Any medical facility appreciates positive improvements in the space’s condition. The fundamentals of medical office buildings are improving, which benefits operators, investors, and property owners alike.
The top 100 U.S. markets are covered in a Q3 2022 study on healthcare real estate by Colliers. The report’s executive summary stated that “Despite economic worries and industry obstacles, the medical office property sector (MOB) continues to grow, hitting record highs for asking rents, sales volume, and pricing over the past four quarters.” Demand is surpassing supply, there is little room for error, and capitalization (cap) rates are largely consistent. As a result, development activity is accelerating and demonstrating sector confidence.
But there is a catch: things aren’t looking so good for the healthcare sector, on which they rely. Price pressures remain present, and MOB owners may need to be monitored and given possible treatment options.
On the bright side, the top 100 metro areas had an average vacancy rate of 8% in the first half of 2022. This constitutes a 40 basis-point decrease from the same time last year.
The highest net MOB asking rentals in the top 100 were in Los Angeles, where they were $36.85 per square foot. This price is certainly an anomaly.
The research noted that none of the other top 10 metros had an average MOB rent of over $30 per square foot. The lowest costs in the top 10 didn’t include numbers, but a graph clearly demonstrated that four—Atlanta, Boston, Dallas, and Philadelphia—were much below the national average. “Boston and New York are the next highest, at $26.26 per square foot and $26.19 per square foot, respectively.”
Construction increased in an effort to keep up with demand; 14 million square feet were completed in the four quarters that ended in Q2 2022. This was an increase above the 13.7 million square feet from the previous year. More dramatically, from 30.9 million to 37.1 million square feet, MOB under development increased.
Additionally, investor demand was high—it reached a record-high $17.2 billion in the four quarters that ended in Q2 2022.
Since many individuals find it difficult to refuse medical care, MOB is substantially positioned to survive economic storms. The prices are also a concern for practitioners. That would suggest real estate overhead will also be under review. “In the face of lower income and, in some cases, operating losses, some providers are eliminating staff despite an overall shortage of employees in the healthcare industry.”
As the inflationary environment intensifies, multifamily deals with pre-existing loans and favorable interest rates will be the most popular in the coming months. Stabilized properties will also be in even greater demand because they can offer higher returns and more certainty, according to one industry veteran.
According to Otto Ozen, Executive Vice President of The Mogharebi Group, the asset class will continue to be a desirable inflation hedge because it has historically outperformed other asset classes from a yield perspective, and demand drivers are still strong given that the costs of homeownership are still staggeringly out of reach for many prospective buyers.
He claims that when mortgage rates increase, the affordability gap grows, raising the entry barriers for home buyers and ultimately pushing them into renting. Because of this change, the rental market will be robust and rental rate growth will outperform inflation.
At a panel discussion at GlobeSt’s upcoming Multifamily Conference in Los Angeles in October, Ozen will elaborate on these observations and provide more perspectives on what will make multifamily deals successful in the current environment. He says he’ll be keeping an eye on core inflation and interest rates going into 2023 to better understand transaction velocity. He mentions that value-add and opportunistic deals may start to slow down as the risk involved with these transactions increases as interest rates rise.
Investors with and without US-based bases foresee difficulties in closing deals in both the US and, to a greater extent, in Europe due to economic uncertainties. Foreign investors are less bullish about both regions than in prior surveys, but they are more positive about the US than Europe. Branson notes that, in contrast to overseas investors (67%), Americans (92%) are more gloomy about the “inevitability” of a US recession.
Another top goal for survey respondents was energy independence, and over two-thirds said they are currently actively working to increase their energy efficiency. Eighty-two percent of respondents to the study think that the need for investors to address an ESG agenda will increase as a result of the global energy crisis. Additionally, 59% of investors give priority to projects that have previously earned certain sustainability certifications, such as LEED and BREEAM.
In contrast to US-based investors (31%), who place a higher premium on getting rid of outdated or inefficient assets, non-US investors (43%) are more inclined to focus on capital spending for sustainability improvements.
Four of the major financial regulatory organizations—Office of the Comptroller of the Currency, Treasury, Federal Deposit Insurance Corporation, and National Credit Union Administration—published a proposed revision to a 2009 policy governing commercial real estate loan accommodations and workouts in the Federal Register at the beginning of last month.
The Federal Reserve has since released its interpretation of the policy with a comment period concluding on November 14, 2022.
The proposed statement was created in consultation with state bank and credit union regulators by the Board, the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corporation (FDIC), and the National Credit Union Administration (NCUA), and is identical to the one that was previously made public.
The initial 2009 declaration followed the Great Recession and a significant shakeout in the real estate market, among other factors. The pandemic’s experience and the numerous revisions that came about as a result of business closures that left many owners and investors in a bind are incorporated into the present suggested edition.
