This Week's Topics
Convenience Store Boom
The post pandemic market has been kind to convenience stores such as 7-Eleven, especially as these stores have revved up their selection of better food and drink options. In 2023, foot traffic in convenience stores was higher than fast food, coffee shops, and gas stations. They were also higher than previous years foot traffic for these same stores, as shown in the graph below from placer.ai:
Jefferies Analyst, Corey Tarlowe, wrote “The largest players have strong, recognizable brands, they’re rooted in communities they serve, they have really long track records of growth, and they are modernizing their tech and supply chains for future growth. They’re much different concepts than just simple gas stations now.” These big programs have also started implementing loyalty programs, apps, and ready-to-go food that has seriously increased sales and traffic. Coming out of the pandemic people are out on the roads again, convenience stores help these people save one valuable commodity, time. Vontobel Asset Management portfolio manager, Markus Hansen, said, “Time is the most valuable commodity, and [convenience stores] have found a way to monetize it.” With ballooning prices due to inflation, these stores offer cheap and quick alternatives that help consumers save money and time, that's why they are crushing it right now. As people stop to get gas it's easy to pick up food at the same location, these convenience stores are in a nice spot to cater to these customers.
Source: Barron’s, Teresa Rivas
Home Prices Climbed, Where to Next?
Shaina Mishkin of Barron’s wrote, “The S&P CoreLogic Case-Shiller Home Price index tracking changes in 20 of the nation’s large cities is expected to have been 6.6% higher in January than it was one year prior, according to FactSet consensus estimates. A seasonally adjusted index measuring month-to-month price gains is estimated to have risen 0.15% from December’s levels.” Reasons for this increase in home prices is mostly due to a combination of low supply of homes for sale and the locked-in mortgage rates that are lower compared to the current Fed rates.
The following numbers are reported by Mishkin, “The median home in February sold for $384,500, up 5.7% from the same month in 2023, according to the National Association of Realtors—the greatest price increase in the trade group’s data set since October 2022. Redfin data suggests prices have remained strong in March: over the four-week period ended March 17, home sale prices rose 5.3%. Industry economists expect gains will slow later this year. The Mortgage Bankers Association estimates that home prices in the fourth quarter measured by the FHFA’s home price index will be 4.1% higher than one year prior—a slower growth rate than the anticipated 5.7% in the first quarter of this year. Fannie Mae expects its home price index to be 3.2% higher than one year prior at the end of the year, slower than an anticipated 7.2% first-quarter increase. That’s despite mortgage rates that remain higher than levels immediately before the pandemic. Higher rates and prices has made it harder for first-time buyers to enter the market. The share of buyers purchasing a previously owned home for the first time fell to 26% of all transactions in February from 28% the month prior, the National Association of Realtors said earlier this month.”
Mortgage rates are extremely high right now with the average 30-year being 7.516% and the average 15-year being 6.636%. These high rates are making it so not many people are interested in selling their homes at the moment, this is keeping the supply of houses extremely low, causing buyers to have to accept homes at higher prices. House sales have been up this year a little bit as the market has gotten use to higher rates and more expensive prices, these prices are essentially becoming “normal”.
Source: Barron’s
Fall In Mortgage Applications
Mortgage applications fell 0.7% last week due to high rates causing people to steer clear of buying homes at the time. The mortgage applications index (SWDA) sank to a level of 145.7 which is just about at the lowest level we’ve had in the last twenty years. The average mortgage payment is at its highest in the last 20 years and its not even close to levels seen in previous years. The current mortgage rate is about 7%, these are not enticing situations to bring new buyers into the market. Currently, the prices of homes are growing faster than household incomes. Aarthi Swaminathan of MarketWatch wrote the following, “To afford a median-priced home in February at $413,000 at current mortgage rates, a buyer would need to earn an annual income of $113,520, according to analysis by real-estate brokerage Redfin. That’s 35% more than the median income is in America, which is $84,000.” The graph below shows the “Purchase vs Refinance Index” from Mortgage News Daily:
Buyers are waiting patiently for rates to come down and for more houses to enter the market, but we really have no idea when this will be. Inflation seems to be stickier than anticipated and we have a long way to go for rates to be at comfortable levels for buyers and sellers.
