[Exclusive Research] Investor Sentiment Recovers[Exclusive Research] Investor Sentiment Recovers
Survey results point to returning confidence in commercial real estate values and performance, while momentum for recovery varies across geographies and property types.
April 7, 2021
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Sponsored by Marcus & Millichap
Investor Sentiment Recovers
Investors express returning confidence in commercial real estate values and performances.
Despite the ongoing economic challenges related to the COVID-19 pandemic, commercial real estate optimism has been quick to recover. Exclusive research from the latest WMRE/Marcus & Millichap Investor Sentiment Survey shows that investor sentiment has returned to pre-pandemic levels with an index score that jumped 25 points to 165. The first-half 2021 survey results are nearly on par with the 166 recorded a year ago just prior to the onset of the pandemic.
That bounce is not surprising considering the health crisis will likely be a comparatively short-term shock to the system. Although it has been a year now, in real estate terms that is a relatively short time period because hold times tend to run five, seven and 10 years or longer,” says John Chang, senior vice president of Research Services at Marcus & Millichap. Another key difference between the COVID-19 recession and the Great Financial Crisis is the liquidity in the market. Financing is still available for most property types and areas, and more than half of respondents (56 percent) said they have an abundance of capital ready to invest.
Vaccinations are continuing to roll out, and that is boosting optimism as people begin to see the light at the end of the tunnel, adds Chang. More respondents now believe that the worst of the economic downturn is behind us at 40 percent versus 26 percent who thought that was the case in the second-half 2020 survey. However, views are still mixed with 37 percent who said that the worst could still be ahead, and 23 percent who were neutral in their opinion on whether the worst was in the past or still ahead.
The optimism is mixed as there is a healthy dose of caution due to the risks and uncertainties that remain in the market, notes Chang. Will work-from-home policies drive secular shifts in the office market? How long will it take consumers to return to pre-pandemic levels of in-person shopping, entertainment and travel? Are the population shifts and outmigration from urban centers temporary, or perhaps more permanent? “Those are very important questions that we do not have answers to yet. So, as investors look forward, they recognize there are a lot of opportunities in real estate, but there are certainly both short- and long-term risks that must be factored in,” says Chang.
Survey Methodology: Wealth Management Real Estate’s research unit, Informa Engage, and Marcus & Millichap emailed invitations to participate in this online survey to public and private investors and developers of commercial real estate. Recipients of the survey included Marcus & Millichap clients as well as commercial real estate investor, pension fund, and developer business subscribers of WMRE who provided their email addresses. The survey was conducted between Feb. 3-10 with 509 respondents. Participants represent a broad cross section of industry respondents that include private investors, developers, advisors, lenders, and REITs, among others. The largest percentage of respondents are private investors at 37 percent and financial advisors at 21 percent. Respondents are invested in a variety of property types with a majority of 59 percent invested in apartments, followed by retail at 34 percent, office at 32 percent and industrial at 27 percent. On average, respondents have $28.3 million invested in commercial and/or multifamily property.
Confidence is Reflected in Appetite for Acquisitions
The typical investor plans to increase real estate investments by an average of 10 percent.
Similar to the second-half 2020 survey, 55 percent of respondents said they plan to increase commercial real estate holdings over the next 12 months. Although that percentage is down compared with the 61 percent who expected to increase investments prior to the pandemic, it continues to show a relatively high level of confidence. An additional 35 percent of respondents plan no change to holdings in the coming year, while 10 percent anticipate a decrease. The typical respondent plans to increase real estate investments by an average of 10 percent.
Another factor influencing plans to increase real estate holdings is the changing view on whether the real estate market is approaching a cyclical peak. While 74 percent of survey respondents thought commercial real estate values were near the peak a year ago, just 41 percent now hold that perception. Among the remaining respondents, 30 percent are neutral, and 29 percent do not think values are near the peak. Interest rates also have started to move higher and a majority of respondents (61 percent) expect interest rates to increase further over the next 12 months. “The spread between interest rates and cap rates remains attractive, and expectations that interest rates will rise could spur transaction activity as investors capitalize on the current low rates,” says Evan Denner, executive vice president, head of business for Marcus & Millichap Capital Corp.
Survey results also indicate strong investor appetite for assets in smaller markets. At least half of respondents believe now is the time to buy in tertiary markets (57 percent), secondary cities (55 percent) and suburban areas of both secondary and tertiary markets (50 percent). “The tertiary markets investors are targeting are still relatively large cities that have been attracting strong in-migration for several years,” says Chang. “That trend accelerated last year as the pandemic spurred people to seek more space and a lower cost of living once they were not tied to a work commute into a major city.” Private investors in particular have led the charge into tertiary markets as institutional investors tend to be more cautious with small cities, favoring top-tier assets in those markets, he adds.
