THE U.S. ECONOMY HAS IMPROVED significantly since April, the peak of the pandemic-induced recession of 2020. Unemployment rates at 6.0 percent in March are well below the 14.8 percent April peak. Companies were effective in implementing work-from-home technology, keeping unemployment rates for office-based service sectors relatively low. For those with a bachelor’s degree or higher, unemployment rates were only 3.7 percent as of March. Third-quarter GDP growth made up much of the second-quarter losses, followed by 4 percent annualized economic growth in the fourth quarter. Retail sales also rebounded quickly, returning to pre-pandemic levels by June and continued to increase through the beginning of the year. However, the U.S. economy is still far from ‘normal’. Of the 22 million people who lost jobs in March and April, only 57.8 percent had regained employment by March 2021. Stronger growth should return jobs to industries hit hardest during the pandemic. In March, restaurants and bars added 176,000 jobs; arts, entertainment, and recreation venues added 64,000 jobs; and accommodations added 40,000 jobs. Still, employment in the overall leisure and hospitality sector is down by 3.1 million, or 18.5 percent from February 2020.1 Other than a minor surge around year-end holidays, air travel has minimally improved over the past three months. As of mid-February, TSA throughput travel in the U.S. remains down by 57 percent from a year ago.2
The good news is that the availability of an effective vaccine followed by a slowdown in U.S. and global cases of COVID are listed as the most important factors influencing traveler decisions.3 New COVID cases in the U.S. are down, and with a broader summer vaccine rollout expected, travel plans should improve soon. Almost one in three people was willing to make a driving trip of fewer than 100 miles in Q4 2020, up significantly from about one in four on average in the previous three months. Flight plans are relatively unchanged, though. Hospitality stocks have already started to recover, with REITs posting a 72.3 percent total return from November through mid-February.
Office owners are taking steps to make safer workplaces in order to entice employees back into the office. An ongoing survey of how frequently office security passes are used shows that in ten of the largest cities in the country, only 24.7 percent of office workers were back in the office as of mid-February.4 Texas metros lead the way with more than a third of office workers back, but San Francisco and New York are lagging, with only 13 percent and 15 percent of workers back in the office, respectively. Similarly, the pandemic has impacted nursing facilities where employment remains down by 11 percent year-over-year in January. While federal government employment is up slightly year-over-year, state and local governments are already feeling the impact of lower tax revenues – the biggest loser has been education, where jobs are down by 11 percent at the state level and 8 percent at the local level.
3MMGY Travel Intentions Pulse Survey Results for December 2020
Interestingly, some retail sectors have been the biggest job creators over the past year. With more people at home, Americans have changed some of their habits, including how they purchase things. The biggest job creators, each creating more than 100,000 jobs since last January, were warehouse clubs, couriers and messengers, building and garden stores, and warehouses. Americans returned to eating at home in 2020; food & beverage stores (e.g. grocery) created more than 100,000 new jobs after March 2020. Overall, real personal consumption expenditures on goods increased by 7.0 percent year-over-year as of the fourth quarter of 2020. Of course, a good portion of spending switched to online purchases. Non-store and electronic shopping purchases increased by 24 percent year-over-year. This method of shopping now comprises 29 percent of all retail sales, accelerating the previous online shopping trend and now surpassing the market share of general merchandise, apparel, furnishings, and other retail sales (GAFO), a proxy for shopping center type sales.5 It is yet to be seen how much, if any, of this trend will reverse after the pandemic ends, creating uncertainty for retail property owners.
The pandemic-induced work-from-home trend impacted the housing market. With higher-income households generally fully employed and urban centers providing less of a draw, existing single-family home sales increased by 9.1 percent in February from a year ago. Robust sales and limited inventory drove the median home price of existing homes up by 15.8 percent in February from a year ago.5 The market is further supported by attractive mortgage rates, which trended up in the last quarter but remained at historic lows and are likely to remain low as the Federal Reserve made it clear at its January meeting that it remains in an accommodative mode. Consequently, single-family building permits were up by 15 percent year-over-year in February to a 1.1 million annualized rate, the fastest pace since 2006.
Across all markets in the U.S., there was a trend of tenants leaving large, high-cost cities such as San Francisco, San Jose, Los Angeles, and New York. However, most apartment markets remain healthy. After increasing by 40 basis points in the first half of the year, vacancy for U.S. institutional-quality apartment buildings held steady in the second half of the year at 7.7 percent, lower than shopping centers (9.0 percent), office (15.3 percent), and higher than warehouse (6.6 percent) . Part of the apartment vacancy reflects a robust construction pipeline, which increased total stock by 3.8 percent, or 372,000 units, in 2020. Alternatively, vacancy for stabilized properties is under 6 percent. Rent collections as of March remain high at 95.9 percent, down slightly from 97.2 percent a year ago.6 Low-cost markets such as Dallas, Atlanta, and Houston led demand in 2020, each absorbing more than 10,000 units. The South/Southeast exhibited strong demand in markets such as Charleston, Charlotte, Jacksonville, Raleigh, and San Antonio.
