Two-lane recovery

US Real estate markets are at an interesting juncture, characterised by sluggish activity but high investor demand, writes Tsering Namgyal

The US commercial real estate sector is in ‘gradual recovery’, led mainly by the multi-housing residential market and apartment sector, economists say. Meanwhile, the bottom for the residential housing market is near, if the inventory of the distressed housing and the rising prices are any indication.

“We are quickly approaching the bottom of the residential housing,” says Eduardo Martinez, senior economist at Moody’s Analytics. Yet, there are still uncertainties, including the outcome of the presidential elections, how the government will resolve the ‘fiscal cliff’ and whether interest rates will rise in the near future. “It is a calculus,” Martinez says, pointing out that how the situation pans out will depend on who controls the houses and who wins the election.

Overall, the US real estate market is at an interesting juncture. While the sector is characterised by sluggish leasing activity, it is also experiencing strong demand from investors.

“The real estate industry recovery is gradual,” says Asieh Mansour, head of Americas research at CBRE. “We will not see another recession unless something awful happens next year, which I do not think anybody expects.”

Favourable factors include quantitative easing by the Fed, cheap availability of quality credit, clear signs of recovery in manufacturing growth and the role of the US as a safe haven for international investors.

Among all sectors, apartments are experiencing the strongest growth, thanks to the consequences of the housing crash and the demographic shift. “Owning a house is no longer considered a part of the American dream,” says Terry Loebs, the founder of Pulsenomics, which analyses the housing industry. He believes that the residential housing market is still very sluggish and yet to see its “final bottom”.

The situation in the housing sector affects the real estate sector as a whole. For instance, many of the people who lost their homes during the downturn still need to live somewhere. Ironically, the sub-prime fallout has actually benefitted the multi-housing and apartment sectors.

And those who are renting apartments are mostly younger graduates – unable to afford to buy their first homes. And the ‘pent-up demand’ from the younger group, especially those aged 20-34 who are entering the improving job market, would further boost demand. The metro areas well placed to benefit from this trend are Raleigh, Las Vegas, Austin, Phoenix and Charlotte.

“Lots of people have stopped being homeowners and that has increased demand for apartments,” says Martinez. “Because of reduced earning potential, a lot of the younger people are not in a position to buy homes as they would have been if they had graduated 10 or 15 years ago.”

Not surprisingly, the permits issued for multi-family housing (which includes condominiums and apartments) have outpaced single-family housing for more than a year and half. “So this has allowed investors to increase their rent and revenue stream,” Martinez says.

Home ownership in the US has now fallen to below 66%, the lowest in 15 years, according to Moody’s Analytics.

The latest round of quantitative easing has helped keep down yields on 5-10-year bonds, often the benchmark for commercial real estate mortgages, which is positive for a lot of recovering industries. The tech sector, for exmple, is doing well.

“In some sense, they [tech firms] have already recovered, for instance, a lot of the internet-based companies,” says Martinez. This is reflected in a great deal of construction activity in San Jose, San Francisco Bay area and Seattle.

And the demand from technology companies in the gateway cities, such as Seattle and San Francisco, means that office rents are rising, leading to higher investments in these sectors. The demand for office space is also likely to improve as financial services and other industries related to real estate, which bore the brunt of the housing crash, expand once again, according to Moody’s.

Indeed, the office markets, especially in the business districts of key gateway cities are already recovering. Yet other retail sectors such as shopping centres have a lot of vacancy, thanks to weak consumer spending. Meanwhile, the ongoing consolidation in the retail industry, part of which is led by the thriving online retailing industry, is benefitting the warehousing sector. There is a demand for large and more modern warehousing facilities, according to CBRE.

“If you look at the whole retail sector, it is really lagging and it has not really recovered,” says Mansour. One exception is high-street retail where occupancy rates are very high, and are commanding relatively high rents.

The US real estate market continues to be somewhat bifurcated. While the overall real estate industry is still relatively sluggish, the real estate prices, especially in the primary gateway markets (New York, Chicago, Washington DC, San Francisco and Los Angeles), are still relatively expensive.

This has presented a dilemma for institutional investors planning to buy higher quality real estate in prime markets because of a lack of supply. Transaction activity actually fell over the summer – and it is not because of lack of demand but the lack of supply.
Institutional investors are “looking for cheap entry points,” says Martinez. But assets are anything but cheap.

“Investors want to invest in the core assets, high quality and prime assets in the gateway markets, but the pricing is really rich, and it is very expensive,” says Mansour.

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