Fed executes steepest rate hike in decades. At its June 15 meeting, the Federal Open Market Committee (FOMC) raised the federal funds rate 75 basis points to a target range of 1.50 percent to 1.75 percent. This was the largest single increase since November 1994 and brings the total year-to-date advancement to 150 basis points. Additional rate hikes are anticipated through the rest of the year, likely lifting the year-end target range into the 3.50 percent zone for the first time since before the Global Financial Crisis. These actions are applying substantial upward pressure to short-term interest rates. To lift longer-term rates, the Fed has also initiated quantitative tightening. The central bank is reducing its balance sheet at a measured pace of $47.5 billion per month from June to August, before accelerating to $95 billion beginning in September. The plan could adjust if economic risks shift. Causes of inflation outside of central bank’s control. Previous guidance from Chairman Jerome Powell had prompted the market to anticipate a 50-basis-point increase in June. The FOMC’s decision to accelerate that pace was driven by decades-high inflation in May when headline CPI grew 8.6 percent year-over-year, due largely to factors outside of the Fed’s control. Global supply chains remain beleaguered by COVID-19 lockdowns in China and the war in Ukraine. This is leading to a shortage of goods globally and at home, lifting prices. The conflict in Eastern Europe is also disrupting food and energy markets. Nearly half of last month’s multidecade-high jump in inflation was driven by greater food and energy costs. Removing those two categories, core CPI advanced 6.0 percent year-over-year in May, a slight deceleration from recent months. Nevertheless, several domestic factors continue to apply upward pressure to a range of prices

Lack of sufficient homes and labor lifting prices. The nation’s growing housing shortage was exacerbated by the health crisis. Pandemic-influenced lifestyle changes and low interest rates pushed the demand for single-family homes well ahead of supply, resulting in sales prices climbing more than 36 percent since 2019. The Fed’s actions are now aimed at curbing that demand by substantially raising borrowing costs. The average 30-year fixed rate mortgage surpassed 5.7 percent in mid-June, its highest level since 2008. New home costs are also continuing to advance, due to shortages of raw materials from abroad and labor at home. The workforce shortfall is not unique to the construction sector either. Across most industries, job openings well exceed the number of people looking for work, applying upward pressure to wages, another source of inflation. Powell sets price stability ahead of labor market. Given the multiple forces driving inflation, the Fed has embarked on this path to curb consumer demand until supply can catch up. Chairman Powell has identified achieving price stability as the first goal, even at the cost of full employment. The Fed believes the labor market is so tight that some hiring demand can be siphoned off. Even if unemployment climbs modestly to around 4 percent, the measure is still tight by historical standards. Positive momentum in other aspects of the economy, including strong levels of household and business spending, could also help support the jobs market while interest rates climb. Nevertheless, the Fed has acknowledged that bringing inflation back near the 2 percent target could require slowing the economy more than they initially hoped, with the Federal Reserve’s GDP growth expectations for the year now falling under 2 percent.

Impact of Tighter Monetary Policy on Commercial Assets

Fed rate hikes have notable repercussions for capital markets. The higher-than-anticipated 75 basis point June bump in the federal funds rate, and guidance of a similar move in July, have financiers re-evaluating their offerings. Lenders that benchmark to credit markets, including CMBS and life insurance companies, may begin to push their spreads and their quoted rates higher. Banks and other balance sheet lenders may hold the line a bit longer, especially for borrowers they have a strong relationship with. Forward-looking momentum is nevertheless moving toward higher lending rates. This will create both short- and long-term headwinds for investors. Buyers making near-term adjustments as spreads likely to rise in summer. Over the short term, some borrowers may face adjustments to quoted rates on transactions they have in process. In some instances buyers will absorb the rate increase, and in others they may reduce their leverage. The Fed move could also spawn a round of re-trades with sellers, as buyers attempt to renegotiate pricing based on the rapid rise in the cost of capital. Depending on the pool of investors pursuing each asset, this could begin to weigh on market pricing for commercial properties. Over the longer term, lenders may begin to widen their spreads to mitigate interest rate risk, particularly through the summer. Historically, many lenders have widened spreads a bit in the summer months before tightening them again in the fall. Given the increased uncertainty created by the Fed’s accelerated rate hike plan, however, more lenders may bake-in higher interest rates. Impact to sales varies at property level, widespread correction unlikely. Higher lending rates have the potential to restrain some buyers, reducing the competition for assets and potentially softening the market for select properties in some markets. The impact of rising rates will depend on a variety of factors. The type of lender the buyer is using, and the buyer’s relationship with that lender, will have a notable influence on terms. The forward-looking supply and demand metrics for each property is also critical, as is whether there is a value-add component. Properties with inflation resistance integrated into the future cash stream, as well as that asset’s prospects for rent growth, will play large roles as well. The range of variance across the commercial real estate spectrum could be substantial as each investor sharpens their pencil and recalibrates their underwriting. A tremendous volume of capital continues to pursue commercial real estate investments, so even though interest rates went up more than many expected and the expectation gap between buyers and sellers may widen, a broad-based pricing correction remains improbable.

Single-family construction in large metro urban areas fell while multifamily construction there spiked, according to the National Association of Home Builders (NAHB) Home Building Geography Index (HBGI) issued this week.

The rate of year-over-year single-family construction growth in small metro urban, suburban and rural regional submarkets also slowed in the first quarter. 

Large metro suburban counties fell from 18.7% in Q1 2021 to 5.2% in Q1 2022.

The only region to post an increase in growth was micro counties (small towns) – a 3.9 percentage point increase to 16.7%.

John Hunt, senior analyst, Founder & President, MarketNsight, tells GlobeSt.com “There’s no inventory, especially for homes under $300,000 which means people are moving to second tier suburbs because of price. This is happening in every market.”

NAHB Chairman Jerry Konter, a home builder and developer from Savannah, Ga., said in prepared remarks, “Ongoing building material production bottlenecks have delayed or stalled home building projects, construction labor shortages are running near an all-time high of 400,000 workers and more recently the rapid runup in mortgage rates have all combined to exacerbate the housing affordability crisis.”

NAHB Chief Economist Robert Dietz said that the more pronounced drop in growth for the large suburban markets “is due to the easing of the rapid shift of home buyer preferences for the suburbs in the aftermath of the COVID-19 pandemic.”

MF Growth Found in Large Population Centers

Multifamily growth in large population centers posted sharp gains during the same time period, rebounding from negative growth rates.

Dietz noted that apartment construction growth is far outpacing single-family building in all regional geographies. “Low rental vacancy rates and rising rents give multifamily developers confidence to continue building despite rising costs for land, labor and materials,” he said.

Key findings from the first quarter HBGI show that four-quarter moving average single-family growth rates in:

Large metro suburban counties fell the sharpest, from 18.7% in the first quarter of 2021 to 5.2% in the first quarter of 2022.

Large metro core counties very marginally slowed down from 9.5% in the first quarter of 2021 to 8.8% in Q1 2022.

Developers simply cannot build enough new, luxury apartments to fill existing demand, contributing to double-digit rent increases in many U.S. markets.

This is despite the fact that developers are on pace to finish more luxury apartments in 2022 that they have in decades—but renters are expected to fill them up, even as rents continue to rise. Economists—so far—are also not worried that developers will eventually build more apartments than the current demand calls for. Instead, they worry about how long the U.S. economy will continue to run so hot—creating new households and new demand for housing.

“Rent growth will not materially slow down until demand cools and vacancy ticks up, which will happen if and when affordability becomes a headwind or if the job market stumbles,” says Jay Parsons, vice president and head of economics and industry principals for RealPage, based in Richardson, Texas. “The worst-case scenario is a slowing job market that stagnates wages, while other consumer expenses continue to surge.”

Not building enough apartments for an overheated economy

Even though developers opened hundreds of thousands of new apartments in 2021, vacancy rates continued to shrink and rents continued to swell.

“The shortage of luxury apartments has become particularly acute over the past year,” says John Sebree, senior vice president and national director of Marcus & Millichap's Multi Housing Division, working in the firm’s Chicago offices.

Just 3.0 percent of luxury, class-A apartments were vacant at the end of March 2022, according to Marcus & Millichap. That’s the lowest the luxury vacancy rate has been since Marcus & Millichap began counting in 2000. It’s also 180 basis points lower than the vacancy rate was at the end of 2019—before the coronavirus pandemic.

Developers are building apartments as quickly as they can—they are planning to open 400,000 new apartments in 2022—a record-breaking number, according to Marcus & Millichap.

But the vacancy rate is likely to keep dropping anyway. Just 2.4 percent of apartments overall are likely to be vacant the end of 2022, according to Marcus & Millichap. That’s the lowest the measure has been in over two decades.

“We are not building enough multifamily on a national level,” according to data firm CoStar, headquartered in Washington, D.C.

Developers continued to build new apartments—even during the pandemic—but not enough to keep up with the pace of household formation. The rising cost of land and construction materials continues to hold developers back, according to Moody’s.

In addition, homebuilders built fewer single-family homes in the past decade than any in the last 50 years, according to Ermengarde Jabir, an economist at Moody's Analytics specializing in commercial real estate. And a significant minority of single-family homes being bought and built are going to the single-family rental market rather than to homeowners. 

“I don’t see any product types close to being overbuilt,” says Paula Munger, assistant vice president of industry research and analysis at the National Apartment Association.