Source: Bloomberg, Mortgage News Daily
Why Is Commercial Property Insurance Going Up? and the New York Real Estate Groups Seek End to Raising Insurance Costs
In today's uncertain economic and geopolitical climate, the landscape of commercial property insurance is undergoing significant upheaval, with costs soaring across the board. Recent data indicates a substantial rise, with commercial property insurance rates escalating by 10.7% in the most recent quarter.
Several key factors contribute to this surge, each exerting considerable influence on pricing dynamics. The frequency and severity of natural disasters, including hurricanes, floods, wildfires, and tornadoes, have surged in recent years, inflicting significant damage on commercial properties.
Economic downturns and inflationary pressures have contributed to rising costs throughout various sectors, including insurance. Heightened economic uncertainty increases overall risks, prompting insurers to adjust pricing structures to mitigate potential losses. Escalating construction costs further strain the commercial property insurance market. Factors such as supply chain disruptions and increased demand for materials drive up expenses associated with property repair and reconstruction, leading insurers to pass on these costs through higher premiums.
The upsurge in extreme weather events has led to a corresponding increase in commercial property insurance claims. As insurers face mounting claim payouts, premiums rise in response to maintain financial stability and cover anticipated losses. Property-specific factors, such as location, condition, and usage, significantly influence insurance rates. Properties situated in high-crime areas or prone to natural disasters incur greater risks, warranting higher premiums. Similarly, properties with structural deficiencies or costly building materials command higher coverage costs.
The nature of the business and its historical claims activity directly impact insurance rates. Industries with higher risk profiles, such as restaurants or manufacturing facilities, face elevated premiums due to the potential for significant losses. Moreover, past claims history serves as a predictor of future risk, influencing insurer assessments and pricing decisions. The emergence of cybersecurity threats poses additional challenges to insurers, necessitating investments in risk mitigation and recovery efforts. Moreover, the phenomenon of social inflation, characterized by escalating litigation costs and claim settlements, further strains insurance industry resources, leading to higher premiums for policyholders. Lately, New York has been battling issues with rising insurance costs.
Two prominent New York real estate groups, the Empire State Chapter of Associated Builders and Contractors and the Real Estate Board of New York, have aligned with the Consumers for Fair Legal Funding coalition to address soaring insurance costs through reforms in lawsuit lending.
Driven by concerns over New York's unique scaffold law, which holds contractors and property owners fully liable for worker injuries, regardless of fault, the coalition aims to combat fraudulent claims driving up insurance premiums, particularly impacting infrastructure and affordable housing projects. Brian Sampson, president of the local Associated Builders and Contractors, warns of the imminent market exodus by insurance carriers due to exposure to fraudulent lawsuits, potentially exacerbating construction slowdowns and housing crises.
Legislative reforms addressing lawsuit lending are gaining momentum across states like Indiana and West Virginia, underscoring the growing recognition of the need for regulatory oversight in the industry.
Insurance represents one of the most significant expenses for commercial properties and can profoundly impact the success or failure of an investment. Selecting the appropriate insurer, tailored to the location, is crucial to safeguarding profitability over the long term.
2024 Healthcare Marketplace: What to Expect and What is Happening
According to Colliers International, the medical office sector continues to demonstrate resilience, boasting low vacancy rates and record-setting asking rents amidst robust demand outpacing supply. However, many developers need to be more cautious about breaking ground due to elevated construction costs. The sector faced challenges stemming from disruptions in capital markets due to the Federal Reserve's aggressive rate increases, resulting in a noticeable decline in sales volume in 2023 as higher cap rates and downward pricing pressure widened the bid-ask spread.
Looking ahead to 2024 and beyond, the outlook appears promising. The demand for healthcare services is expected to continue growing, driven by population expansion and the aging of the youngest Baby Boomers, who are reaching 60. This is directly resulting in lower vacancy rates across the industry.
One significant potential lies in the realm of Artificial Intelligence (AI), which, despite being in its early stages, holds promise to revolutionize the healthcare sector by enhancing efficiencies and driving profitability. Additionally, the surge in demand for mental health services has been notable, accompanied by increased funding for much-needed facilities.