At the same time, about one-third of investors believe now is the time to sell assets located in primary gateway markets (32 percent) or urban metro areas of those primary markets (34 percent) [Figure 2]. “The pandemic has sparked an important investor recalibration,” says Chang. Going back even five years most investors were pursuing assets in the urban core, particularly apartments and downtown CBD office assets. That model has changed, at least temporarily. “Investors are pulling back and rethinking their investment strategies,” he says. The question that has yet to be answered is whether the people and businesses that left those urban centers reflect a short-term change that will come back quickly, or whether this is a longer-term structural change, he adds.
Property Outlook Falls in Three Tiers
Depending on asset allocations, some investors have felt the negative effects of the pandemic more than others.
Although most respondents (62 percent) said commercial real estate offers favorable returns relative to other investment classes, the sentiment is slightly weaker compared with the second-half 2020 survey when 68 percent held that view. It also remains considerably lower compared with 74 percent who thought returns were more favorable in the first-half 2020 survey. That sentiment is not surprising given the broader context of the negative economic effects of the pandemic, with some property types and cities experiencing a more significant impact. “If you own a hotel, shopping mall or even apartments, you are acutely aware of the pandemic and the challenges it has brought,” says Chang. “So, depending on where an investor has assets allocated, some felt the negative effects more than others.”
When all survey respondents were asked their views on whether they think it is a better time to buy, hold or sell properties across different sectors, nearly half of respondents (46 percent) favored industrial, followed by self-storage at 45 percent; seniors housing at 44 percent; and apartments at 42 percent. Nearly one-third (32 percent) thought that it was a good time to buy hotels. Those property types that rated lower for buyer interest were office and retail at 16 percent each. When the same question was asked only of those investors who already are actively involved in each property type, more investors thought it was a good time to buy. Sixty-three percent of industrial owners thought it was a good time to buy, followed by seniors housing at 60 percent, apartments at 48 percent, office at 44 percent and hotels at 43 percent. Fewer thought it was a good time to buy retail and self-storage at 18 percent and 16 percent, respectively [Figure 3].
Sentiment on specific property sectors is falling into three distinct clusters, notes Chang. The first cluster contains property types that have held up comparatively well during the pandemic and appear to have sustained near term demand drivers – industrial, multifamily and self-storage. The next cluster includes seniors housing and hotels, which faced a significant impact from the pandemic. However, both property types have good long-term drivers that are tied to vaccinations and the recovery. The third cluster – retail and office – are still under a cloud of uncertainty due to behavioral changes impacting the workplace and retail shopping that could be temporary or semi-permanent. “So, when you look at these three groupings, it is easy to see why sentiment varies so dramatically. Each group is tied to momentum, recovery or uncertainty,” Chang says.
Considering only the property types in which they are currently invested, a majority of respondents were bullish on rising property values over the next 12 months. Industrial led at 72 percent; followed by self-storage at 71 percent, apartments at 64 percent and seniors housing at 59 percent. Nearly half of respondents (47 percent) also anticipate increasing hotel values, while investors were least confident on the outlook for office and retail with only 27 percent and 30 percent, respectively, expecting values to rise in the coming year. Overall changes in value for the next 12 months range from a high of 8.2 percent for industrial to -2.8 percent for retail. [Figure 4]
Momentum Investments: Industrial, Apartments and Storage
The majority of investors believe values will rise in these sectors.
E-commerce has been driving demand for industrial space over the past several years, and the pandemic delivered a powerful boost to online shopping. According to the U.S. Census Bureau, e-commerce as a percentage of core retail sales increased from 16 percent in 2019 to 19 percent in 2020 with nearly $880 billion spent on online purchases. Additionally, companies that ran out of products due to high demand and disrupted supply chains are now increasing their “just in case” inventories. Retailers stocking more necessity items locally will align with the revival of international trade to support rising demand for industrial space, says Alan L. Pontius, senior vice president, national director of the Office and Industrial divisions of Marcus & Millichap.
Seventy-two percent of industrial investors believe values will rise over the next 12 months with an average increase expected of 8.2 percent. Additionally, 63 percent think it is a better time to buy versus 28 percent who said it is better to hold or sell at 9 percent. Although growth in e-commerce is attracting more attention to industrial assets, there are several niche sectors within industrial that are outperforming, such as cold storage and data centers, adds Pontius. However, investors do need to be mindful of potential supply risk in select markets. The 315 million square feet of new industrial space built last year exceeded net absorption by nearly 100 million square feet, resulting in vacancies that climbed from 5.0 in 2019 to 5.5 percent in 2020, according to Marcus & Millichap.