The demand for apartments has been growing for a long time—especially for the most expensive, luxury apartments. The number of occupied “four- and five-star” units has increased by 2.6 million units or 127 percent since the start of 2010, according to CoStar, which uses “four-star” and “five-star” to designate class-A properties.

The demand is likely to keeping growing quickly for all kinds of housing—including apartments—as long as the U.S. continues to quickly create new jobs. So far in 2022, the U.S. economy added an average 518,000 a month to the number of people with jobs. This has been a surprise given the tight labor market conditions, according to CoStar. The percentage of workers who say they are unemployed and looking for work has stayed under 4 percent.

Many of those newly-employed people are likely to use their wages to form new households, moving out of parent’s basements or leaving roommates behind. And each new household will need a place to live.

“Renter incomes are still surging and lease-ups are still filling up fast,” says Parsons. “The high-income renter demand pool for new luxury apartments has proven far deeper than even the most bullish developer could have ever anticipated.”

The net demand for apartments was 75 percent higher than its previous peak in the 30 years that RealPage has gathered data about apartments.

“If anyone had modeled and forecasted such a number going into 2021, they would have been laughed out of the room,” says Parsons. “When you look at that type of demand combined with huge increases in market-rate renter household incomes plus a severe housing shortage, the rent growth isn’t so surprising.”

Surprises of the future

The biggest potential challenge that could hurt apartment investments would be problems in the whole U.S. economy… such as inflation and the federal response to fight it.

“Inflation has been the biggest surprise for economists over the past 18 months,” says Sebree. Prices were expected to rise as the pandemic came to a close and federal stimulus like low interest rates continued. “The persistent severity of the price increases have defied most expectations.”

The Federal Reserve now plans to raise its benchmark interest rates seven times in 2022—its most aggressive actions in decades. “These policies have substantial implications for interest rates and the economy at large,” says Sebree.

Other factors could also weaken the demand for apartments. “The ongoing conflict in Ukraine, new COVID variants (the impacts of which vary widely by country) and persistent inflation are all real threats to the economy,” says NAA’s Munger. “If the Fed can successfully tame inflation without inciting a recession, it will be a very pleasant surprise.”

The recent 50-basis point increase in the overnight rate—which took the federal funds rate to 0.75%—has been on the lips of economists and industry watchers for the last week. That, coupled with the Fed’s initial steps toward quantitative tightening, has investors treading lightly. 

But the moves toward quantitative tightening were “well-telegraphed,” according to Marcus & Millichap’s John Chang, who said “it seems that Wall Street has already baked them into the market.” With that said, the Federal Reserve is making a concerted effort to get inflation back under control, and the consumer price index was 8.5% at last reading, with a new number set to be released May 11.

“Basically, inflation is at its highest level in 40 years, and the Fed is trying to use monetary policy to rein it in,” Chang says. “The idea is that by increasing interest rates borrowing will be reduced and spending will slow down. That would shrink the demand side pressure that’s pushing prices up.”

In response to some critics opining that the Fed is behind the curve, Chang maintains there were some challenges that the Fed didn’t initially anticipate.

Chief among them? The ever-present supply chain problems plaguing virtually all facets of the global economy.

“The supply chain problems haven’t gone away,” Chang says. “They’re in better shape today than they were six months ago, but China is still the number-one producer of consumer products, and they keep going through massive COVID lockdowns.”

Shanghai is also the world’s largest port, moving one and a half times as much container volume that the ports of Los Angeles and Long Beach combined – and the entire city has also been under COVID lockdowns since March 28, “so basically nothing is leaving the Shanghai port,” Chang says.

Underlying inflation drivers like the price of oil, construction materials, housing and wages have all also been rising, further fueling the Fed’s predicament. And though the cost of borrowing is going up, “the US is flush with cash,” Chang says, with household savings exceeding household debt for the first time in three decades. That means “it may take awhile before the brakes catch.

“If the inflation curve doesn’t flatten, investors should expect additional significant rate increases coming from the Fed’s meeting on June 15 and July  27. At this point a 75 basis point increase this summer is not off the table.”

For CRE investors, that means looking to stash capital in inflation resistant property types like multifamily, self-storage, and hotels. Chang also says investors should plan for rising interest rates by locking in long-term debt as soon as possible, but notes that strong household balance sheets will remain a tailwind for spending supporting properties in the retail and hospitality sector.

And as for pricing, “some buyers are pushing back due to rising interest rates,” Chang notes. “But demand drivers for housing and space in most commercial property types still have a strong outlook, and new supply risk has been mitigated by the pandemic. That means the fundamentals outlook remains strong, and rent growth will be strong for most property types in most areas. In addition, capital liquidity is still elevated, so there are many buyers and we’re still in a competitive bid climate.”

WASHINGTON — The Federal Reserve on Wednesday raised its benchmark interest rate by half a percentage point, the most aggressive step yet in its fight against a 40-year high in inflation.

“Inflation is much too high and we understand the hardship it is causing. We’re moving expeditiously to bring it back down,” Fed Chairman Jerome Powell said during a news conference, which he opened with an unusual direct address to “the American people.” He noted the burden of inflation on lower-income people, saying, “we’re strongly committed to restoring price stability.”

That likely will mean, according to the chairman’s comments, multiple 50-basis point rate hikes ahead, though likely nothing more aggressive than that.

The federal funds rate sets how much banks charge each other for short-term lending, but also is tied to a variety of adjustable-rate consumer debt.

Along with the move higher in rates, the central bank indicated it will begin reducing asset holdings on its $9 trillion balance sheet. The Fed had been buying bonds to keep interest rates low and money flowing through the economy during the pandemic, but the surge in prices has forced a dramatic rethink in monetary policy.

Markets were prepared for both moves but nonetheless have been volatile throughout the year. Investors have relied on the Fed as an active partner in making sure markets function well, but the inflation surge has necessitated tightening.

Wednesday’s rate hike will push the federal funds rate to a range of 0.75%-1%, and current market pricing has the rate rising to 2.75%-3% by year’s end, according to CME Group data.

Stocks leaped higher following the announcement while Treasury yields backed off their earlier highs.

Markets now expect the central bank to continue raising rates aggressively in the coming months. Powell, said only that moves of 50 basis points “should be on the table at the next couple of meetings” but he seemed to discount the likelihood of the Fed getting more hawkish.

“Seventy-five basis points is not something the committee is actively considering,” Powell said, despite market pricing that had leaned heavily towards the Fed hiking by three-quarters of a percentage point in June.

“The American economy is very strong and well-positioned to handle tighter monetary policy,” he said, adding that he foresees a “soft or softish” landing for the economy despite tighter monetary policy.

The plan outlined Wednesday will see the balance sheet reduction happen in phases, with the Fed allowing a capped level of proceeds from maturing bonds to roll off each month while reinvesting the rest. Starting June 1, the plan will see $30 billion of Treasurys and $17.5 billion on mortgage-backed securities roll off. After three months, the cap for Treasurys will increase to $60 billion and $35 billion for mortgages.

Those numbers were mostly in line with discussions at the last Fed meeting, as described in minutes from the session, though there were some expectations that the increase in the caps would be more gradual.

Wednesday’s statement noted that economic activity “edged down in the first quarter” but noted that “household spending and business fixed investment remained strong.” Inflation “remains elevated.”

Finally, the statement addressed the Covid outbreak in China and the government’s attempts to address the situation.

“In addition, Covid-related lockdowns in China are likely to exacerbate supply chain disruptions. The Committee is highly attentive to inflation risks,” the statement said.

“No surprises on our end,” said Collin Martin, fixed income strategist at Charles Schwab. “We’re a little bit less aggressive on our expectations than the markets are. We do think another 50 basis point increase in June seems likely. … We think inflation is close to peaking. If that shows some signs of peaking and declines later in the year, that gives the Fed a little leeway to slow down on such an aggressive pace.”

Though some Federal Open Market Committee members had pushed for bigger rate increases, Wednesday’s move received unanimous support.

The 50-basis-point increase is the biggest increase the rate-setting FOMC has instituted since May 2000. Back then, the Fed was fighting the excesses of the early dotcom era and the internet bubble. This time around, the circumstances are quite a bit different.

As the pandemic crisis hit in early 2020, the Fed slashed its benchmark funds rate to a range of 0%-0.25% and instituted an aggressive program of bond buying that more than doubled the size of its balance sheet. At the same time, Congress approved a series of bills that injected more than $5 trillion of fiscal spending into the economy.

Those policy moves were followed by clogged supply chains and surging demand as economies reopened. Inflation over a 12-month period rose 8.5% in March, as gauged by the Bureau of Labor Statistics’ consumer price index.

Fed officials for months dismissed the inflation surge as “transitory” then had to rethink that position as the price pressures did not relent.

For the first time in more than three years, the FOMC in March approved a 25-basis-point increase, indicating then that the funds rate could rise to just 1.9% this year. Since then, though, multiple statements from central bankers pointed to a rate well north of that. Wednesday’s move marked the first time the Fed has boosted rates at consecutive meetings since June 2006.

Stocks have tumbled through this year, with the Dow Jones Industrial Average off nearly 9% and bond prices falling sharply as well. The benchmark 10-year Treasury yield, which moves opposite price, was around 3% Wednesday, a level it hasn’t seen since late 2018.

