Our outlook for real estate investing
A new cycle emerges in 2021.
As we enter 2021, the U.S. faces a markedly different real estate investment landscape than it did just a few months ago. After navigating a stormy 2020, shaped by the massive uncertainty caused by the COVID-19 global pandemic and the presidential election, we believe that clearer skies are on the horizon.
In late November 2020, Green Street Advisors updated its economic forecast, estimating 3.8% U.S. GDP growth in 2021 and a full return to Q4 2019 output levels by Q4 2021—nine months earlier than its summer 2020 forecast. With a new administration, equity markets reaching new highs, multiple COVID-19 vaccines hitting the streets, and the resumption of economic growth, it seems as if we are poised to exit the trough of the 2020 downturn and enter a new cycle of recovery in 2021.
The 2021 recovery goal is bound to focus on a return to normalcy—the caveat being that some things may not feel truly “normal” again for many years. This transition back to “business as usual” will play out differently across the various asset classes. Certain asset classes and strategies will simply continue their upward marches. Others will finally start to see the first signs of recovery, while some will only begin to feel the true ramifications of the pandemic as tenants and landlords stop relying on the “kick the can” strategies that carried them through 2020.
CrowdStreet enters 2021 with stronger-than-ever conviction around our 18-hour city thesis. As our country looks to resume growth, we’ll continue to focus on many of the same growing secondary markets we valued prior to the pandemic. But as a post-COVID twist, we’re expanding that list with the addition of select markets within the Mountain region.
With a high diversity of potential outcomes in play and an outlook of a nearly 40% increase in total U.S. transaction volume according to CBRE, 2021 should present ample opportunities for investors across a multitude of geographies and strategies.
How we’re evaluating each asset class
Although our economy is entering the early phase of a recovery, asset classes sit in vastly different positions to one another. Correspondingly, our outlook ranges from strongly bullish to defensive depending on the type of real estate and its geography. Our team sees immediate opportunity in certain asset classes, with the potential emergence of opportunities in others, the timing of which will depend upon the market’s ability to flush out any residual overhang from 2020 and embrace price discovery.
Back in January, we noted our hopes that the recovery in the hospitality sector would begin in the second half of 2021. As this property type is marked-to-market daily, hospitality is a leading indicator for the broader commercial real estate market. Recent data now suggests the beginning of a broad-based and sector-specific recovery is underway, sooner than originally anticipated.
STR is a division of CoStar Group that provides market data on the hotel industry worldwide. Heading into 2021, STR initially projected a 30% annualized year-over-year increase in RevPAR (revenue per available room), from $45.48 in 2020 to $59.12 for 2021. Its weekly U.S. RevPAR index has shown strong momentum, coming in at $66.99 for the week of April 10, a 57 week high and an astounding 87% increase over January’s reported average RevPar of $35.72.
We’re also seeing a dramatic spike in TSA daily throughput. For the first 18 days of April, TSA’s daily throughput averaged 61% of the same timeframe in 2019, hitting a high of 69% on April 3rd. April’s TSA daily throughput activity represents a marked increase over February, which averaged 43% of 2019 levels.
The March jobs report also shows how the industry is beginning to staff up for a recovery. While the U.S. added a total of 916,000 jobs in March (our strongest so far in 2021 and a meaningful step up from February’s 379,000 jobs added), what stood out was the 280,000 jobs added in the Leisure and Hospitality sector. WE have now seen 664,000 jobs added to this sector so far in 2021, a telling sign that the industry is hiring to meet an anticipated spike in summer demand.
While good news currently abounds for resurging demand in the hospitality sector, true recovery at the operating level is still likely months, if not a year away. As a result, as we evaluate select hotel deals for the Marketplace in the near term we’ll stress the strength of sponsorship first and foremost. Despite the increase in demand, the hospitality market still sits in a state of high inefficiency. The best sponsors will win the best deals at the right prices while lesser operators may be caught overpaying for less desirable assets. We will also seek to ensure that deals are prudently capitalized with adequate reserves to see them through to stabilization.