Two important initial concepts are still supported by the proposed statement. One, even if the amended loans have flaws, lending institutions who use “prudent CRE loan accommodation” won’t face criticism for doing so. The second is that modified loans won’t be adversely classified if the borrower has the capacity to repay them on fair conditions because the value of the collateral is lower than the loan balance.
Such arrangements are described as tools “to mitigate adverse effects on borrowers and would encourage financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations during periods of financial stress” in a new section on short-term loan accommodations.
Former US Treasury Secretary, Lawrence Summers, reassured CRE CEOs that “if the vehicle’s moving faster, we need a firmer brake, but it doesn’t imply we’ll hit the wall before the car stops” on a day when a stubbornly high inflation rate dashed hopes for a smooth landing for the US economy.
Hessam Nadji, CEO of Marcus & Millichap, conducted a wide-ranging online debate on Tuesday. In it, Summers projected that the Fed’s ongoing rate hikes will soon lead to a “recession of choice” that will end the record-breaking employment creation of the previous year.
Summers stated, “The Fed seeks to limit it by constraining demand by hiking rates. We have constant inflation owing to a conflict between supply and demand. My best judgment is that the economy will enter a recession and that employment creation will slow down in the coming year.”
The economy, and the CRE sector in particular, is far better prepared to survive an economic crisis than it was in 2008 when the housing market crashed, according to the former Treasury director.
Summers said, “We won’t see something like 2008 again,” pointing out how much less indebted homeowners have, how the inventory is not overstocked, and how much stronger and more cautious lenders are now than they were before the sub-prime crisis.
Summers suggested that the recession would not start for a few months since fundamentals like consumer spending are still strong and have some capacity to increase.
“It’s important to keep in mind that there is still a significant savings overhang. According to Summers, $2 trillion was the amount of money that individuals were unable to spend because of the epidemic.
Only $300 billion of the total had been spent; more than half was still in checking accounts. That seems to me that customers will persist. Due to discounted salaries, I don’t believe they will run out of money to spend,” he remarked.
Summers advised CRE participants not to assume that “structural” developments, such as the increase in remote work and the boom in e-commerce, that have been triggered by the epidemic, will have a detrimental influence on the demand for CRE.
Even in a year or two when there is no employment growth, there will be significant ferment and opportunity in the CRE markets, according to Summers.
The former US Treasury Secretary adds “Many individuals believe that working from home will be awful. That is untrue.” According to him, the movement of people into new areas creates a need for real estate. He also said that the pandemic’s quick rise in e-commerce increased the need for warehouses exponentially.
Summers believes hybrid work is here to stay in the office sector, but he does not think it will have the same impact on office footprints as some may anticipate.
Many will travel far away from work as the need to live closer to the workplace lessens. He said employers will become a little more tolerant of workers working from home as they make improvements to their oversight of remote workers.
But if employees work three days a week, the employers will want them to come in on those days, so there won’t be as much of an influence on office footprints, according to Summers.
The former Treasury Secretary made a forecast that is a sweet relief to the commercial real estate industry, stating that CRE, with cap rates presently averaging 5.7% across asset classes, represents an attractive investment option when compared to equities and bonds.
In the upcoming months and years, “the position of CRE in portfolios is going to be bigger,” Summers said.
According to Summers, commercial real estate should have a bigger presence in many portfolios. It is very tax advantageous, and it seems even better after taxes.
“A bond currently yields 3.3 percent, and that is all it will continue to yield after 10 years. Property values are far more likely to increase over ten years. It will rise, not fall.” he continued.
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Commercial real estate experts won’t be overjoyed by the Federal Reserve’s September Beige Book, also known as the “Summary of Commentary on Current Economic Conditions by the Federal Reserve District.” However, the good news offers optimism for some reprieve in construction, while the bad news is already known.
First, the obvious bad: don’t expect an early end to interest rate hikes since “price levels remained substantially elevated,” which indicates that inflation is still occurring.
In spite of the fact that nine of the Fed’s 12 districts “reported some degree of moderation in their rate of increase,” indicating that at least the rate at which inflation was increasing had slowed, the report stated that “substantial price increases were reported across all districts, particularly for food, rent, utilities, and hospitality services.” That’s a crucial indicator that prices will finally stabilize. But it appears that is still a ways off.
“The Fed still has an inflation concern and is determined to front-load rate hikes as aggressively as possible,” says Jeffrey Roach, chief economist at LPL Financial.”If next week’s inflation report surprises positively, the chances of a 75-basis point boost later this month may grow.”
The Fed also pointed out that certain aspects of real estate still face difficulties. It was noted in the study that, “despite some reports of strong leasing activity, residential real estate conditions weakened noticeably as home sales fell in all twelve districts and residential construction remained constrained by input shortages. Commercial real estate activity softened, particularly demand for office space. “Loan demand was mixed; while financial institutions reported generally strong demand for credit cards and commercial and industrial loans, residential loan demand was weak amid elevated mortgage interest rates.”