When the Fed was last this aggressive with rate hikes, it took the funds rate to 6.5% in early 2000, but was forced to retreat just seven months later. With the combination of a recession already underway plus the Sept. 11, 2001 terrorist attacks, the Fed rapidly cut, eventually slashing the funds rate all the way down to 1% by mid-2003, shortly after the Iraq invasion.

Some economists worry the Fed could face the same predicament this time — failing to act on inflation when it was surging, then tightening in the face of slowing growth. GDP fell 1.4% in the first quarter, though it was held back by factors such as rising Covid cases and a slowing inventory build that are expected to ease through the year.

Results from the first-half 2022 WMRE/Marcus & Millichap Investor Sentiment Survey are overwhelmingly positive. The Investor Sentiment Index climbed five points from 165 in the H2 survey to reach 170 – the highest level since 2015

 A number of factors are driving optimism across all sectors of the commercial real estate market. Vacancy rates for apartments, industrial and self-storage are at or near record lows. For other property types that have faced challenges during COVID-19, the outlook in a post-pandemic cycle is turning an important corner. “Vaccination levels are rising and society in general is feeling more confident in the ability to live with COVID-19,” says John Chang, Senior Vice President and National Director of Research and Advisory Services at Marcus & Millichap. “As a result, other property types that aren’t already at record levels, such as retail and hotels, see upside on the horizon as people get out and travel and go to entertainment venues, restaurants and stores.”

The country is also moving toward some resolution of what return-to-office plans might look like. Although hybrid work models are still evolving, there is an expectation that companies will increasingly return to the office in the near future. Therefore, demand for office space should deliver gains, adds Chang. “The positive movement in the index reflects all of those dimensions – the positive trends that are already here in some property types and the momentum that is coming in the future in other sectors,” he says.

Investor confidence is reflected in the record high transaction volume that occurred in 2021. Commercial and multifamily sales topped $846 billion last year, significantly higher than the pre-pandemic total of the $600 billion in 2019, according to Real Capital Analytics. Survey results show a healthy appetite to continue acquiring assets in the near term. More than half of survey respondents (54 percent) said they plan to buy property in the next 12 months, a slight uptick compared to 50 percent who planned to increase holdings in the second-half 2021 survey. Relatively few (6 percent) expect a decrease. The typical respondent plans to increase real estate investments by an average 12 percent, which also climbed higher compared to the 9 percent increase anticipated in the second-half 2021 survey.

“The amount of capital coming into commercial real estate is higher than it has ever been as evidenced by the transaction volume of 2021,” says Evan Denner, Executive Vice President and Head of Business at Marcus & Millichap Capital Corp. Consistent with WMRE/Marcus & Millichap surveys over the past several years, a majority of respondents (61 percent) continue to have an abundance of capital ready to invest. Additionally, a majority of respondents (71 percent) believe commercial real estate offers favorable returns to other investment classes. However, that view is slightly below the first-half 2020 survey, where 74 percent thought commercial real estate offered favorable returns relative to other investment classes. That slight decline could be a reflection of cap rate compression over the past two years, particularly in high-demand sectors such as multifamily, industrial and self-storage, notes Denner.

The Los Angeles apartment market is seeing renewed strength this year. Research from Marcus & Millichap shows that vacancy has declined by at least 350 basis points in Downtown Los Angeles and the Westside markets, two of the largest employment hubs in the city. As a result, the two submarkets have a sub 2% vacancy rate.

The rebound in the Los Angeles area has come in advance of a widespread return to the office, suggesting that more demand is likely to come later this year. As a result, Marcus & Millichap predicts that the vacancy rate will fall 40 basis points this year and rents will increase 7.2%.

The strong fundamentals are driven not only by strong demand but also a dearth of supply. While demand has rebounded, construction activity has not. Downtown Los Angeles will record a record decline in apartment deliveries this year, and Santa Monica is the only market on the Westside to deliver more than 500 units, according to the report. Overall, Los Angeles’ apartment construction pipeline will deliver 10,000 units this year, increasing the total apartment stock by .9%.

Downtown Los Angeles and the Westside market are not the only Los Angeles areas to see a surge in growth. The suburbs are also on fire. The San Fernando Valley and South Bay-Long Beach are attracting new renters looking for affordability. The two markets have a 1.8% and 2% vacancy rate, respectively.

The Los Angeles market rebounded quickly from the pandemic. Last year, rents increased 14% in the Greater Los Angeles area, according to research from Apartment List. Rents in the metro fell 9.6% in 2020 as a result of the pandemic. Before the pandemic, rent growth has stagnated in the market with little to no growth each month, but the pandemic jump-started double-digit rent growth once again.

While the fundamentals are good news, Los Angeles landlords are still facing challenges from the pandemic. Los Angeles County has $3 billion in total rent debt, and Los Angeles city has about $1.5 million in unpaid rent from the pandemic. Among those with rent debt, the average tenant owes $2,800 in unpaid rent, according to research from UCLA and USC. The share of renters unable to make payments only worsened as the pandemic wore on. From May to July 2020—near the onset of the pandemic—about 7% of renters did not make a single payment. Likewise, from January to March 2021, the same share, 7%, of renters did not make a single payment. However, the share of renters that made a partial payment increased from 17% in May through July 2020 to 31% in January to March 2021.

Multifamily rents have increased significantly for new leases while concessions have tanked—and the sector is showing no signs of cooling off, according to a group of analysts from MRI Software.

“Two years after the onset of the COVID-19 pandemic, the multifamily market finds itself in a familiar position entering peak season: unemployment has returned to historical lows, housing demand continues to be strong, new supply continues to lag need and housing affordability is back in the headlines,” the report says. “These macroeconomic factors, which are normalizing as we move from pandemic to endemic, are setting up owners and operators for strong pricing power as seasonal demand peaks arrive.”

MRI predicts that new lease pricing should continue to increase throughout the summer after ticking up roughly 20% over the last eight months.  Data from Yardi Matrix reveals that multifamily asking rents ticked up yet another $10 in February to hit a national average of $1,628, with year-over-year growth also posting a 15.4% increase.

And the increases won’t be limited to new deals, either. “The widening gap between market rate and in-place lease rates will likely lead to aggressively higher renewal offers intended to close the gap, or to drive new availability that will be filled at current higher market rates,” MRI experts predict, adding that some renewal offers may feel “brutal” to existing residents.

That will be particularly true as concession volumes have returned to pre-COVID levels.  Concessions peaked last summer as operators used discounts to lure new residents into their communities but have decreased steadily since against a backdrop of rising prices and surging demand.

On-time payment performance has also bounced back in recent months and is near pre-pandemic levels, according to MRI.

 “It’s already a landlord’s market,” says Brian Zrimsek, Industry Principal, MRI Software.  “And we’re about to enter the summer season, which traditionally is the most active and lucrative season for leasing. Given the other market forces we’re experiencing, such as low unemployment, low supply of new housing, and high inflation, we can expect a challenging summer for renters.”

What does this bill do?

1) Extends, through June 30, 2022, procedural legal protections against eviction based on nonpayment of rent or other financial obligations under the lease that accumulated between March 1, 2020, and March 31, 2022, provided that, as of March 31, 2022, there is an application pending for emergency rental assistance corresponding to all or part of the amount demanded. (Unless otherwise indicated, all further references to “rent” should be understood to include both rent and all other financial obligations under the tenancy.)

2) Updates the content of notices that landlords must provide to tenants after March 31, 2022, and before July 1, 2022, prior to seeking a court order for eviction based on nonpayment of rent, so that the information is accurate in light of the extension of protections against eviction and expiration of the deadline to apply for emergency rental assistance.

3) Extends, through June 30, 2022, statewide preemption of local laws as follows:

a) Local ordinances adopted before August 19, 2020, in response to the COVID-19 pandemic to provide protection against eviction for nonpayment of rent remain grandfathered in and are applicable according to their own terms, subject only to specified state modifications to any timeline for repayment that the local ordinance provides.

b) Local jurisdictions are preempted from applying new or additional local additional protections against eviction for nonpayment of rent, if that rent accrued on or before March 31, 2022.

c) For rent that accrues on or after April 1, 2022, local jurisdictions are free to establish additional protections against eviction. (Code Civ. Proc. Sec. 1179.05.)

This bill is composed of three basic parts.

1)      Three-month extension of eviction protections for those who submit rental assistance applications by the March 31, 2022 deadline

Existing law provides that a landlord who wants to remove a tenant in California for failure to pay the rent or any other financial obligation under the lease that accrued between March 1, 2020, and March 31, 2022, may file in court requesting a court order for eviction. However, the court is not supposed to proceed with the case unless the landlord affirms, through specified procedures, that the landlord applied for rental assistance to cover the unpaid rent but was unable to obtain it. Furthermore, once the case proceeds, a judge is not supposed to order the requested eviction in the form of a judgment until the court is satisfied that, indeed, the landlord tried but could not get compensation from the rental assistance program for the unpaid amount. (Code Civ. Proc. § 1179.11.)

This bill extends those same protections for three months, but only in those cases where a rental assistance application was submitted by the March 31, 2022, deadline and is still pending. The idea is to protect everyone who has applied on time for long enough for their applications to be processed and their rent paid. This should spare from eviction the roughly 165,000 to 190,000 low-income California households who will still have rental assistance applications pending on April 1, 2022.