As for pricing, discounts to 2019 pricing are still obtainable but they have narrowed, a 10-15% discount is now viewed as attractive. Being in the early phase of recovery suggests the pursual of the highest quality assets in each submarket. As demand returns, it may require some time before we see normalized daily rate spreads across the spectrum of asset quality. In the interim, the highest performing assets pre-COVID may likely be the ones who absorb the lion’s share of resurgent demand.
We are still hopeful that the ensuing months of 2021 may present outstanding opportunistic and value-added acquisition opportunities. 2021 may still yet prove to be the year to scoop the bottom of this sector.
We also believe that the green light for new development is now illuminated. With signs of a faster than previously anticipated recovery for the sector, we now believe that the hospitality market could be white-hot by 2023 and, potentially, the perfect time to deliver a new asset.
Industrial Last updated – January 2021
Industrial property values steadily increased over the course of 2020 thanks, in large part, to the dramatic spike in online shopping driven by the pandemic. While the stratospheric growth rate of 2020 will almost certainly temper in the years ahead, a report published by Green Street Advisors in October anticipates that 30% of all retail sales will occur online by 2030. Translating that growth rate to demand for industrial real estate, JLL projects that the U.S. will require an additional one billion square feet of industrial real estate by 2025.
This step function shift in e-commerce sales fuels the continuation of a long-term surge in demand for logistics real estate. And, while e-commerce drives demand for certain types of assets—data centers, last-mile distribution, cold storage—it affects the entire industrial sector. Demand for older Class B properties may not be directly correlated to e-commerce sales, but they are also experiencing strong rent growth, tight vacancies, and strong renewal rates.
With asset price appreciation, leasing absorption, and tight vacancies—even throughout the pandemic—the industrial sector enters 2021 full steam ahead. We see opportunity on multiple fronts for industrial real estate.
First, odds are that heightened demand for last-mile distribution spaces will continue for years to come, likely in growing metro areas, as companies strive to ensure they are well-positioned for the future. As such, we are keeping an eye out for smaller industrial deals (typically sub-300k square feet) that cater to last-mile demand where we can find the appropriate risk/reward characteristics.
Second, we are targeting larger distribution centers (600k+ square feet) that are mostly situated in the outskirts of metros. This type of industrial real estate is directly correlated to the surging demand in logistics real estate that is being driven by e-commerce growth.
Third, we are bullish on Class B industrial real estate that caters to manufacturing uses. This type of use may not directly correlate to the growth of e-commerce, but its fixed supply and strategic positioning near population bases mean that it will remain in high demand. As the sector scrambles to fill the void in supply of distribution centers, Class B industrial owners will quietly thrive in the shadows.
Finally, we’re also keeping an eye on niche industrial projects, such as data centers. Forbes reported that, amongst REITs, data centers were the only industry segment to “show a positive gain for the first quarter of 2020, growing by 8.8%.”
See what our Chief Investment Officer, Ian Formigle, and Director of Investments, Anna-Marie Allander Lieb, have to say about industrial in 2021. Watch now.
Medical Office Last updated – January 2021
2020 was an unusual time for the medical office sector. The number of visits to certain types of facilities—mostly elective-use practices and dentists—plummeted while critical-use facilities ran at full capacity. We believe that the sector should revert to a more normal state in 2021 with the medical office sector resuming its growth trajectory, fueled by aging baby boomers and steady growth in healthcare spending. In fact, the Urban Land Institute has rated medical office as one of its “best bets” for 2021.
Over the next 10 years, the number of people aged 65 and older will grow by more than 30%. Americans in this age cohort visit the physician’s office nearly six times per year on average, much more frequently than younger people do, so growth in this demographic means an increase in demand for medical office space.
Medical office construction may also gain some momentum in 2021. More than 2.8 million square feet were delivered in the second quarter of 2020 despite a construction slowdown due to the pandemic. On a national basis, vacancy rates climbed 20 basis points to 8.9% this year, but that stands in sharp contrast with the 13.6% vacancy rate for traditional office space. Rent growth in medical office also maintained its upward trajectory, rising by 9% over the last year to a second-quarter average of $25.22 per square foot. All in all, the outlook for this sector is good.