The districts that specifically mentioned real estate included Boston, where the outlook deteriorated; Richmond, where activity was flat to slightly down, Atlanta, where there was a mix of commercial and residential real estate activity, Chicago, where construction and real estate declined slightly, and San Francisco, where residential activity slowed.
There were also some encouraging developments in the crucial field of materials. The report stated that lower fuel prices and a decline in overall demand helped to relieve cost constraints, particularly those related to freight transportation rates. However, manufacturing and construction input costs remained high. However, most contacts outside of the Federal Reserve system believed price pressures would last at least through the end of the year. “Several districts reported some tapering in prices for steel, lumber, and copper.”
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While CRE transactions may level off this year, investor sentiment is still positive, according to a recent Marcus & Millichap investor poll.
The headline index number of 159 in the mid-year poll is “somewhat similar to the path we witnessed in 2016,” according to John Chang of Marcus & Millichap, in which confidence somewhat dipped as rising interest rates bit into the market. But they’re not down as much as one might anticipate, he adds.
The index fell 12 points in 2016 and there was a flattening of CRE transactions. In what Chang refers to as a “very minor softening,” the index has dropped 11 points this year, and it might produce comparable outcomes.
According to him, “yes, the market is seeing a recalibration as investors redo numbers based on the increasing cost of capital, but the survey respondents aren’t telegraphing a substantial market change.”
The poll indicates that interest rates and inflation are the two main issues for investors. Almost 9% said they would buy more commercial real estate as interest rates rise, while more than two-thirds said they would not change their investment plans as rates rise.On the sell side, 77% claimed that the rate hikes had not changed their plans, and 11% claimed that they intended to sell more as a result.
The survey found that participants disregarded inflation even more. However, over 12% of respondents indicated they would buy more CRE. Twenty-four percent of respondents said they would buy less CRE. A higher percentage of investors overall indicated they would purchase more of the more inflation-resistant property types, such as flats, hotels, and self-storage, with 14.4% indicating they would do so.
In addition to rising interest rates, cap rates are anticipated to climb as well; according to 14% of investors questioned, cap rates will increase by 50 basis points or more during the next year. About 35% predict an increase of less than that, while 27% predict no change. According to Chang, yields and stability look appealing because there is still a lot of cash flowing into CRE.
Think about the fact that the year that just ended, in the second quarter of 2022, was by far the busiest for commercial real estate investment transactions ever, Chang advises. The upcoming year “will probably rank as the second most active year, even if activity slows down a little.
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After a protracted period during which the asset class was experiencing high demand, the third quarter saw a slight decline in demand for multifamily housing as household formation returned to normal and inflation started to affect consumer budgets.
According to a recent Marcus & Millichap analysis, the average effective monthly rent in the United States increased by almost 16 percent in 2021, with certain Sun Belt markets seeing increases of more than 25 percent in just the previous year. But as economic headwinds accelerated, 80,000 fewer households were generated in the first half of the year, depressing the market.
Over the past two years, the median price of a single-family house has increased by more than 30%, and mortgage rates have reached levels that many customers haven’t experienced in their adult lifetimes. Has a single-family median price. Additionally, according to the firm, “this is widening the affordability gap, or the difference between an average monthly payment on a median priced home and an average rent obligation.” The affordability gap is now more than $1,000 per month, which is roughly three times the size of pre-pandemic norms.
According to the research, “the cost-saving benefits, coupled with lifestyle elements, locational advantages, and flexibility, will sustain apartment demand.”
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According to a study this week from RSM, real estate funds seem to be maintaining their path and accounting for a small overall cooling of the market.
The volume of sales transactions and associated cap rates realized in those transactions have both decreased, it was claimed, and fundraising is adopting the same mentality.
Since interest rate increases and inflationary pressures suggest that a possible impending recession may be imminent, investors are currently on the defensive and reevaluating values and strategy. RSM stated that capital is being directed toward core and core-plus assets, value-add investments, and less risky initiatives.
Real estate investment may have slowed down from its record-breaking rate in 2021, but prices are still significantly higher than they were before the pandemic, and there is still enough of money for investors to keep spending.
Finance Is Generally Affordable
According to RSM, property cash flow, particularly from multifamily and industrial properties, is still strong, and financing is still quite affordable.
According to the statement, “We anticipate transaction volume to pick up in the fourth quarter of 2022 or early 2023 as fund managers reevaluate their strategy and the return expectations of their investors, looking to deploy cash that has been sitting on the sidelines.”
Cap rate compression on a global scale
Even the “darlings” of the pandemic, multifamily and industrial, saw cap rates compressed.
Compared to an average reduction of 0.15% over the preceding three years, multifamily cap rates have decreased by 0.79% since the second quarter of 2020, according to CoStar.
RSM claimed that because of growing values, it has become harder for acquisitions to meet investment objectives.
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