What doesn’t this bill do?

It is important to highlight what the three-month extension proposed by this bill does not do. It does not provide any protection against eviction for tenant households that do not pay their rent from April 2022 on as it accrues. Unless there is a local ordinance in effect that pre-dates August 19, 2020, tenants who are unable to pay their rent for April 2022 onward will face eviction just as they would have prior to the pandemic. The extension also does not offer protection against eviction in scenarios in which the tenants fell behind on rent during the period from October 1, 2021, and March 31, 2022, but neither the landlord nor the tenant submitted an application for emergency rental assistance to cover the unpaid amount.

2)      Three-month extension of local ordinance preemption

When California first enacted statewide statutory eviction protections in the late summer of 2020, the bill included provisions preempting the ability of local jurisdictions to go farther than whatever protections against eviction for nonpayment of rent they already had on the books as of August 19, 2020. (AB 832, Chiu, Chapter 27, Statutes of 2021; Code Civ. Proc. Section 1179.05(a).) Each time that the state has extended statewide eviction protections since then,

the state has also extended these preemption provisions for an equivalent length of time. This bill follows the same pattern. To match the three-month extension of the legal protections against eviction, this bill also extends the preemption provisions for three months. As a result, the terms of any local ordinance in effect on August 19, 2020, will continue to apply. The terms of any subsequently enacted local laws protecting tenants against eviction for nonpayment of rent will not apply until July 1, 2022, when the three-month extension expires.

3)      Updates to the information in relevant notices

The extension of protections against eviction proposed by this bill necessitates updates to the information contained in certain notices that landlords must provide to tenants before proceeding to court to seek an order for eviction. Currently, some of those notices advise tenants that they should apply for emergency rental assistance, for example. After March 31, 2022, when the state program will stop accepting new applications, it would be misleading and cruel if tenants continued to receive notices urging them to apply. Accordingly, this bill provides alternative required content for notices that landlords deliver to their tenants beginning April 1, 2022. The new notices simply inform tenants of the scenarios in which they may have protections against eviction and provide the tenant with an entry point for seeking out further legal advice. To be clear, landlords would only have to include this content if they are demanding rent that accrued on or before March 31, 2022, since no additional state protections apply to rent that accrues after that date.

SUPPORT: (Verified 3/30/22)

California Housing Consortium

City of Mountain View

City of San Diego

County of Santa Clara

OPPOSITION: (Verified 3/30/22)

Apartment Association of Greater Los Angeles

Apartment Association of Orange County

Berkeley Property Owners Association

California Rental Housing Association

East Bay Rental Housing Association

Nor CAL Rental Property Association, Inc.

North Valley Property Owners Association

Santa Barbara Rental Property Association

Small Property Owners of San Francisco Institute

Southern California Rental Housing Association

When President Joe Biden presented his administration's proposed budget for fiscal year 2023, he again included a new tax rule that would essentially eliminate 1031 exchanges, or like-kind exchanges, which are widely used to lower taxes for those buying and selling commercial real estate.

If Biden is able to get the budget past with the new rule in place — capping the capital gains deferral at $500K for an individual and $1M for a couple — real estate experts say it could spell disaster for an already-challenged industry and for the U.S. economy.

After two years of pain from the pandemic’s effects on the real estate industry, with inflation at the highest it has been in a generation and interest rates already on the rise, Engineered Tax Services founder and CEO Julio Gonzalez said the proposal, if enacted, would cause a major slowdown for the entire industry.

“During a time where we're having hyperinflation, I think it would be really devastating to the real estate industry. Last week we started raising interest rates, so that already alone hurts the real estate industry,” he said. “If you're going to take away 1031, that’s like putting the nails in the coffin for most real estate players.”

Current policy allows investors to sell a real estate asset and then use sale proceeds to purchase another property of a similar value, so long as they can make a purchase within 180 days. The gain on the sale of the property goes untaxed as long as it is reinvested.

Biden said he would get rid of 1031 exchanges on the 2020 campaign trail and instead expand funding for the care economy. But that elimination has yet to happen. Instead, the newest federal budget proposals suggest keeping lower-value 1031 exchanges intact — a move that real estate investors say is akin to scrapping 1031 altogether.

“The effect of the cap is likely to be very equivalent or close to equivalent to eliminating section 1031,” Phillips Nizer LLP Managing Partner and Real Estate Practice co-Chair Marc Landis said. “Being able to defer half a million is small potatoes.”

In last year’s budget, the Biden administration also proposed modifying 1031 exchanges via a value cap rather than eradicating the policy. And while it never happened, the threat spurred a wave of 1031 exchange activity as real estate investors sought to offload high-cost, high-tax assets in the Northeast and the West Coast in exchange for lower-cost properties in business-friendly Sun Belt locales.

Many mom-and-pop businesses own the real estate that houses their restaurants or shops, and the proposed rule would make it difficult for them to upgrade or move facilities, Landis said. And while bigger players in real estate investment may not face the same existential struggles, Landis says a lack of access to 1031 exchanges will mean investors may be stuck with properties that they can’t utilize or renovate.

“This time last year, everybody was racing to complete their 1031 deferral exchanges in 2021 because they were afraid [the elimination] might happen,” said Landis, who predicts that a similar rush may happen again if the federal government is able to advance the cap on 1031 exchanges. 

But real estate investors speaking to Bisnow said with real estate lobbyists making their interests clear on Capitol Hill, change to the 1031 policy is unlikely. Evan Liddiard, senior policy representative for federal taxation at the National Association of Realtors, told Bisnow in an email that NAR had spent time last year with policymakers on both sides of the aisle explaining the impact of limiting 1031 exchanges.

“NAR opposes any changes to the like-kind exchange rules, and we are redoubling efforts to explain to policymakers the negative impact of a limit in the amount of gain that can be deferred,” Liddiard wrote.

NAR and other experts argue that restricting 1031 exchanges will mean property owners are more likely to sit on their assets rather than selling them, causing slowdowns in other industries like construction, spelling bad news for the U.S. economy. 

Gonzalez argued that limiting 1031 exchanges is shortsighted. While the move may generate more tax revenue for the federal government to fund other programs, it will mean a slowdown in real estate transactions — generating less gross revenue for the government long-term.

Research from Ernst & Young, prepared on behalf of the 1031 Like-Kind Exchange Coalition and published last May, estimated that current 1031 exchange rules generate $55.3B in economic impact and $4.4B in related consumer spending and investments.

“With every 1031 exchange, even the smallest one, there are probably at least 30 jobs that are generated,” IPX1031 Vice President Suzanne Goldstein Baker told Bisnow this week. "And when you think about the job generators, it's the much larger properties that generate far more jobs.”

The real estate industry effectively convinced Congress to kill the 1031 cap in last year's budget, and the industry's lobbyists are mobilizing in opposition again, exuding confidence that the rule won't see the light of day.

"We have all spent a lot of time and energy educating our policymakers as to the powerful economic stimulus that is provided by section 1031," Goldstein Baker said.

“There’s no real appetite for raising this particular tax in Congress in a midterm election year,” Landis added. “I don't think it's likely that Congress is going to push this one forward.”

For a while now, the commercial real estate industry has been bracing for interest rate hikes this month—the first increase since before the pandemic began. But record high inflation and a war in Ukraine which spiked energy prices may cause the Federal Reserve to take a more cautious approach when the announcement comes this afternoon, following two days of meetings by the Federal Open Market Committee.

Marcus & Millichap President & CEO Hessam Nadji and three CRE industry economists told Commercial Property Executive they expect the Fed to raise interest rates, which are at near-zero levels, by 25 basis points not 50 basis points as some economists had projected.

Nadji said he was expecting a 25 basis-point increase, noting Federal Reserve Chairman Jay Powell reconfirmed the quarter-point plan in his testimony last week to Congress.

“The last thing they want to do is surprise markets or investors,” Nadji said. “I do think that the plan for later in the year could include some 50-basis-point moves if we continue to see the high readings on inflation. I would not rule that out, and I think the market should be prepared for that.”

Ryan Severino, JLL chief economist, said he also anticipates the Fed will raise interest rates by 25 basis points rather than 50 basis points.

“I felt that once the Fed was going to start tightening, even in the face of elevated inflation, they were going to do so cautiously, but responsibly. I didn’t think there was a need for the shock and awe of 50 basis points. It seemed like there was more potential trouble associated with that than just coming out of the gate with a 25 basis-point increase.”

Sabina Reeves, global chief economist, CBRE Investment Management, said before the war in Ukraine began there was a lot of debate about whether the March rise would be a 25 or 50 basis-point and the market may have been pricing in the 50 basis-point increase just before the war broke out.

Reeves, who is anticipating the 25 basis-point increase, said central banks around the globe have been increasingly nervous about inflation and how it feeds into wage and price inflation. Inflation concerns had caused both the European Central Bank and Fed to become a bit more hawkish, even before the war in Ukraine exacerbated energy price inflation, she said.

“What you’ve seen really since the global financial crisis is a lot of coordinating among the central banks,” said Reeves, who is based in London. “Typically, the central banks do talk amongst themselves and try to act in a coordinated way. I imagine you will see them move in step.”

Last week, the ECB said it would begin phasing out its bond-buying program by September or earlier and also indicated there would at least one interest rate hike later this year.