We continue to like multiple segments of medical office but two stand out. The first is small-to-mid-sized medical offices located near hospital campuses. These facilities offer patients easier access compared to offices buried deep inside large hospital campuses and they offer hospital systems and practices lower operating costs. As a result, health professionals have been migrating from hospital campus locations to purpose-built outpatient facilities, a trend we previously pursued for the Marketplace and see continuing in the years ahead. The use of telehealth in such facilities has spiked during the pandemic and we see it continuing to gain traction post-pandemic as an evolution within the sector.
The second use is critical care uses, such as renal care. The initial lockdowns in 2020 highlighted the resilience of this portion of the medical office sector. While patients were delaying visits to their general practitioners and dentists across the country, dialysis centers continued on at maximum capacity. This factor, combined with the continued growth of the underlying tenants, leads us to believe that properties occupied by such tenants under long-term leases provide relatively attractive income-oriented investments.
Multifamily Last updated – January 2021
The availability of sub-3% Fannie Mae and Freddie Mac financing, combined with strong occupancy rates and collection rates that never dipped below 90%, placed a firm floor under multifamily pricing in 2020. With a generally improving economic outlook in store for 2021, this sector enters the new year on solid footing.
Geography mattered greatly for multifamily in 2020—rents fell as much as 20% in downtown San Francisco while they grew over 4% in Phoenix. In November, the cost to rent a one-way, 26-foot U-Haul truck from San Francisco to Phoenix was eight times the cost of the same trip in the opposite direction. Migratory patterns at the national level were in full effect in 2020 and we believe it will continue to separate the relative winners from losers during the early phase of the recovery.
In addition to disparity across metros, location within metros has also mattered as the pandemic compelled apartment dwellers to vacate urban cores in favor of more space in the inner suburbs, aka “hipsturbia.” Data at the national level showed a modest decline in multifamily values last year, but those declines were heavily weighted towards urban apartments in major metros. In markets where rents have grown, prices immediately bounced back after the initial phase of the pandemic. With transaction levels looking to increase in 2021, we expect to see a multitude of investment opportunities for the multifamily sector across an array of strategies.
The disparity in outcomes for the multifamily sector in 2020 may present a few types of investment opportunities in 2021. For our most-favored growing secondary markets, we see the ability for operators to resume core-plus and value-added strategies: improving properties in strong submarkets within growing metros, leading to increased rents and improved tenant bases. While pricing in large urban markets most affected by the pandemic may never drop to the same level of office properties, we would pursue opportunities to invest in well-located apartments in cities like New York and San Francisco at an attractive discount to 2019 values, as we see those cities bouncing back by 2024.
We also continue to like the prospects of ground-up multifamily development projects in key markets, especially those projects that will deliver late in 2021 or 2022. Fresh entitlements for new developments were muted over the course of 2020, meaning fewer competitors in 2022–2023. This strategy continues to play into a window of outsized opportunity, which means it may close by the end of 2021.
We also see opportunities in certain emerging multifamily business models. First of all, we remain strong proponents of a relatively new model within the multifamily sector called “Build-to-Rent.” Build-to-Rent communities are primely positioned to capture demand for more space and amenities from the millennial demographic and we are actively seeking investment opportunities with this strategy. We also like the adaptive reuse of converting hotels into multifamily properties for 2021, a strategy we think could help solve the country’s affordable housing crisis. Steep discounts to replacement cost for distressed hotels will translate to an all-in converted cost well below similarly appointed multifamily properties and provide a catalyst for affordable rents.
See what our Chief Investment Officer, Ian Formigle, and Director of Investments, Anna-Marie Allander Lieb, have to say about multifamily in 2021. Watch now.
