The highly respected list from our CRE professionals highlights some important items for all to be aware of as we battle what appears to be a recession in the making. TriStar gives some perspective to the report. Before investing in real estate consider the following:
1. Inflation and Interest Rates – commodity prices are up which is troubling for developers on two fronts – materials costs and interest rates. Material costs are driving up construction costs and ultimately rents in a stressed economy. Interest rate escalations means you aren’t going to pull proceeds when you refinance, and the debt coverage ratios are going up, which means you will need more equity in your deals to be able to close your loan. Expect agency debt requirements to go from 80% leverage to 50-60%.
2. Geopolitical Risks – Russia will have a prolonged war with Ukraine, and their disruption on gas to Europe will be painful. Ukraine supplies an estimated 12% of all calories in the world (wheat/grain). Finally, China will stubbornly be in lock down mode rather than use drugs available from the West, as chip makers and off shore manufacturing come to a halt for the foreseeable future. Food prices at restaurants may curb retail center attendance?
3. Hybrid Work – with unemployment hovering under 4%, workers are in short supply. During COVID, workers learned to work from home, and corporate America is trying to figure out how to get people to return to the office without losing employees. The new work environment will probably be in office 3-4 days a week until we have a recession, and workers will be more reluctant to resist coming back to the office if they want a job. Like many changing cycles, the pendulum swings wildly, but will usually return to the middle. This will affect office building occupancy and usage.
4. Supply Chain Disruption – there is a worker shortage at the docks and on the road with a lack of truckers. Goods from China are delayed because of worker lockdown, and if product is available, it is more difficult that ever delivering it to market. Simply put, the machine making the widgets has been out of operation during COVID, and it’s trying as hard as it can to catch up from pent up demand. Industrial distribution centers are still the rage among investors, but there may be a short term pause in the robust expansion we saw with the likes of Amazon, over the last few years.
5. Energy – the good news is that the United States can be energy independent (fracking and Canadian oil pipeline). However, there is an environmental movement that the current governmental administration doesn’t want to disrupt the oil industry. So, the petroleum shortage will continue even though petroleum and gas are abundant. President Biden’s visits to Saudi Arabia could have gotten more supply released, however, the ability to refine the product into what is needed (gas at the pump) is limited. Cost of energy affect everyone in all industries.
6. Labor Shortage Strain – the largest segment of the population (the baby boomers) is retiring in droves, and early due to COVID and burnout. Some younger generations are less motivated by money than they are about idyllic lifestyles. COVID allowed many to save, because there was nothing to do or spend money on (travel). The trillions of dollars in government relief (needed or not) were used to delay re-entry into the workforce. So, we have a labor shortage, which you may have already noticed.
Peter Zeihan is a geopolitician who wrote The Accidental Superpower and has a new book, The End of the World is Just the Beginning. He addresses a long-term problem where many developed countries had declining birth rates. It takes 2.25 births per capita to replace a population. Many countries are below one (1) which means the demographic outlook predicts a shrinking population. This creates a labor shortage of people to produce GDP (gross domestic product). The problem becomes in replenishing a tax paying population to carry on an economy and pay for the retirement pensions for the current retirees living off the government pensions. The need for labor at every level is a point of consternation at the politician level as we talk about immigration laws. As we protect our current labor unions from low wage workers, we are watching our economy slow due to lack of productivity that is so needed.
7. Housing Imbalance -in past economic cycles there was a ratio of housing permits that came with a recovering economy. The millennial generation is coming into the “buying years” for housing, but the supply of product is significantly below the past cycles. The good news is that there is no overbuilding as in the past. The bad news is there is a lack of housing to purchase. In addition, as the economic gap of the haves and have nots increases, there is a dangerous lack of affordable housing in most cities. With the increase in interest rates, more home buyers will be pushed to rental housing due difficulty to qualify for a home to purchase. It is still a good time to be an investor in multifamily housing. Watch for the rising trend in affordable townhomes for rent.
8. Regulatory Uncertainty – State vs local authority on land uses combined with mandates for affordable housing is a place to start. Government seemingly has good intentions, but complex and outdated regulatory scrutiny, especially in affordable housing, piles more paperwork on much needed solutions.
9. Cybersecurity Disruptions -hackers can steal your identification, your money and can hold a corporation hostage with malware. A recent event showed that a hospital and its emergency system were hacked and held hostage for ransom. The ransomware can affect all operations of business. How can a “smart building” protect itself?
10. ESG Changes - “Environmental, Social and Government” funds are in play that were created for the social good of the world. These “heart-string” investments started with green initiatives (LEED certifications etc.). Capital wants to be in this space, and it’s molding how developers are playing to meet the requirements of the capital…but this is easier said than done. At the end of the day, the for-profit real estate world still needs to make a profit, and the initiatives by the ESG funds are trying to push social agendas without necessarily reducing returns and fees to get the “good” done.