“That was an interesting signal that central banks will continue to tighten maybe in a more measured way,” Reeves said.

Inflation record high

Back in the U.S., the Fed is walking a fine line as it attempts to curb inflation, which hit a 40-year high in February, at nearly 8 percent.

“The Fed is trying to deal with inflation in a very uncertain world while at the same time trying not to raise rates so much to push the economy into recession, which clearly is a real risk. In fact, it’s leaning more in that direction,” said Joseph LaVorgna, chief economist, Americas, Natixis.

LaVorgna said higher than anticipated inflation and the war in Ukraine added more levels of uncertainty to the economy, particularly higher energy prices due to shortages in supplies.

“You have a situation where inflation is actually higher than people thought and it looks like the situation in Ukraine, among many things, could also extend the time for which inflation stays higher,” he said. “Perhaps even though it’s still likely to slow by spring/summer, the rate of slowdown may not be as quick because of the persistence of these supply disruptions.”

Nadji noted commodity prices could fall dramatically, relieving inflationary pressures and brightening the global economic outlook if the conditions change soon in Ukraine.

“Hopefully there’s an immediate solution or at least a cease fire,” Nadji said. “In that scenario, which will hopefully come to fruition, the Fed is going to have to raise interest rates if not aggressively at least on a steady basis throughout this year because we’ve had this long period of time where rates have been so low.”

How many more hikes?

Economists are undecided on how many more times this year the Fed will raise interest rates after this month. LaVorgna said he was not sure how many to expect after May, which he thinks could be a 50 basis-point increase.

“It’s not clear to me if they’ll go three or four or five,” he said.

Reeves said the Fed could choose to go with four to six hikes of 25 basis points each time, watching the market reaction between increases. “It would have been at the lower end of that before the war and now maybe toward higher end,” she said.

Severino said six or seven interest rate increases, as some economists have suggested, this year sounds “a bit extreme.”

“My general sense is they’re going to try to be careful and consistent especially because we’re dealing with a new variable in the equation that we really haven’t dealt with in a really long time with the situation in Europe,” he said.

Severino said his model for what the market could bear is in the 200 to 300 basis-point range, noting that increases would be coming from such a low starting point.

“I don’t think they will be able to raise in such a way that becomes too uncomfortable for the sector,” he said.

Nadji pointed to a recent Marcus & Millichap investor sentiment survey which showed it would take another 100 basis points from a low of around 2 percent to 2.9 or 3 percent on the 10-year Treasury before the investment community would start to pull back from acquisition plans.

“The percentage of people who said they would probably reduce acquisitions increased substantively at that level but not below that level. So, it seems like there’s a lot of room in the market for interest rates to go up further,” he said.

The survey found that at a 50 basis-point rate increase, 70 percent of investors said there would be no change in their acquisition plans. It dropped to 67 percent of investors saying they would not change plans for a 100 basis-point increase. It was nearly evenly split at a 150 basis-point increase, with 48 percent saying no change and 46 percent saying they would buy less. A 200 basis-point increase would cause 63 percent of respondents to buy less, and a 250 basis-point increase would cause 67 percent of those surveyed to buy less real estate.

The California Apartment Association has derailed legislation that would have prohibited landlords from using credit reports as part of the tenant-screening process.

At the insistence of CAA, Assemblywoman Sharon Quirk-Silva, D-Fullerton, agreed Monday to shelve the proposal, AB 2527.

AB 2527 would have prohibited property owners from asking about anything that would be included in a report, such as payment history or evictions.

“A credit report is the primary tool a rental property owner has to make the most objective determination about the ability of a potential tenant to pay the rent,” says a CAA opposition letter.

An article about the bill appeared in CAA’s electronic newsletter this past Friday, spurring a flurry of online comments.

“If this passes, it is the last straw for me,” one reader writes of AB 2527. “I will be taking my rental off the market. A bank wouldn’t give you a loan without first screening your credit. And that is completely fair.”

Another reader commented: “The financial solvency of rental property owners is directly linked to the financial responsibility of the renters. We depend on the proper cash flow provided by monthly rents to meet the many expenses of operating a rental property – mortgage, taxes, insurance, and ongoing maintenance and repairs. A bad tenant is a sure route to bankruptcy.”

While AB 2527 is off the table, two other bills that take aim at using credit reports during tenant screening remain at play: AB 2203 by Assemblywoman Luz Rivas, D-San Fernando Valley, and SB 1335 by Sen. Susan Eggman, D-Stockton. These bills, however, would be limited to instances involving a government rent subsidy. Stay tuned for updates on these proposals and ways you can help CAA’s opposition.

Despite continuing headwinds for multifamily development such as increased labor and material costs, construction delays, and other COVID-related difficulties, the pace of multifamily building permitting and starts has accelerated since the beginning of 2021 when tracking seasonally adjusted annual rates (SAAR). The SAAR is the number of permits or starts expected over the next 12 months based on the monthly seasonally adjusted rate.

The annual pace of multifamily permitting decreased 8.8% in January to 629,000 units from December’s revised rate of 690,000 units, according to the U.S. Census Bureau. While December’s number was inflated by a tax issue in Philadelphia, January’s rate indicates that multifamily permitting is still going strong. Annualized multifamily permitting in January was 12.3% greater than it was in January 2021.

Multifamily starts also slipped a little from December, but the 2.1% decrease in the pace of starts was smaller than the decline in permits. Still, the annual rate of 510,000 multifamily units started in January was 8.7% greater than in the previous year.

Meanwhile, single-family permitting and starts have stalled from post-pandemic recovery trajectories but remain at sustainable levels. The share of single-family permits to total residential permits was averaging about 80% before the housing bubble of the mid-2000s but averaged about 65% from 2012 to 2019 before jumping to almost 72% at the end of 2020. Since then, it has slipped back below 65% as multifamily development takes a larger share of total housing.

The annual rate for single-family permits in January improved 6.8% from December to 1.205 million homes, down 5% from January 2021. Single-family starts dipped 5.6% from December and were down 2.4% from last January to 1.116 million homes.

Together, total residential permits were almost unchanged from December at 1.899 million units and total residential starts were down 4.1% to 1.638 million units. Compared to one year ago, total residential permits were up just 0.8% while total starts were up the same amount.

Multifamily completions were unchanged from December at 309,000 units while single-family completions of 927,000 units were down 7.3% from last month’s annual rate. Multifamily units under construction are up 13.9% from last year with a SAAR of 745,000 units. Units authorized but not started are trending upward with 125,000 units delayed, up 43.7% from January 2021.

The annual rate for multifamily permitting was up in two of the nation’s four Census regions from January 2021, with the largest annual increase in the Midwest region (up 56% to 88,000 units). The South region’s annualized rate increased 34.4% to 311,000 units. Meanwhile, the Northeast region slowed by a third (down 33.7% to 68,000 units), while the West slipped 4.4% to 163,000 units from last January. Compared to the previous month, permitting fell by two-thirds in the Northeast (-66.7%), and was down 7.9% in the Midwest but jumped 32.7% in the South and was up just 1.6% in the West.

Regional annual multifamily starts were up strongly in the South (+50.2% to 249,000 units), and Midwest (+24% to 53,000 units). The Northeast region slowed by 44.1% to 68,000 units, while the West region had a moderate increase of 0.9% to 140,000 units. Compared to December’s SAAR, the Midwest dropped 55%, while the remaining regions increased their annual rates from 4.7% (South) to 36.7% (Northeast).

At the metro level, nine of the top 10 permitting markets returned to the January list from December. New York continues to lead the nation in multifamily permitting with 34,016 units, about 540 units more than last year but about the same amount less than last month.

Philadelphia, due to its tax program-related surge in permitting in December, continued in the #2 spot in January with 25,194 units permitted. That was almost 17,400 units more than the year before. Austin, Dallas, and Seattle returned in order, with Austin’s 24,818 units permitted just behind Philadelphia’s. Dallas’ 19,100 units permitted were two-thirds more than last year’s total and Seattle permitted about 42% more units than the previous year with 17,543.

Houston moved up one spot to #6 with 16,321 units permitted in the year-ending January 2022 but was the only top 10 market with a major decrease in permitting – down 2,369 units from last year. Denver slipped one spot to #7 with 15,763 units permitted through January but that was an increase of more than 7,200 units from the year before. Phoenix returned at the #8 spot with 15,489 units permitted, only increasing about 12% from last year, while Nashville moved up a spot to #9 with 14,862 units permitted for the year, an annual increase of 37%.

Los Angeles fell out of the top 10, replaced by Washington, DC, which moved back to the #10 spot after a one-month absence, permitting 13,887 units for the year, almost 25% more than last year.

Nine of the top 10 multifamily permitting markets increased annual totals from the year before and saw generally large increases (with the exception of New York), ranging from a low of 1,714 units in Phoenix to almost 17,400 additional units in Philadelphia. Six of the top 10 markets increased multifamily permitting by at least 4,000 units over last year’s pace.

Other markets outside of the top 10 that saw significant year-over-year increases in annual multifamily permitting in the year-ending January were Atlanta (+5,068 units), Raleigh/Durham (+4,265 units), Orlando (+4,030 units), Jacksonville, FL (+3,545 units), Charlotte (+3,427 units), Fort Worth (+3,368 units), and North Port-Sarasota-Bradenton, FL (+3,082 units).