Office Last updated – January 2021
We expect to see bifurcation for the office market in central business districts (“CBDs”) in 2021. Assuming we see the mass delivery of a vaccine by the summer, we believe Q3 2021 will begin to shed light on what the CBD office environment will look like moving forward. It is at this point that we believe the prevailing current six-month lease extension strategy that both tenants and landlord throughout 2020 gives way to more substantive negotiations.
On the upside, we have already seen a few trophy assets trade at record pricing in late 2020 in cities such as Seattle, Charlotte, and Dallas. For those assets, which are backed by strong credit tenants (Amazon, in the case of a downtown Seattle office tower) and long lease terms, buyers are demonstrating a willingness to pay up for certainty even in the city core.
We see mixed effects on office space demand moving forward. First, we are already seeing companies announce that some office workers can work remotely indefinitely, reducing the need for space. However, those that do come back will likely demand more space around them to feel safe. The days of the most densely occupied open offices, with as little as 125 square feet per employee, are gone for now and it’s uncertain if they will ever return.
Since office occupancy cost is a real consideration, one path to making more square feet per employee pencil is for companies to seek cheaper office space. Suburban office space is cheaper than urban office space and is available all over the U.S. It’s mostly low-rise (meaning the stairs are widely usable) and it offers employees abundant and, usually, free parking. As a result, we see a shift coming towards suburban office markets, particularly in the largest metros with the most expensive urban office space.
Finally, there is little doubt that the office sector will come under short-term pressure as a result of the current environment. Some markets may have knee-jerk reactions in the valuation of these assets and we would view those scenarios as buying opportunities, although such scenarios are likely still months away.
See what our Chief Investment Officer, Ian Formigle, and Director of Investments, Anna-Marie Allander Lieb, have to say about office in 2021. Watch now.
Retail Last updated – January 2021
Similar to hospitality, the retail sector should see an uptick in transaction volume following the nearly non-existent market in 2020. However, unlike the hospitality sector which we believe will begin to experience a broad recovery from a uniformly devastating year, we view the recovery for retail as uneven and with less velocity.
A post-pandemic recovery for retail may look a lot like consolidation. The handful of best-located centers within each submarket should bounce back reasonably well. Even if these desirable assets experienced a spike in vacancy in 2020 due to COVID-19 induced tenant failures, they should be able to readily backfill those vacancies with other survivors who are eager to upgrade their location. However, weaker assets—those which are older and were beginning to struggle prior to the pandemic—give us the greatest concern. Some may simply not recover. As a result, the highest and best use of their real estate may ultimately be to redevelop them into residential, self-storage, or even last-mile distribution uses, all of which could harness their well-trafficked locations and easy accessibility.
We view grocery-anchored shopping centers as the best investment opportunities within retail right now. As such, we’ll be looking for grocery-anchored deals with a combination of strong grocery sales, high traffic counts, and a mix of inline tenants that we believe can bounce back in 2021 as we regain a level of normalcy in our lives. We will seek them at compelling prices that offer strong prospects for attractive risk-adjusted returns.
In addition to grocery-anchored centers, we see the possibility of one-off opportunities for well-located shopping centers. If we are able to source a situation where a strategically-located center within a submarket is trading at a compelling basis relative to its 2019 value, and we believe the center will emerge from likely future consolidation as one of the winners, we will likely pursue it.
Self Storage Last updated – January 2021
As expected, self-storage has demonstrated resilience throughout the pandemic. Numerous operators in our portfolio have commented on their ability to lease units in 2020 while continuing to increase rents.
The biggest question surrounding self-storage has historically been its supply growth, but that concern now seems to be abating. According to Green Street Advisors, the anticipated rate of annual new supply from 2020 to 2024 is just over 3%, substantially lower than the 5.25% annual rate of new supply growth the sector averaged from 1995 to 2009. With continued growth in demand and, now, relatively muted supply, self-storage appears to be poised for a good run over the next four years. The outlook for net-operating-income (NOI) growth between now and 2024 ranks a solid third, behind only manufactured housing and industrial.