Survey results show that apartment investors are much more confident in their outlook for improving values. Sixty-four percent expect values to rise by 5.2 percent over the next 12 months compared to 48 percent who believed values would rise in the second-half 2020 survey. That confidence is likely supported by the fact that rent collections have remained relatively strong during the pandemic. According to the National Multifamily Housing Council Rent Payment Tracker, more than 93 percent of renter households have continued to make full or partial rent payments. A new stimulus package and extended unemployment benefits will provide added support to rent collections in the coming months. “The big question is how significantly a third round of stimulus will affect the market, because we are not out of the woods yet,” says John S. Sebree, senior vice president, national director of the Multi Housing Division at Marcus & Millichap.
According to Marcus & Millichap, apartment vacancies edged slightly higher to 4.4 percent in 2020, likely due to record levels of new construction with 345,000 new units completed last year, the most in over 20 years."The supply risk will likely continue to create headwinds for Class A space, particularly considering the challenges people face when moving during a pandemic," say Sebree. Survey results also show that investor appetite to buy apartments ticked higher from 42 percent in the previous survey to 48 percent. Forty-one percent think it is better to hold and only 12 percent said it was a better time to sell. “Despite the significant construction pipeline, we still have a housing shortage. We do not have appropriate levels of housing, especially at an affordable price point, and we are still trying to cover that gap. That is the ultimate driver for long-term apartment demand,” he says.
Self-storage investors also have a positive outlook on improving fundamentals in the coming year. Seventy-one percent think values are likely to rise by an average of 6.5 percent. Those gains reflect the strong year for fundamentals in 2020. “We saw demand rise and enormous absorption during the pandemic,” says Steven Weinstock, first vice president and national director of Marcus & Millichap’s Self-Storage Division. Self-storage vacancies dropped from 9.5 percent in 2019 to 7.2 percent by year-end 2020, according to Marcus & Millichap.
The bolstered net operating income and profitability some owners are experiencing may explain why nearly half of respondents (46 percent) think now is a good time to sell. Thirty-eight percent said it is better to hold and 16 percent consider it a good time to buy. “There is a perception that self-storage is a recession-resistant property type, which it has demonstrated over the last two downturns. That is attracting a lot of investors who are new to self-storage,” says Weinstock. “That influx of interest is causing some existing owners to consider harvesting their gains.”
Hotels and Seniors Housing Are Positioned for Recovery
Even with still grim metrics, investors are more bullish on buying opportunities in the coming year.
Although hotels have seen a dramatic improvement from the extreme lows in the second quarter of 2020, they continue to be battered by the severe decline in business and leisure travel. According to recent STR Inc. data for January, U.S. hotels were averaging occupancies of 39.3 percent, while average daily rates (ADR) of $90.79 was down nearly 28 percent year over year and revenue per available room (RevPAR) was down 48 percent at an average of $35.72.
Yet even with those still grim metrics, investors are more bullish on buying opportunities in the coming year. Although more than half (54 percent) still think it is a better time to hold, 43 percent consider it a good time to buy hotels compared with 27 percent who held that view in the second-half 2020 survey. Those who believe it is a better time to sell are in the minority at 4 percent. Hotel investors are more optimistic that the sector has hit bottom. Nearly half (47 percent) expect values to rise in the coming year with an average gain of 4.3 percent.
The survey results likely represent the segmentation within the hotel market, notes Brian Hosey, vice president, national director of Marcus & Millichap’s Hospitality Division. “Hotel performance is very fragmented depending on location and service level,” he says. For example, properties in drivable vacation destinations and properties with suites and in-unit kitchens have fared better compared with urban hotels that cater to conventions and conferences. The positive buyer sentiment likely also reflects investors hoping for significantly discounted buying opportunities in the sector. However, big price cuts may be increasingly difficult to find now that vaccinations are gaining momentum, adds Hosey.
Seniors housing also has had to manage a variety of pandemic-driven headwinds that pushed occupancies to a record-low 81.2 percent in the fourth quarter of 2020, according to NIC MAP® data. There are, however, some big geographic disparities ranging from highs of 87.2 percent occupancy in San Jose to lows of 73.1 percent in Louisville. Within property subsegments, occupancies in assisted living averaged 80.3 percent in the fourth quarter and independent living occupancy averaged 83.3 percent. Since March 2020, assisted living and independent living occupancies have fallen by 740 and 630 basis points, respectively.
However, investors remain optimistic about the recovery outlook with 59 percent of respondents who predict that values will rise in the coming year by an average of 6.7 percent. Sixty percent of respondents think it is a good time to buy more, while 40 percent believe it is better to sell. People 65 and older and workers at senior care facilities are both in the highest priority group for receiving vaccinations, which should help speed the recovery of this industry, and the long-term demand drivers for the sector remain sound as baby boomers move into the age range that most often needs seniors housing, notes Todd Lindblom, vice president and national director of Marcus & Millichap’s Seniors Housing Division.