Only one of the top markets saw decreases in the year-ending January 2021. As mentioned, Houston permitted 2,369 fewer units than last year. Significant slowing in annual multifamily permitting also occurred in the non-top 10 markets of Lubbock, TX (-1,802 units), San Jose (-1,547 units), and San Diego (-1,099 units).

Half of the top 10 markets had more annual multifamily permits than the previous month, with Nashville up 6.2% from December’s annual total. Despite decreasing from last year, Houston saw an increase in annual permitting in January of 3.8% from last month, while Dallas improved 3.4%. The remaining two top 10 markets averaged 1.3% increases for the month. Philadelphia, Austin, and Denver permitted from 2.5% to 4.7% fewer units than last month’s annual totals.

The annual total of multifamily permits issued in the top 10 metros in January – 196,993 – was about 35% more than the 146,516 issued in the previous 12 months. The total number of permits issued in the top 10 metros was almost equal to the number of permits issued for the #11 through #38 ranked metros.

Below the metro level, all of last month’s top 10 permit-issuing places returned to this month’s list with the six remaining in the same order. The list of top individual permitting places (cities, towns, boroughs, and unincorporated counties) generally include the principal city of some of the most active metro areas.

The city of Philadelphia remained at the top of the list in January with an annual total of 21,574 units as the aforementioned tax abatement policy change caused a flood of permitting in 2021.

The city of Austin returned as the #2 permit-issuing place, with an annual total of 13,514 units, down about 720 units from last month. The city-county of Nashville-Davidson returned at #3 with 13,148 units permitted, about 900 more than December. The cities of Seattle and Los Angeles switched places at #4 and #5 with 10,357and 9,931 units permitted, respectively, but both were down slightly from the month before.

The cities of Denver and Houston and Mecklenburg County (Charlotte) remained in the #6 through #8 spots but only the city of Houston and Mecklenburg County had significant increases in their annual permitting over December (+662 units and +872 units).

New York’s Brooklyn borough moved up one spot, displacing the city of Dallas to the #10 spot. While each permitting place declined slightly from their annual totals in December, both permitted roughly 6,500 units for the year-ending January 2022.

Marcus & Millichap CEO Hessam Nadji joins Yahoo Finance Live to talk about the outlook on the real estate market, housing sales growth, anticipating the Fed's interest rate hikes for renting and homebuying, and the most sought after real estate markets.

Video Transcript

EMILY MCCORMICK: As the broader market continues to languish in the red this afternoon, let's get a check of real estate stocks. This morning, existing home sales came in much higher than expected, in fact, reaching the highest level in a year at a seasonally adjusted annualized rate of $6 and 1/2 million. That was good for a 6.7% month over month increase. Now on the heels of that, the S&P 500 real estate sector, as you can see on the screen, is still lower on the day, but also off session lows and also outperforming the broader S&P 500.

Now for the year-to-date, however, the sector is still the worst performer after communication services, with prospects of higher interest rates weighing on many real estate stocks. But taking a look at two homebuilders specifically, we are seeing shares of KB Home, as well as Toll Brothers, coming well off session lows. Toll Brothers shares have actually now turned positive. So one part of the market that we're continuing to watch closely is that real estate sector.

RACHELLE AKUFFO: Well, lots of data there. We know that existing home sales jumped 6.7% in January to a seasonally adjusted annual rate of $6.5 million. Now this also comes amid record low inventory, with homes often getting snatched up in a day or two, and leaving less affluent buyers out in the cold. Well, to break down what's happening with the housing market, let's welcome Hessam Nadji, Marcus & Millichap CEO. Thank you for joining me.

HESSAM NADJI: Thanks for having me on the program.

RACHELLE AKUFFO: So I want to first start by getting your reaction to some of this data. Obviously, looking at this 6.7% surge in existing home sales. Median existing home price is up 15.4% on the year to $350,000. In this competitive market, though, what opportunities do you see?

HESSAM NADJI: Well, first of all, the number is not surprising, given the trends that we've seen over the last year, in that the housing market has had a supply shortage. Unlike the 2008, 2009 crisis, where overspeculation had actually created a vast majority of the credit problems that led to that downturn and a recession, real estate on this side of the cycle has actually been a contributor. And there's been no oversupply in housing or in commercial real estate.

And of course, the effect of the pandemic has created so much demand for people to work from home, expand their living spaces, and so on. We're seeing the same phenomenon carry out in apartment rentals, which are also registering record demand and rent growth.

So where does it go from here? We do have some concerns in that affordability is becoming an issue. Less and less people will be able to afford the 15 and 1/2%, 16% price increase that you just mentioned on a year over year basis. On top of that, as interest rates go up, of course, that affordability becomes even more acute.

But the supply side of the equation is still constrained by the supply chain issues, labor costs, and so on. So, again, supply-demand is going to be fairly balanced. We don't expect prices to continue increasing for the for-sale market at the same rate they have been, so some cooling off of prices. But nonetheless, the market is fairly stable.

On the commercial real estate side of the equation, because of low interest rates and the fact that commercial real estate as an investment vehicle has always been viewed strongly as an inflation hedge, we continue to see record demand from investors wanting to invest in apartments, office buildings even, shopping centers, and in self-storage assets, every category of commercial real estate.

RACHELLE AKUFFO: So then as we talk about the Fed here, you said that a significant rapid increase in interest rates by the Fed could weigh on commercial real estate investment. What sectors are the most exposed? And how are you advising your clients to really brace for potentially four to seven rate hikes this year?

HESSAM NADJI: Well, first and foremost, you have to remember, the 10-year Treasury yield has already ran up quite a bit this year, and the market has adjusted fairly well. Lender spreads have come in, and what's really important for commercial real estate investments and valuations is the pace by which interest rate increases are met with rent growth increases. If the income and occupancy of these assets are healthy and growing at, at least the same pace, if not faster, than the rate of increases in interest rates or the cost of debt, valuations are well supported.

So far, that's what we're seeing. The biggest risk is if the Fed goes too far too fast or has to react even more aggressively than anticipated to basically fight inflation. And I think we need some time to see if that's going to be necessary or not. Let's not forget that we're coming off of a significant recovery in jobs last year. Now the pace of job growth is slowing. Therefore wage growth should probably begin to crest a bit. And the supply chain at some point is going to start easing again. So it's not a foregone conclusion that the Fed will have to really overplay its hand.

RACHELLE AKUFFO: Now I want to talk more about commercial real estate and, really, the record breaking amount of investment, we saw last year. Investors bought more commercial real estate in 2021 than ever before and a record $335 billion just into apartments across the United States last year. But then you also have renters who want to become first-time buyers because the rents are increasing and a lot of leases are coming to an end. So what is your outlook for the apartment market in 2022? And what are some of the headwinds that you're watching for?

HESSAM NADJI: The outlook for apartments is quite robust because as I mentioned earlier, the for-sale housing affordability issue is going to become more of a problem. If you look at some of the metros like Austin or Salt Lake City, Phoenix, Los Angeles even, San Jose, the Inland Empire here in Southern California, they've registered price increases of this 19%, 18% to 28% on a year over year basis. A lot of consumers are going to get priced out of the for-sale housing market and will have to continue renting.

And a lot of consumers, we've seen over the last five years, pre-pandemic, really were choosing to be renters, to have the flexibility and the lifestyle that they've enjoyed as renters. And the apartment development community has responded by building product that the 30 somethings, 40 somethings, couples without children or empty nesters really want to rent. Those trends have captured more renters than ever before. And for those reasons, the outlook for apartments is quite robust for 2022 and really-- and beyond.

RACHELLE AKUFFO: And speaking of trends, we're seeing obviously Omicron-related COVID rates continuing to fall in the US. We're seeing a return to either in-person work or some sort of hybrid work from home, in-person model. What are you watching for in the office market? And what are you seeing with the best and worst performing markets for vacancies?

HESSAM NADJI: The office market still has a lot of cloud over it, especially in urban America, where the vacancy rates are still very high. And of course, the pandemic affected urban markets much more severely than suburban markets. And the outmigration that we've seen was happening even before the pandemic. The millennials that were really fueling the demand for urban housing and professional service jobs, office jobs, were beginning to enter their 30s, forming families. 60% of them are now in their 30s. And they were already moving to the suburbs before the pandemic, and the pandemic, of course, accelerated that trend.

So the office outlook is somewhat mixed in that you still have leases on average in place where the tenant has to pay the rent for another four years. So we have plenty of time for there to be a recovery in demand. But public transportation, getting people comfortable to come back into the office is going to take some time. We believe it'll happen over time, but the hybrid solution, workplace solution is here to stay. We're experiencing it. Every one of our clients, in some ways, is experiencing it. So it will reduce office space demand.

But let's not forget that places like New York, Los Angeles, where the leading job creators in the last 12 months-- 300,000 jobs in LA, 200 plus thousand jobs in New York. Dallas was the third largest job creator. So the urban markets are beginning to come back. And I think business formations that we're seeing at record levels will eventually bring new demand to the office market. But it's going to be a bit of a transition. And we're seeing a lot of opportunistic investors take advantage of office right now being the diamond in the rough.

RACHELLE AKUFFO: We'll certainly have to keep an eye on that. We'll have to leave it there. Thank you so much. Hessam Nadji there, Marcus & Millichap CEO, thank you so much.