As an asset class that is still maturing and becoming more institutional in nature, we continue to like ground-up development and adaptive reuse storage opportunities. Our bias is partially due to the abnormally large spread between a typical stabilized yield on cost to develop (or redevelop) self-storage properties (typically ranging from 8–9%), versus the typical exit cap of a stabilized self-storage property (roughly 5–5.5%). This means a sponsor can often sell a stabilized self-storage property for 40–45% more than the cost to build it, while a stabilized apartment community, for example, would fetch roughly 20–25% over its total development cost. As a result, new development and redevelopment opportunities present attractive risk-reward possibilities, although they still rank high in absolute risk.
While self-storage properties do typically take longer to stabilize than other properties, we believe this outsized spread is largely attributable to the insatiable demand from the public REITs, most notably Cube Smart and Extra Space, to acquire stabilized assets for their portfolios with their relatively cheap cost of capital. When we seek new development or redevelopment opportunities, we look for growing metros with a relative dearth of supply, namely five square feet or less of self-storage space per capita within the primary market area.
Senior Housing Last updated – January 2021
Senior housing entered 2020 already facing headwinds attributable to oversupply. The onset of the pandemic added yet another obstacle in the path of this struggling asset class. As expected, we have seen the rates at which new residents move into senior housing facilities slow dramatically over the course of 2020. However, almost surprisingly, many properties have still been able to lease to new residents during the pandemic, so new resident growth for the sector may not be as bleak as one might assume.
Despite a challenging market, there are a few bright spots for the sector. One benefit of the pandemic has been a reduction in resident turnover. Senior housing properties that were already stabilized heading into the pandemic have performed relatively well.
The brightest light at the end of the tunnel for senior housing is the fact that we are now less than four years away from the first wave of Baby Boomers turning 80 years old. As the industry has become increasingly aware, the average age of a new assisted living resident continues to increase, climbing from 82 to 84 years old in recent years. As we transition from the Silent Generation to the Baby Boomer generation as the primary target demographic, the senior housing sector will likely see a massive influx of demand. This sector will thrive again one day, especially as our population ages.
The current state of the senior housing industry may provide an optimal window to acquire assets at significant discounts to replacement cost. While we don’t necessarily expect an immediate rebound to occur for the industry, if we are able to identify assets at compelling prices in 2021, we could see scenarios where assets are positioned to perform remarkably well by 2024–2025 when we expect the eligible resident population to begin to balloon. As a result, we are approaching this sector cautiously but with an eye towards potential opportunities to partner with best-in-class operators on deals priced at compelling discounts to pre-pandemic trades.
Student Housing Last updated – January 2021
Sometimes a major shock causes a shakeout of a market and brings clarity to its outlook. With student housing, we believe we experienced that market-defining event in 2020. The roller coaster ride from March to October (trending from school shutdowns in the spring to record enrollment for some schools by September) shed light on who the most likely winners are going to be this cycle. No other asset class has provided this much clarity this fast. And given its inefficiency, we believe the market has not yet fully digested these events and priced in its outlook.
For 2021, we see a dichotomous market for student housing. We expect the momentum to continue to shift towards the larger universities in major conferences at the expense of smaller and weaker institutions. In addition, with an unusually large number of 2020 deferrals attributable to the pandemic and an expectation of unemployment levels to remain at elevated levels, the outlook for fall 2021 enrollment is good.
We see opportunity in Tier I, major conference, student housing offerings for the Marketplace. We expect that the most desirable and best-capitalized universities will continue to exploit the competitive advantages they demonstrated in 2020 to attract the nation’s best students in record numbers which, in turn, will propel their student housing markets. We particularly look for projects near or adjacent to campus–location is hyper-critical for this asset class.
In addition, it is important to note that, along with conventional apartments, student housing benefits from the same cheap long-term financing made available through Fannie Mae and Freddie Mac. With the outlook of extremely low agency interest rates for the foreseeable future, the current outsized spreads between borrowing rates and cap rates in student housing should provide upwards pricing pressure for the next few years. This means we could see cap rates further compress over the next real estate cycle.