Uncertainty Clouds Office and Retail Outlook
With the shift to remote working and the pandemic-driven rise in online shopping, these sectors have less certain outlooks.
The pandemic dramatically slowed office leasing last year, pushing the national average vacancy rate up to 15.2 percent as negative absorption approached 150 million square feet, according to Marcus & Millichap. The shift to remote working has definitely clouded the outlook for the office sector. Once the vaccine reaches 75 percent distribution (herd immunity), the vast majority of survey respondents (93 percent) expect those who worked in an office full-time before the pandemic to return to an office setting at least partially. However, those who believe people will return full time are in the minority at 15 percent. More than half (58 percent) predict that office workers will work from home 1-2 days a week, 21 percent said people are likely to continue working from home 3-4 days a week, and 7 percent also think people will work from home full time. [Figure 5].
Remote working has reiterated the importance of coming together for things such as collaboration, training, driving productivity and creating a sense of corporate culture, says Pontius. “We believe the majority of office workers will return at least part-time, but questions will linger as to the future impact on space demand,” he says. “There are a lot of variables at play, and we could potentially see an evolution of the office model in coming years. The challenge is assessing where and how significant the changes will be.”
That uncertainty is reflected in sentiment for office. Respondents are split on expectations for property values in the coming year with 27 percent predicting an increase, 32 percent anticipating a decline in values and 41 percent who are neutral. Overall, the average change in the coming year is negative at -2.7 percent. Nearly half of investors (47 percent) think it is a better time to hold office assets, while 44 percent believe it is still a good time to buy and 10 percent prefer to sell. Although capital remains cautious about urban office in major metros, there is an expanding base of capital looking for investment opportunities in suburban markets and secondary and tertiary markets that have benefited from population growth, adds Pontius.
Retail has been struggling with competition from e-commerce for years, and that competition was only exacerbated by the pandemic-driven shift to online shopping out of necessity. Respondents were split on expectations for property values with 30 percent predicting an increase, 29 percent anticipating a decline in values and 41 percent who were neutral. Overall, the average change in the coming year is -2.8 percent.
“People have been talking about a so-called retail apocalypse for years, and that weighs on investor sentiment,” says Daniel Taub, senior vice president, national director of the Retail and Net Leased Properties divisions of Marcus & Millichap. “But in reality, a dichotomy has emerged within retail real estate.”
Investors continued to buy and sell shopping centers over the last year, with strong bidder activity and even some cap rate compression raising prices on well-located grocery-anchored centers that exhibited good rent collections and a good track record. Demand also remains strong for single-tenant net lease properties such as quick-service restaurants equipped with drive-thrus. At the same time, there are some retail centers that face a more sedate transaction climate due to uncertainty about tenancy such as gyms, movie theaters, restaurants or other entertainment. “Until there is more clarity on the outlook for some types of retail, it will remain particularly difficult to price assets,” says Taub. That is creating obstacles in the marketing of some retail assets. Retail investors were fairly evenly split on whether it is a better time to sell (42 percent) or hold (40 percent), while 18 percent view it as a good time to buy.
Changes in Tax Law Leap to Forefront
Potential tax law changes under the Biden administration are a concern for the majority of investors.
It is no surprise that the containment of the coronavirus and the state of the U.S. economy remain at the forefront for investors. Nearly half of all respondents rated the two issues as top concerns in the coming 12 months at 54 percent and 48 percent, respectively. But the bigger fear among nearly two-thirds of respondents is potential changes to taxes ahead under the new Biden administration.
One of the reasons taxes top the list of concerns is uncertainty. It is too early to get a solid reading on what the new Congress and president plan to tackle this year, notes Chang. There is a path for the Biden administration to raise taxes with Democratic control of the House and a 50-50 split in the Senate. “Is it going to be the first thing on their list, absolutely not. But it is something they are going to have to deal with at some point given all of the stimulus money that has been plowed into the economy,” he says.
When asked specifically about potential tax law changes, most survey respondents are concerned about higher capital gains taxes (72 percent), followed by a higher personal tax (61 percent). Nearly half of respondents also worry about higher corporate taxes (49 percent), changes to the estate or gift tax (49 percent) and the modification/elimination of 1031 tax-deferred exchanges (48 percent) [Figure 6]. At the same time, it is important to note that a majority of respondents do not believe changes to tax law, higher interest rates or the Biden administration will impact their decisions to buy or sell real estate in 2021.
The results of the investor sentiment survey paint a picture of cautious optimism, notes Chang. “We still have very severe headwinds over the short term. There also are clearly those property sectors that continue to perform well, or are in recovery, and then there are those that have a great deal of uncertainty. That is showing up in investment sentiment,” he says. “However, investors are very cognizant of a possible post-pandemic surge as pent-up consumer and business spending is released later in the year, creating a tailwind for all commercial real estate.”