However, challenges persist, including patient accessibility issues, workforce deficits, and supply chain challenges. Moreover, healthcare policies will remain a focal point, with candidates articulating campaign promises concerning Medicare/Medicaid, health insurance premiums, women’s healthcare, and prescription drug pricing in 2024. Policies like this will directly affect the supply and demand that we will see in 2024.
In terms of market fundamentals, the medical outpatient building (MOB) sector experienced a decline in vacancy rates in 2023, contrasting with the broader office sector's increase in vacancy. Demand for medical outpatient space remains strong, outpacing new supply, with average net asking rents reaching unprecedented highs. The drop in sales prices and increased demand for healthcare have provided an upward trend in the healthcare sector.
Overall, the healthcare industry stands at a pivotal crossroads, characterized by challenges and opportunities. Ongoing consolidation and innovation are expected, driven by favorable long-term trends and attractive investment opportunities. Despite affordability issues and talent crises, untapped potential in areas like behavioral health and AI suggests continued growth and evolution in the healthcare sector.
Source: Colliers
CNBC Features Marcus & Millichap CEO Hessam Nadji - Don't Judge a Book By Its Cover
In a recent interview on CNBC, Hessam Nadji, the CEO of Marcus & Millichap, shared valuable insights into the current state of the real estate market and offered perspectives on key trends shaping investment opportunities. Nadji's interview commenced with an assessment of prevailing market trends, highlighting the impact of macroeconomic factors and shifting consumer behavior on commercial real estate dynamics. Nadji emphasized that contrary to popular belief in America, commercial real estate is in a great spot. The misconceptions stem from the decline in office space, particularly larger, older urban buildings. Demand for office space on a national level was positive in Q4 for the first time since spring 2022.
Against the backdrop of economic uncertainties and global challenges, Nadji reiterated the resilience of commercial real estate as an asset class. Drawing upon Marcus & Millichap's extensive market research and industry expertise, he explained that most of the CRE market is being repriced due to a rise in interest rates.
In response to changing market demands and evolving consumer preferences, Nadji emphasized that now is the time to buy for some investment institutions because of the record capital ready to be distributed and price changes opening up a lot of opportunities in the market. Nadji expressed surprise at the demand for shopping centers and retail, as they have bounced back strongly since the fall during the pandemic. New quality office space in suburban areas has been a strong investment with the shift of demand in the office world after COVID-19. He concludes his remarks remaining optimistic about the CRE market.
Source: CNBC
Unlocking Tax Benefits: Investing in Commercial Real Estate
As individuals seek avenues to optimize their financial portfolios and mitigate tax liabilities, commercial real estate emerges as a compelling asset class offering a myriad of tax benefits. Beyond the potential for attractive returns and portfolio diversification, investing in commercial real estate presents unique opportunities for tax efficiency. In this guide, we'll explore various tax benefits associated with investing in commercial real estate.
Depreciation Deductions
One of the most significant tax advantages of owning commercial real estate is the ability to claim depreciation deductions. Unlike other assets that typically appreciate over time, real estate can be depreciated for tax purposes, allowing investors to deduct a portion of the property's value annually. This depreciation expense can offset taxable income generated by rental income, resulting in reduced tax liabilities for investors. Through cost segregation studies and accelerated depreciation methods, investors can optimize depreciation deductions and enhance cash flow.
Pass-Through Tax Treatment
Many commercial real estate investments are structured as pass-through entities, such as partnerships, limited liability companies (LLCs), or S corporations. In pass-through entities, income and tax deductions flow through to individual investors' tax returns, bypassing entity-level taxation. This pass-through tax treatment enables investors to benefit from favorable tax rates on rental income, capital gains, and deductible expenses. Additionally, investors may qualify for the 20% pass-through deduction under the Tax Cuts and Jobs Act (TCJA), further enhancing tax efficiency.
Capital Gains Tax Deferral and 1031 Exchanges
Investing in commercial real estate offers opportunities for capital gains tax deferral and potential tax-free exchanges through Section 1031 of the Internal Revenue Code. Under Section 1031, investors can defer capital gains taxes on the sale of a property by reinvesting the proceeds into a like-kind replacement property. By continuously reinvesting in qualifying properties through 1031 exchanges, investors can defer capital gains taxes indefinitely, allowing for the compounding of wealth over time. This tax-deferral strategy provides investors with greater flexibility and liquidity while preserving capital for future investments.
