Published on: February 13, 2021
BY TED C. JONES, PH.D.
Just like the foggy and drizzly weather today in Houston, the economic fog of the pandemic is distorting the view of commercial real estate markets across the country. Jobs are everything to an economy with the U.S. still down almost 10 million positions from where it was in February of last year. The housing market continues to boom but the same is not true for all types of commercial real estate. Detailed insight is needed to help ascertain where real estate markets are at and heading. 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 values. Ideally, Phase 2 - Expansion is the sweet-spot in for real estate investor performance as shown in the following two graphs and discussion.
Across the cycle, Dr. Mueller has described rental behavior within each of the phases, using market levels (stages) ranging from 1 to 16. Equilibrium occurs at Market Level 11 in which demand growth equals supply growth – literally the sweet spot. The equilibrium Market Level 11 is also the peak occupancy level.
Phase 1 - Recovery Declining Vacancy, No New Construction
1-3 Negative Rental Growth
3-6 Below Inflation Rental Growth
Phase 2 - Expansion Declining Vacancy, New Construction
6-8 Rents Rise Rapidly Toward New Construction Levels
8-11 High Rent Growth in Tight Market
Phase 3 - Hypersupply Increasing Vacancy, New Construction
11-14 Rent Growth Positive But Declining
Phase 4 - Recession Increasing Vacancy, More Completions
14-16, then back to 1 Below Inflation, Negative Rent Growth
Dr. Mueller’s Q4 2020 report shows the current cycle stage from a national perspective across property types. Apartments, Industrial (Research & Development and Flex Space) and Retail (Neighborhood/Community and Factory Outlet), with growing ecommerce, ongoing new deliveries, and a pipeline of construction, are in Phase 3 - Hypersupply with rents still increasing but at a declining rate. Phase 4 – Recession contains both Retail Power Centers and Regional Malls where rents decline.
Industrial warehouse property continues to be the big winner in real estate driven by ecommerce needs, is resting at Equilibrium Market Level 11. Also in the desired Phase 2 - Expansion are Downtown Offices (sitting near the fringe at Stage 7) and Suburban Offices at Stage 8.
Retail is shown in the next table for 54 individual Metros across the country. Two out-of-every-five Metros in Mueller’s study (43 percent) are in Phase 3 – Hypersupply or Phase 4 – Recession for retail. As described in Mueller’s full report, the number following the Metro shows how that specific market changed from the prior quarter across the stages. Markets that are shown in bold italic font make up 50 percent of the total space monitored by Mueller’s report.
Mueller’s quarterly report, which is based on more than 300 individual econometric models, also includes these metrics for apartments, office and retail properties across the 54 metros. 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 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 Q4 2020 report click https://daniels.du.edu/assets/Cycle-Monitor-20Q4.pdf