Published on: September 26, 2020
BY TED C. JONES, PH.D.
Jobs are everything to an economy. Period. They create effective demand for real estate – residential and commercial -- enabling not just the need and want but also the ability to pay. The U.S. just posted the largest drop in jobs in history in April 2020, shedding 22.16 million workers --which in turn triggered a record 30+ percent decline in GPD. Since the April employment trough, however, the U.S. has recouped almost one-half of the lost jobs (10.61 million), and a hope of positive GDP to be reported for Q3. Commercial real estate continues to ride the economic roller coaster, making timely access to data across the major U.S. cities imperative.
Dr Glenn Mueller’s quarterly Commercial Real Estate Cycles report gives just that insight. Dr. Mueller defines four distinct phases in the commercial real estate cycle providing decision points for investment and exit strategies. Long-term occupancy average is the key determinant of rental growth rates and ultimately property value. Ideally, Phase 2 is the sweet-spot, as shown in the following graph.
Across the cycle, Dr. Mueller has described rental behavior within each of the phases, using market levels ranging from 1 to 16. Equilibrium occurs at Point 11 in which demand growth equals supply growth – literally the sweet spot. The equilibrium market Point 11 is also the peak occupancy level.
Recovery Declining Vacancy, No New Construction
1-3 Negative Rental Growth 3-6 Below Inflation Rental Growth
Expansion Declining Vacancy, New Construction
6-8 Rents Rise Rapidly Toward New Construction Levels 8-11 High Rent Growth in Tight Market
Hypersupply Increasing Vacancy, New Construction
11-14 Rent Growth Positive But Declining
Recession Increasing Vacancy, More Completions
14-16, then back to 1 Below Inflation, Negative Rent Growth
These are illustrated in the following graphic from Dr Mueller’s report. The long-term occupancy average is a key factor in ascertaining rental growth rates – which in turn impact value.
Dr. Mueller’s Q2 2020 report shows the current cycle stage from a national perspective across property types. Apartments, with ongoing new deliveries in the past six years and a pipeline of construction, are in the Hypersupply Phase with rents still increasing but at a declining rate. Industrial property is now the big winner along with Retail—Neighborhood/Community (think your local neighborhood retail center anchored by the grocery store). Three Retail Property Types now reside at or near bottom of the scale of Phase 4 - Recession: 2nd Tier Regional Malls, Factory Outlet Centers and Power Centers.
The following table shows the 54 markets for Industrial properties. The Coronavirus may have expedited the demise of retail, but to the benefit of industrial properties has everything ordered online and not shipped from a retail storefront comes from an industrial property. Likewise, more manufacturing is being and is going to be done in the U.S. as critical sourcing and manufacturing is likely shifted away from China. Three more metros moved into the Hypersupply Phase in Q2 2020 denoted by the +1 suffix: Baltimore, Charlotte and Miami. Four metros moved one notch further into Hypersupply, going from 12 to 13: Columbus, Denver, Jacksonville and Stamford.
Pay attention to each of the property types in the report focusing on cities that have excess supply, and also those with supply trailing demand. To read the entire report and view the findings for all property types see the following download information.
To download current and historical quarterly reports click https://daniels.du.edu/burns-school/ and scroll down to the REAL ESTATE MARKET CYCLE REPORT section on the Website. For the Q2 2020 report click https://daniels.du.edu/assets/Cycle-Monitor-20Q2.pdf
For commercial real estate practitioners, this is essential reading each quarter.