Interest Deductions and Mortgage Interest
Commercial real estate investors can leverage mortgage financing to acquire properties, benefiting from deductible interest expenses. Interest payments on mortgages and other debt obligations associated with commercial real estate investments are typically tax-deductible, reducing taxable income and lowering overall tax liabilities. By structuring financing arrangements effectively and optimizing debt-to-equity ratios, investors can maximize interest deductions while maintaining financial leverage.
Opportunity Zones and Tax Incentives
The Opportunity Zones program, established under the Tax Cuts and Jobs Act of 2017, incentivizes investment in economically distressed communities by providing tax benefits to investors. Through Opportunity Zone investments, individuals can defer and potentially reduce capital gains taxes by reinvesting capital gains into qualified Opportunity Zone Funds. Furthermore, investors may benefit from tax-free appreciation on investments held within Opportunity Zones for a specified period. By targeting investments in designated Opportunity Zones, investors can align financial objectives with social impact while optimizing tax efficiencies.
In conclusion, investing in commercial real estate offers a multitude of tax benefits that can significantly enhance overall investment returns and wealth preservation. From depreciation deductions and pass-through tax treatment to capital gains tax deferral and Opportunity Zone incentives, individuals deploying excess capital have the opportunity to optimize tax efficiency while diversifying their investment portfolios. By leveraging these tax strategies and consulting with qualified tax professionals and financial advisors, investors can navigate the complexities of commercial real estate taxation and unlock the full potential of their investment endeavors.
[Disclaimer: The information provided in this article is for educational and informational purposes only and should not be construed as tax or investment advice. Investors should consult with qualified tax professionals and financial advisors to assess their specific tax situations and investment objectives.]
NYC vacancy rates are so low—and affordable housing is so sparse—that a super PAC has formed to elect politicians to build more homes
New York City is suffering arguably the worst housing crisis in the nation. With experts agreeing that a “healthy” vacancy rate is between 5% and 10%, The Big Apple boasted a 1.4% vacancy rate at the beginning of February. For perspective, that is the lowest the metric has been since the city began tracking vacancy rates in the 1960s.
The lack of available housing creates a sort of monopoly. Landlords are able to increase rents to match demand and tenants have no other choice but to pay. Rents are nearly 17% higher than they were before the pandemic according to the NYC comptroller. They added, “More than half of all households citywide are classified as rent burdened, with rent consuming more than 30% of pre-tax income.”
In lieu of the ongoing crisis, multiple different advocacy groups have sprouted seeking to bring relief to residents burdened by record-high rents. Abundant New York, a super PAC formed by various housing advocates in the city, has several pro-housing politicians that it is supporting to get elected in upcoming legislative races and municipal elections. Their website states that “New York has some of the most segregated and exclusionary zoning and land use practices in the country,” and they want to change that. The electoral arm of nonprofit Open New York formed in 2016, Abundant New York is spending thousands on not only electing pro-housing politicians but squashing any candidates that they believe aren’t doing enough.
The group already has three endorsements: Micah Lasher for the 69th assembly district; Rachel May for the 48th senate district; and Sarahana Shrestha for the 103rd assembly district. Each candidate has vast experience in housing development and policy that will be essential for change in the city.
Not everyone is for new development though. NIMBYs have long opposed such projects. The acronym stands for “not in my backyard” and represents wealthy residents who are anti-development in order to preserve the character and unique charm of their neighborhoods.
These wealthy residents have been able to afford the political backing necessary to stifle development projects in their neighborhoods. Abundant New York is trying to turn the tides. Recently, Brooklyn’s borough president Antonio Reynoso was quoted saying “The character of your neighborhood is not more important than putting people in homes,” in response to the NIMBY ideology.
New York City is running out of options as the housing crisis becomes increasingly more desperate. According to Kathy Hochul, Governor of New York, “The only way to fix this crisis is to build our way out.”
Source: Fortune
Rents Are Up the Most in These 10 Affordable Places. What’s Going On.
Rents in many historically affordable areas have been on the rise according to data from Zillow’s observed rent index. There are a few reasons for this, but low supply mixed with high demand is a main contributor.
