On January 19th, Graaskamp Center Executive Director Mark Eppli delivered his annual presentation on his 2022 real estate forecast and outlook. He kicked off the presentation by providing some context for the current economic climate, underscoring the unprecedented fiscal stimulus and staggering amount of household savings. He also noted that much of that stimulus remains unspent — wealth is up $32 trillion since Q1 2020, and the top 1% now has one-third of the wealth.
Eppli then dove into what this means for corporations and how they might reposition themselves to sustain operations. After the Great Recession, many companies cut expenses drastically to improve their bottom line, but it is nearly impossible to do that today due to rising wages, higher costs, and a tighter labor market. One way companies can continue to drive growth and profits is capital investment, which bodes well for real estate as it remains an attractive alternative investment.
As for the labor market, there are roughly 10.5 million job openings and 7.5 million people unemployed. In the past 6 months, we have seen the highest quit rate ever recorded, largely attributed to employees not wanting to abide by mandates and finding better opportunities.
Eppli believes that the 4.8 trillion fiscal stimulus was likely too much, evidenced by the record inflation we are currently experiencing, and believes that it will get worse than the Fed expects. In addition, implied inflation is projected to be 2.8% over the next five years.
For some good news, private equity is abundant, as is real estate private equity. Eppli is bullish on private equity investment remaining active in the real estate markets. Monetary and fiscal stimulus has banks and capital markets awash in funds, which will keep rates relatively low.
As real estate investors require higher returns than BBB bonds provide, real estate investments have been seen as less risky, cap rates have been falling, yet property values have been appreciating due to NOI growth. However, the current spread between cap rates and U.S. Treasury yields is roughly 3.1% (compared to the 2.7% on average). This means that real estate assets are still priced fairly well right now.
Eppli also spent time reviewing each of the major property types and how they might fare in the future under the current economic conditions. After a very strong couple of years, he expects industrial properties to continue to do well, with distribution outperforming through 2023 into 2024, then a possible shift to flex space. However, he fears that we may face overbuilding in this space due to the worker shortage and supply chain disruptions aggravating the need for distribution space. He expects multifamily properties to continue to stay balanced, due to the massive housing shortage in the United States as well as the increased construction costs. Retail properties face many challenges with e-commerce, but brick and mortar retail has potential to do well. Eppli offered a bleak outlook for office buildings, evidenced by the very low rates of returning to work and WFH trends.
In short, there are many variables to consider in determining where the real estate industry is headed. Although cap rates will drift higher, asset prices will likely continue to grow due to strong NOI performance. Risk premiums will be squeezed as banks have significant access to capital due to high deposit rates, which will encourage them to lend. Eppli believes these factors will likely drive real estate transaction activity in the short and medium term.