How the Federal Reserve responds to inflation could create headwinds for the commercial real estate market, particularly as the Fed walks back earlier efforts to keep the pandemic-era economy in motion. 

“Inflation is not the enemy of commercial real estate,” says John Chang, senior vice president and director of research services at Marcus & Millichap.. “In fact, inflation can help investors boost their cash flow and property valuations.”

But there’s always a but, Chang says: while the Fed typically targets inflation in the 2% range, it currently sits at between 5 and 7%.

And “the Fed doesn’t like inflation that high,” he says. “They’re trying to curb inflation by tightening the money supply.”

Chang notes that since the onset of the pandemic, the Fed has poured about $4.5 trillion into the US economy through programs like quantitative easing, doubling their balance sheet. At the same time, the Fed dropped the overnight rate to 0% to keep short term interest rates down.

“They were basically juicing the system so we didn’t drop into a pandemic-induced recession,” Chang says. “Don’t forget, we lost over 22 million jobs in just a couple of months at the onset of the pandemic, but now they need to walk the money supply back and raise rates to curb inflation.”

Chang says the Fed may even start selling off Treasuries to push rates up, and notes that the Fed has indicated they will soon raise the overnight rate.

“This is where a potential risk for CRE shows up,” Chang says.  “Elevated capital liquidity is creating an aggressive commercial real estate bid climate that’s putting upward pressure on prices and downward pressure on commercial real estate yields, their cap rates.”

Depending on property type and location, cap rates are running as low as 2.5%. Because most investors take out a loan when they buy a property, they generally want the interest rate to be below the cap rate. As the Fed pushes rates up, the spread between the cost of capital and the property yield tightens.

“If rates rise only or 50 or 100 basis points, it probably won’t be much of an issue, but if the Fed has to hit rates hard to get inflation under control, that could create a challenge for commercial real estate sales,” Chang says. And a significant rise of interest rates – think a couple hundred basis points or something similar—could be sufficient to slow activity and put upward pressure on cap rates.

“There are a lot of variables in play and I’m not saying the sky’s about to fall, but investors need to keep a close eye on how the Fed manages the interest rate climate…investors even thinking about taking chips off the table might want to get a broker opinion of value just to see what the potential looks like,” Chang says.

Job losses, shortages of qualified labor in the workforce and the imminent impact of rising interest rates are all real-time threats to the economy, with the first rate increase expected in March.

Marcus & Millichap hosted a webcast on Jan. 27 titled “2022 Outlook: The Economy — Inflation — Fed Policy — Real Estate” to discuss how upcoming Fed action and inflation might affect the real estate market.

The event’s speakers included Marcus & Millichap President and CEO Hessam Nadji; TruAmerica Multifamily President and CEO Robert Hart; ICSC President and CEO Tom McGee; and Henry Paulson, 74th Secretary of the United States Treasury and former chairman and CEO of Goldman Sachs.

Without sugarcoating the challenges ahead, Paulson says if history is any predictor, the next year or so is not going to be easy. “I’m not really optimistic about the core economic recovery,” he said. “I’m pleased with how the business community has responded, but here’s where I’m going to get more somber: Inflation is really serious, and I don’t think any of us can find an example in recent economic history where the Fed has been able to contain inflation like this and have a soft landing.”

On a positive note, the multifamily sector is expected to remain strong and gain even more momentum as investors shift capital to this relatively stable asset class. Real estate, in fact, is where Paulson’s outlook turns extremely optimistic.

“When I’m looking at constructing a portfolio, I want real estate to be part of it,” he said. “People are going to want to own real assets. When looking at capital preservation, I like real estate as an asset class. When I can find managers who know how to invest in that, I want to give them money.”

Nadji shared a graphic depicting a spectrum of asset classes that Marcus & Millichap has used to study commercial real estate through the pandemic, illustrating a vast difference in performance metrics and occupancy between the lowest end of the scale, lower-tier shopping centers, and the larger growth categories, like life science projects. Multifamily assets also occupy a favorable spot on the scale.

“The suburban multifamily rental market has created record demand,” Nadji said while presenting the chart. “Manufactured housing and affordable housing are in great demand, both in terms of residents and capital chasing the safety of apartments and better-performing assets,” he said. “There has been a big recovery in the student housing segment over the past year or so as well.

Nadji also looked toward what he called the lowest inventory of for-sale housing in many years, which is creating more pressure on pricing and making affordability more of an issue for a lot of consumers. “Combined with the notion of rising interest rates, the Fed almost has no option but to slow down the economy,” Nadji explained.

Parsing demand and location

Nadji said that while there’s been incredible demand across the board, the Class A, newer construction apartment market has taken a bigger hit, primarily because those new deliveries were concentrated in urban America, which Nadji said was hit very hard during the pandemic and has since recovered. “Vacancies are at record lows with incredible demand for apartment housing across the country,” he said.

“We’ve seen record rent growth for a couple of quarters that is exceeding wage growth,” Nadji said. “So we have an affordability challenge on the apartment rental side of the equation. But the trade-out rent factor as eviction moratoriums have expired and the incredible new demand that’s coming in, especially to places like Florida, Texas, Arizona and Nevada that are the growth markets are hard to miss in all the reports I see.”

According to Hart, the multifamily sector is expected to remain strong, in part, because of how well the sector weathered the first phase of the pandemic. While landlords were concerned with the possibility of delinquencies or income loss at the start of the pandemic, Hart said, the infusion of billions of dollars in the hands of qualified renters actually ended up being beneficial to multifamily owners.

“As another result of COVID, fewer people were moving, so all these trends resulted in supply shortages that, going into 2022, have led to robust demand for apartments, typically in suburban markets that are adjacent to major job centers, as well as for single-family rentals, which have had tremendous growth. The pace of suburban rental demand is going to continue through 2022 and beyond, especially in the high-growth Sun Belt, Southeast markets, where, in some cases, asking rents are now jumping as much as 20 percent.”

Hart went on to explain that “confidence of capital” is a result of these factors, with flow especially directed at Class B and workforce housing.

Nadji posed the question to Hart: “Some of the two-and-a-half to three-percent cap rates that we’re seeing in the marketplace are offset by rent growth that looks to have sustainability. Are you saying it’s safe to assume that the balance between investment decisions, cap rates and rent growth is sustainable?”

“Yes, there is much truth to that,” Hart replied. “It’s difficult for historical apartment investors to believe that cap rates have hit below 4 percent in most major markets,” Hart said. “Not to be glib, but some investors say that the 3 cap is the new 4 cap, and it’s hard to believe that. But the smart money that’s going into the space is betting on growth.”

The pandemic’s second year witnessed a robust rebound in rental housing demand, which reduced vacancies and propelled rents higher. Lack of for-sale inventory kept many higher-income renters in their apartments, while the same lower-income folks who suffered the greatest COVID-related job losses were also most rent-burdened. That sober reality has heightened the need for a fully-funded housing safety net, which must take into account safeguarding existing housing from climate change threats.

These were among the issues discussed during the “America’s Rental Housing 2022” webinar, a Joint Center for Housing Studies of Harvard University panel discussion moderated by Vox policy reporter Jerusalem Demsas.

Expert panel

Offering their perspectives were panelists Peggy Bailey, senior advisor on rental assistance, Office of the Secretary for the U.S. Department of Housing and Urban Development; Calvin Gladney, president & CEO of Smart Growth America; Chris Herbert, managing director of the Harvard Joint Center for Housing Studies; and Kara McShane, managing director, commercial real estate for Wells Fargo.

Necessary policy considerations were top of mind for Bailey, who emphasized setting in place intentional policies that at the least subsidize rent and create the right incentives to develop affordable housing along with higher-end rental units.

“We can internally look at things like the affordable housing assistance we currently employ,” she said. “We must look at how do we align our programs at HUD to get those pieces of the affordable housing capital stack working better, ensuring it’s easier to create affordable housing.”

Asked what banks can do to address the lack of affordable housing, McShane noted the affordable crisis is one of supply.

“So whatever we can do as a bank to increase supply and preserve the housing stock we have is what we need to do,” said McShane. “We need a solution from both government policy and the private sector . . . We need to partner together in the private sector, not just big banks but big tech, to create and preserve housing.”

Climate change

Keeping renters in their homes given the increased threat of climate change is a matter, Gladney opined, of the need to “stop doing dumb things.”

Continuing to build in flood-prone zones and in places where it’s recognized homes may burn to the ground are among those ill-advised moves, he added. “We allow things to happen in the market to put renters in harm’s way, and we need to stop doing that.”

Noting the difficulty of building multifamily housing in many places, especially in suburban areas, Herbert said states must take bigger roles in mandating zoning for denser housing within communities. “We can also lean into how we can build housing that’s more affordable,” he added. “Design professionals must be brought into how housing can be designed to make more efficient use of space.”

Another way to overcome resistance to denser development is to design multifamily housing that looks more like single-family housing, Gladney said.

Putting the capstone on the discussion, McShane stressed the need for partnership and collaboration. “One company or organization is not going to get it done,” she noted. “We all need to come together and keep people in homes they can be proud of.”

Demand for market-rate apartments in 2021 soared far above the highest levels on record in the three decades RealPage has tracked the market. Net demand totaled more than 673,000 units – obliterating the previous high set in 2000 by a remarkable 66%. Demand would have been even stronger if not for record-low vacancy, severely limiting the number of units available to rent.