Syracuse, NY saw the highest YoY rent increase at 8.81% followed by Providence, RI, and Madison, WI. The top ten metro areas are predominantly located in the Northeast and Midwest regions. Many of these areas have seen an increase in demand, but not enough supply has led to higher prices. This supply pressure has come from two areas: Lack of new construction and rate-locked homeowners.
You’d be surprised to learn that in 2023, out of the 100 largest metropolitan areas Syracuse had the least amount of new housing permits per capita with Providence and Akron trailing close behind. Commenting on the Midwestern market, Orphe Divounguy, a senior economist at Zillow said the region was “Relatively more affordable than other metros across the country—but perhaps not for long since they’re also markets that don’t tend to build a ton of new housing.”
Higher mortgage rates have also contributed to the rent growth. Many homeowners have found themselves “rate-locked” as interest rates have increased. A recent FHFA paper reported that the likelihood of a homeowner moving out of their residence drops about 18% for each 1% increase in mortgage rates above the homeowner’s origination rate. “Millennials facing obstacles in the for-sale market are turning to single-family rentals,” Divounguy said. He added that in 2023, 29% of renters lived in a single-family rental, up from 21% the year prior.
With supply being squeezed, demand also increased in markets like Charleston, Cleveland, and Madison. The populations in these areas grew faster than average in 2023. “Holding supply fixed, a large increase in demand pushes prices higher. Where supply lags demand, rents increase more rapidly,” Divounguy remarked.
With new housing starts being reported at near 2-year highs last week and signaling from the Fed regarding rate cuts this year, this will undoubtedly bring rent increases in these areas back to earth. For now, landlords are enjoying outsized returns as the markets try to find a sustainable equilibrium.
The Office Market Is in Turmoil. So Why Are Rents More Expensive?
In an unlikely turn of events average U.S. asking office rents are climbing despite ever-growing vacancy rates in the sector. However weird it may seem, there are explanations for the strange phenomenon and reason to believe things will soon change.
According to CoStar Group, Average U.S. asking office rents currently stand at $35.24 a square foot, up from $34.92 in the fourth quarter of 2019. This has to do with how property values and rents are so intricately intertwined.
When investors slash asking rents to fill space, they are effectively devaluing their property. Lower rents equal lower NOI. If the property’s cap rate remains the same, then the value decreases. “This in turn could lead to a covenant default on their loans or at minimum would make it harder for them to refinance,” said David Bitner, head of global research for Newmark Group. With so many investors facing mountains of maturing commercial real estate debt, they simply can’t risk scaring lenders off by decreasing their property value. This is why they would rather scare tenants off with high asking rents instead and face higher vacancy rates.
This approach is, of course, not sustainable. Eventually, more distressed properties will hit the market at a discount. When investors scoop up these deals, they’ll, be able to ask for much lower rents thus putting further upward pressure on vacancy rates where landlords are unable to attract tenants with cheaper space. Sooner or later office property values will have to drop and reflect market conditions which will be followed by lower asking rents.
We are already watching such a correction unfold in San Francisco. On average, prices in the city have tumbled to $53.78 per square foot in Q1 of this year from $75.93 in Q4 of 2019 according to CoStar. “The market has been quicker to adjust to the new reality,” said Phil Mobley, national director of office analytics at CoStar.
Despite the weirdness of vacancy rates and average asking rents rising together, the trend can’t last. As debt matures and unsustainably high vacancy eats away at profits, many investors will be forced to sell distressed assets or find a way to adapt to a new era of office space.
How Much Do Office Amenities Drive Rent And Occupancy Growth? New Report Puts A Number On It
Landlords who have a good understanding of which amenities their tenants want can see big gains in NOI. Tenants are usually willing to pay premiums for things like high-speed internet, gyms, and pool areas. Of course, tenant demographics and geographic location play a large role in what amenities to add to a property. A recent report from JLL attempts to quantify the profitability of some of the most popular features.