However, even some of the harder-hit markets in 2020 began to turn the corner in early 2021. In the city of San Francisco, for example, effective rents stabilized, and net absorption turned positive as of mid-February as new vaccines gave hope of urban reopening and tenants took advantage of low rental levels that haven’t been seen since 2012. Effective U.S. apartment rents held relatively flat in the second half of the year. Class B rent growth increased by 1.4 percent in 2020, while Class A properties experienced slight rent declines, reflecting the large construction pipeline. However, performance varies significantly by market. Effective rents increased by 3 percent or more in 2020 in many markets, including several in the Midwest. The apartment market will need to continue to exhibit strong demand going forward as the construction pipeline remains robust. While down from a peak a year ago, another 474,000 units are under construction, equivalent to 4.6 percent of total stock. Nearly 80,000 units under construction are located in New York and Los Angeles. Other markets with robust construction pipelines include Dallas, Seattle, Phoenix, Houston, Washington, D.C., and Boston.
5Source: Costar, Board of Governors of the Federal Reserve System
6“ULI Real Estate Economic Forecast, A Survey of Leading Real Estate Economists / Analysts”, October 2020
Apartment sales volumes peaked in 2019 but began to rebound towards the end of 2020, topping $32 billion in sales, down by only 4 percent from the previous year. As of the first quarter of 2021, sales volume over the past year remains down by 39 percent from a year ago but is likely to begin an ascent during the Spring season. Prices have held fairly steady however. The average sales price per unit at $165,182 over the past year is up by 0.8 percent year over year as of the first quarter. Similarly, average cap rates at 5.3 percent in 1Q 2021 were down by 10 basis points from the previous year. Central Business District cap rates, averaging 4.8 percent in the first quarter, were up 10 basis points year-over-year, while suburban cap rates at 5.4 percent were down 10 basis points year-over-year. Ten-year treasury yields increased by over 100 bp from historically low levels in early August 2020, bringing the cap rate spread to treasuries back to near the ten-year average level by the first quarter of 2021.
Expectations are that commercial real estate transaction volumes will increase by 25 percent in 2021 and another 20 percent in 2022. Given the improving economic conditions, low interest rates, balanced apartment market, and wide cap rate spreads to treasury yields, apartment market sales are expected to continue to increase in a similar fashion. Walker & Dunlop reviewed multifamily loan maturities, delinquencies, construction pipelines, and sales trends to identify potential impacts on multifamily loan originations. As shown in the table below, multifamily loan originations are expected to increase by 3 percent in 2021, then an average of 11 percent per year in 2022 to 2024.
While the economy has made many positive rebounds, ‘normal’ isn’t quite here. Schools have yet to fully reopen nationally, and the government has struggled to accelerate the vaccination rollout. 9.6 million people who were employed a year ago still remain unemployed. Most concerning is that the pandemic clearly defined upper-income households who were minimally impacted (at least economically) and lower-income households, many of whom remain unemployed. A newly elected government will need to prove its effectiveness both in restoring economic conditions and international trust, as well as restoring at least enough political unity to be productive. The Federal Reserve warned in January that the pace of economic and employment recovery moderated in recent months. Accommodative financial conditions thus remain in place, which should be supportive for real estate markets in the coming months. Additionally, prices are yet to fully recover in some real estate sectors, providing upside opportunity to investors. Real GDP growth of 4.5 percent is expected in 2021. For core properties, national apartment and industrial vacancy rates are expected to remain below long-term averages, while retail and office vacancy exceed long-term averages.
Industrial availability is projected to remain 290 basis points lower than the 20-year average by 2022, while apartment vacancy, which generally varies in a small single-digit range, remains 60 basis points below the 20-year average. The President’s American Rescue Plan promising $1 trillion in spending this year and $3 trillion set aside for infrastructure and energy spending – on top of the trillions that have already been spent by the government on Coronavirus relief – raised questions of inflation fears by some economists in March as the economy begins to reopen. Low unemployment rates could further drive spending, creating a near-term pricing issue as production of goods, which in some cases was slowed by both the virus and transportation issues, catches up. March inflation was up by 2.6 percent year over year, the fastest pace since 2018. However, it should be noted that surging oil prices were the primary cause, as inflation other than food and energy was up by only 1.6 percent year over year. General expectations are that inflation will remain moderate at just over 2 percent for the rest of the year,7 although some expect a summer spike that could reach up to 3 percent. That level of inflation hasn’t been seen since 2012. As mentioned, we aren’t at ‘normal’ yet, and many believe that the normal we settle into won’t be as it was before. With vaccine rollout continuing, both the housing market and the overall economy will welcome a ‘new normal.’ Businesses and consumers will see some pandemic instigated trends remain while others evolve.
7Philadelphia Federal Reserve Bank, Survey of Professional Forecasters, First Quarter 2021