Overall, as we move beyond COVID-19 in 2021, we believe that larger, well-capitalized, and higher profile universities will continue to distance themselves from their smaller, weaker, and lesser-known competition and provide attractive opportunities for investors.
Outlook by geography
As we survey the commercial real estate investment landscape and consider potential strategies, we find ourselves with stronger-than-ever conviction around our 18-hour city thesis. As our country looks to resume growth, we expect a post-vaccine world to continue favoring most of the same growing secondary markets we valued prior to the pandemic. But as a post-COVID twist, we’re expanding that list with the addition of select markets within the Mountain region.
The pandemic has accelerated certain existing trends as well as created new ones. We expect some of these trends to be short-lived, while others, such as the work-from-home paradigm and consumer buying habits. will have lasting effects. As these trends continue to play out over the next few years, we view them as benefitting certain locations around the U.S., while working to the detriment of others.
First, we continue to see pandemic-induced population migration spikes in certain markets, most notably central and south Florida and the Mountain region. This adds an additional layer of demand on top of already solid underlying fundamentals. As a result, we see multiple strategies working well in Florida markets, particularly multifamily. For the Mountain region, we’re generally bullish.
Some secondary markets seem to have been the beneficiaries of pandemic-induced decision making, as companies recognize change within their organizations and adapt accordingly. Multiple companies’ relocation of corporate headquarters from California to Texas, such as Oracle to Austin, CBRE to Dallas, and Hewlett Packard to Houston, were only mildly surprising as they played into greater mid-term trends favoring business momentum in the state. However, the timing of these announcements appears less than coincidental in that they came at a time when all companies are examining where and how they want to work post-vaccine.
As for markets such as Raleigh-Durham, Nashville, and Phoenix, we are seeing residents cast their votes on where they want to live post-pandemic. Population migration is up and apartment rents are growing in these markets despite a mild level of overall dislocation to the multifamily sector this year. Green Street Advisors recently published a report that discusses the cities best positioned to thrive post-pandemic, benefitting from an increased work-from-home environment including Raleigh-Durham, NC, Denver, CO, Charlotte, NC, Austin, TX, and Phoenix, AZ. Now more than ever, secondary markets seem to be garnering favor with investors and residents alike.
In addition to multiple secondary markets, the question of where and how to work post-vaccine has also provided a substantial boost to the Mountain region. Cities such as Boise, ID, Bozeman, MT, and Salt Lake City, UT were already growing and gaining momentum pre-COVID. However, we see these markets particularly benefitting from the trend toward remote work options due to the attractive quality of life, relative affordability, and smaller size in comparison to the regions they are drawing people from (mainly California). As a result, we see a strong long-term outlook for these Mountain locations.
While the COVID-19 pandemic is not yet over and we likely face some tough sledding during the initial months of 2021, we exit 2020 in a relatively better state and with brighter prospects of a swift recovery than most (including CrowdStreet) initially expected as we enter 2021.
Roughly 20% of all dollars now in existence were created in 2020. Combined with record low interest rates (plus the expectation of them remaining near record lows) and the Fed’s indicated willingness to let inflation run above its long-term target, the stage is set for the appreciation of hard assets in the years ahead. As commercial real estate is the U.S.’s largest hard asset class, we view 2021 as a year to seek value wherever possible and bring it to the Marketplace. We expect valuations to grow in the mid-term as we simply don’t see how this much liquidity pumped into markets this fast doesn’t put upward pressure on commercial real estate prices.
But, as we discussed, it’s not all up and to the right for every asset class in 2021. We’ll continue to monitor how each market shakes out and position ourselves accordingly. More than ever, sourcing deals from experienced sponsors who we believe understand how to win in a swiftly changing environment is paramount. The key question we will continue to ask and seek compelling answers to in 2021 is, “Why this deal right now?”
We will continue to bring institutional-quality commercial real estate deals to the Marketplace, adapting our deal flow to meet the times and investor demand. As the market evolves, and it inevitably will, we will constantly re-examine and test our Investment Thesis and report back to you on a regular basis.