Strong demand drove up apartment occupancy 2.1 basis points year-over-year to 97.5%. Both the increase and the resulting rate were the highest on record since RealPage began tracking apartments in the early 1990s.

Household formation is likely occurring at a faster clip than official government data sources are reporting. It’s not just apartments. We’re seeing huge demand and ultra-low availability for all types of housing – including for-sale homes and single-family rentals – in essentially every city and at every price point.

The Sun Belt and Mountain/Desert regions combined to account for more than half of the nation’s apartment demand in 2021, led by Dallas/Fort Worth’s 7.4% share of the U.S. total.

Remarkably, occupancy rates hit or top 96% in 148 of the nation’s 150 largest metro areas. (For context, a rate of 95-96% is traditionally considered “full” when accounting for normal turnover time between leases.) The only exceptions are a pair of small Texas markets: Corpus Christi and Midland/Odessa.

Severely limited availability has led to price appreciation in all types of housing, including apartments. Effective asking rents on new leases increased a record-high 14.4% in 2021. However, there are signs that rent growth could soon moderate – though not dramatically. True new lease rent growth (the replacement rent a new renter pays compared to the previous renter of the same unit) peaked in August and has inched down since then. Asking rents, the traditional headline metric, tend to be a lagging indicator.

New lease rent growth in 2021 reached double-digits in 103 of the nation’s 150 largest metros. Florida and Desert region markets led the way, with appreciation topping 20% in 11 Florida markets: Naples, Sarasota, West Palm Beach, Fort Myers, Tampa, Fort Lauderdale, Port St. Lucie, Orlando, Jacksonville, Palm Bay and Miami. Outside the Sunshine State, 11 more metros topped 20% – including Phoenix, Las Vegas, Austin, Raleigh/Durham, Atlanta and Salt Lake City.

In one major positive sign, renter incomes continued to soar upward – keeping rent-to-income ratios in the low 20% for the average renter household signing a new lease. New renter incomes registered at $70,116 nationally, up 11% above the pre-pandemic high.

It’s tremendously encouraging to see that for the vast majority of market-rate renters, apartments remain affordable. With this big wave of new demand coming in, these renters are bringing big incomes and they are paying rent on time. We’ve seen this not only in our own data, but in reporting from all the publicly traded rental housing REITs. However, averages and medians do not tell the full story. Not every household could afford market-rate rentals even prior to the pandemic, and as much as we need more housing of all types, our country remains in desperate need of more affordable housing.

One encouraging sign: Unlike in single-family, multifamily new supply continues to hit the market in large volumes – and even more is on the way. Nearly 360,000 market-rate apartment units completed in 2021. That’s the biggest addition in more than three decades. Another 682,000 units are under construction. Of those, roughly 426,000 are scheduled to complete in 2022 – marking the first time since 1987 supply will top the 400,000-unit mark.

The increase in supply is great news for renters unable to find available housing. We need more housing – all types of housing. But most of these new apartments are higher-rent, Class A+ communities. Affordable housing requires government support and funding in various forms, and there simply isn’t enough of that across most of the country right now.

Construction leaders remain the usual markets, led by Dallas/Fort Worth, Phoenix and New York. On a relative basis (construction relative to the size of the market), metros seeing significant volumes of supply under way include Nashville, Austin, Salt Lake City, Phoenix, Charlotte, Raleigh/Durham and Jacksonville – all high-demand areas.

“Multifamily starts have been robust over the last decade and stalled only briefly when the pandemic first hit before re-accelerating again,” said Carl Whitaker, RealPage’s Director of Research and Analysis. “Starts in 2022 will likely top 2021 levels, meaning completions should remain very high through at least 2023-2024. That’s especially true in many of the nation’s Sun Belt metros, most notably D/FW, Austin, Phoenix and Nashville.”

Marcus & Millichap is expecting the US to add roughly 400,000 new rentals in 2022, a record for the last few decades. Rental demand is anticipated to increase this year with rising interest rates and elevated single family home prices.

“The new supply will play a key role in appeasing the housing shortage,” Marcus & Millichap predicts.

The Sun Belt is poised to account for one-fourth of the new units with Dallas-Fort Worth, Phoenix, Austin, Houston, Nashville and Atlanta leading the way with each expected to add more than 10,000 units in 2022.

Migration to those metro areas is expected to combine to 250,000 new households this year.

Other Markets Still Intrigue

This is not to say that developers are focusing exclusively on these markets. At the recent GlobeSt.com Multifamily conference, investment professionals and experts explained where they are placing capital going forward. 

Jerry Fink, managing partner at the Bascom Group, says Las Vegas has the firm “most intrigued.” Fink likes the fundamentals, which include limited land for new development, a narrow new construction pipeline and, the kicker, 10% rent growth.

The Colorado market, and specifically Denver, is also a favorite secondary market, according to Loryn D. Arkow, a partner at law firm Stroock, said. She added that she has seen client interest in Miami and other sunbelt cities, but said there is some concern that a bubble is looming in those markets. She is most confident in the northwest and Rockies.

In Arizona, Brian Tranetzki, principal and head of multifamily at Taylor Street Advisors, said that Tucson was the most underrated market in the state. It is a discount compared to Phoenix, but there has been strong job growth and the economic growth drivers are equally as attractive.

The most unlikely market to make the cut: Albuquerque. It is the favorite underrated market of Jeff Adler, VP at Yardi Matrix. He called the market unloved, but said that it has strong fundamentals and has historically performed well with strong 7% rent growth.

David Harrington, EVP and managing director at Matthews Real Estate Investment Services and Fink are also bullish on core markets, and both like Los Angeles specifically. The Bascom Group is focused on what Fink called the doughnut around Downtown Los Angeles, neighborhoods like Boyle Heights. “We are finding tremendous demand for low-density, renovated two-story buildings,” Fink said.

Assembly Bill (AB) 107 requires that the Department of Real Estate collect information about military, veteran, and spouse license applications, including the number of expedited license applications, the number of expedited licenses issued and denied per calendar year, and the average length of time between application and expedited license issuance. DRE will submit an annual report to the Legislature.

AB 502 allows homeowners associations (HOAs), regardless of size, to elect by acclamation candidates for the board of directors, if the number of candidates is no greater than the number of vacancies. To do so, the HOA will have to meet increased noticing provisions, have had a regular election in the past three years, confirmed receipt of a candidate nomination, and provided a disqualified nominee the opportunity to appeal. The HOA board must also consider the vote by acclamation at a meeting where the agenda includes the name of each candidate to be elected in that manner.

AB 830 allows real estate licensees who change their legal surname from the name under which the license was originally issued to continue to use their former surname for business purposes. The bill also provides that the former last name does not constitute a fictitious name prohibited under real estate law. The licensee must file both the new and previous name with DRE.

Beginning July 1, 2022, AB 838 requires that a city or county inspect a property if it receives a complaint about lead hazards or substandard living conditions. Upon inspection, it will have to advise the property owner of violations and required remedies, and then re-inspect the property. Among other provisions, AB 838 provides that an inspection not be conditioned on a tenant being current on rent or other factors. Inspection fees cannot be charged, unless substandard conditions or lead hazards are found.

AB 948 creates the Fair Appraisal Act. Among its provisions, every sales contract for real property made after July 1, 2022, must include a notice stating that the property appraisal of the property must be unbiased, objective, and not influenced by specific factors, including: race, color, religion, gender, sexual orientation, marital status, medical condition, military or veteran status, national origin, source of income, ancestry, disability, genetic information, or age. The notice will also include information on actions a buyer or seller can take if they believe an appraisal has been affected.

Department of Real Estate licensees, among other professions, will be required to deliver this same notice when involved in the refinancing of a residential real estate property of up to four units.

AB 1101 modifies current financial practices and insurance requirements for homeowners associations (HOAs) in common interest developments. The bill prevents managing agents from investing HOA funds in stocks or high-risk investments, and removes the ability to co-mingle funds, among other provisions. The bill also requires HOAs and their managing agents to maintain crime insurance, employee dishonesty insurance, and fidelity bond coverage, or their equivalents.

AB 1466 changes the Restrictive Covenant Modification process. Among these changes are increasing the types of people and entities that can request a modification, expanding current notices to include information on how to request a modification, and requiring that professionals involved in property sales inform buyers and sellers about an existing restrictive covenant and increasing their duty to assist in filing a modification. In addition, the bill creates a new $2 fee on real estate instruments subject to the SB 2 (Atkins, Chapter 364, Statutes of 2017) recording fee to fund redaction work.

Beginning January 1, 2023, Senate Bill (SB) 263 modifies the content of two courses required to take either the real estate salesperson or broker licensing exam. The real estate practice course will include a component on implicit bias and the legal aspects of real estate course will include a component on federal and state fair housing.

Also beginning January 1, 2023, the required continuing education course for salespersons and brokers on fair housing will include an interactive participatory component and a new two-hour implicit bias continuing education course will be required.

SB 800 extends the sunset date for both the Department of Real Estate and the Bureau of Real Estate Appraisers to January 1, 2026. The measure also allows the Department of Real Estate to use debarment notices issued by sister agencies as grounds for action, codifies the current policy of expediting license applications for veterans and partners of members of the Armed Forces, and clarifies the definition of a real estate license in good standing.

Issue Date: November 2021