despite these potential challenges facing real estate in the coming years, this asset class also provides some potential advantages for investors. Here is just a partial list of the factors pointing to the possible opportunities for individuals investing in real estate:
As the national unemployment chart in the introduction shows, joblessness has been held below 5%, which economists have historically considered a mark of “full employment,” for more than a year. If this trend continues, it is a good indicator that more businesses will require real estate, a potential boon to REITs invested in commercial properties such as office buildings, manufacturing plants, and other facilities that house a business’s workforce.
As USA Today reported at the end of 2017, the median U.S. household income had risen for the second year in a row. Boosts in workers’ paychecks also translate to more consumer spending (70% of total GDP, as we pointed out earlier), which can fuel more demand for real estate for manufacturing, retail stores, warehouses and distribution centers, all of which could boost returns for REITs that own and operate such properties.
With more than 75 million living members, Millennials now represent the largest living generation according to a recent report in the Washington Post. As more Millennials become independent, join the workforce and rent their own apartments, their sheer numbers are expected to boost demand for several types of commercial real estate, from multifamily residential properties to office buildings.
The financing environment is also supportive of commercial real estate. As Forbes reported at the end of 2017, a Federal Reserve study found that bank loans for U.S. commercial real estate projects had become so robust that they surpassed pre-recession levels. The study notes several factors contributing to banks’ continued confidence in U.S. commercial real estate: low interest rates, growing demand for apartment units, and foreign investors’ continued interest in U.S. real estate. The accessibility of financing could potentially help real estate managers add to and improve their portfolios of properties.
Finally, the emergence of a new category of REIT, non-public traded REITs that pool small investments from a large number of individual investors, have made investing in REITs that are not traded on major stock exchanges (once available only to high-net-worth investors) accessible for the first time to average investors.
With many macroeconomic indicators suggesting the commercial real estate market may continue to enjoy strong fundamentals and steady growth (with some bumps along the way, of course), we believe buying into a diversified real estate investment, spread across many commercial properties that are managed by a team of experts, represents a potentially viable avenue for some of your investment capital.
As we pointed out above, however, different REITs will perform differently, depending on property selection, the organization’s underlying strategy, and the experience of its management team.
All information provided herein is solely informational and not an offer or solicitation of any specific securities, investments, or investment strategies. Nothing contained herein constitutes investment, legal, tax or other advice and should not be relied upon to make an investment decision. This may contain forward-looking looking statements and projections that are based on current beliefs and assumptions we believe to be reasonable. Such statements involve risks and uncertainties with investing and nothing is guaranteed.
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