Compared to other class-A buildings in the same submarket, a property with a sky terrace is able to charge a premium of 5.2%. Other top amenities on the list are courtyards with outdoor seating and being LEED certified which garner 3.5% and 2.8% premiums respectively. Just having an amenity, however, doesn’t necessarily mean you can charge the top-dollar premium. Quality is a strong factor in what tenants are willing to pay for various perks. An ordinary fitness center, for example, would typically generate a 0.5% rent premium. However, if that fitness center had shower facilities, tenants would be willing to pay a 2.9% premium. “The same is true for a restaurant versus a food hall, which have 0.1% and 1.4% rent premiums, respectively,” the article said.
Amenities are also driving up occupancy in some markets. “Highly amenitized buildings, defined as assets with 10 or more tagged amenities and at least one differentiated offering like a roof terrace or full-service fitness center, have gained 23.3M SF of absorption since the onset of the pandemic, as other urban Class-A product lost more than 50M SF of occupancy,” the article stated.
This trend is sure to continue as the work-from-home lifestyle has made tenants become more thoughtful of the spaces that they are spending more time in. Stacking your property with fancy amenities and new features won’t always help though. According to CoStar, location, building age, and proximity to public transportation are also main influencers of where a person chooses to live. For those properties that are newer and in favorable locations, beefing up specific amenities might improve occupancy and increase rents.
Data Center Asking Rents Surged as Much as 54% Over Eight Months
Although not a highly publicized asset class, data centers are currently the darling of commercial real estate. In key markets like Chicago, Dallas-Ft. Worth, Northern Virginia, Phoenix, and Silicon Valley, rents have surged by 20% to 54% in the last 8 months according to CBRE.
This astounding growth highlights the effects AI is having on the broader economy. With every company allocating more of their budget to implement AI in the workplace mixed with millions of VC dollars flowing into AI startups, space is needed to house all of the associated hardware. The exorbitant amounts of energy required for these data centers has limited the amount that can be constructed and operable. With ever-increasing demand, this has forced occupiers to pre-lease space 18-36 months in advance, a large difference from the 6-12 month norm. The squeezed supply and high demand have also forced vacancy rates to historic lows in many of the main markets.
Figure 1: Vacancy Rates, H1 2021-H2 2023
Source: CBRE Research, H1 2021 to H2 2023.
Figure 2: Average Rental Rate, H1 2021-Q1 2024
Note: Figures and data from H1 2021 to H2 2023 reflect 5-10 MW pricing. Q1 2024 data reflects 3-10+ MW pricing.
Source: CBRE Research, H1 2021 to Q1 2024. Q1-2024 Data is as of February 29, 2024.
The demand for data centers will only increase as the world continues to adopt and utilize artificial intelligence. For those looking for a solid, in-demand investment, this alternative asset might just be the way to go.
RV Parks: An Up-and-Coming Commercial Real Estate Investment Asset
For decades, RV parks were mainly run by mom-and-pop owners looking to have a small business. However, this is beginning to change as more institutional investors see the potential for huge gains in a largely overlooked market.
When asked what a traditional RV park was, John Hutchinson, Co-Chief Executive Officer and Global Head of Origination at Trez Capital said they are: “Places where people with recreational vehicles can stay overnight or longer in allotted spaces.” He continued, “The parks usually have access to activities, events, entertainment and amenities such as outdoor seating.” This differs from a “luxury” RV park which is catered to longer-term residents and is typically a mix of a hotel and multifamily type property. These luxury RV parks include things like pools, bars, restaurants, dog parks, office space, and other convenient amenities according to Hutchinson.
Many institutional investors are looking to scoop up luxury RV parks or convert traditional parks into that model. There are a few reasons for this, with the first being that they’re simply higher-quality investments with better construction and materials. Another reason is that this model attracts both long-term and short-term residents. This means overall occupancy will usually be higher than a traditional RV park that typically just sees folks passing through for a couple of days. The pandemic has left many workers with much more flexible lifestyles thus allowing them to find a change of scenery for a while in these hotel-like parks. Individuals and families will want to stick around longer the more the RV park feels like a multifamily community which drives up investor profits.
This asset class is bound to evolve and adapt in the next few years into a more mature investment. Investors looking for out-of-the-box investments should keep their eye on this emerging market.
Single-Family Production Shows Signs of Stirring Across the Nation
Recent findings from the National Association of Home Builders (NAHB) shed light on evolving trends in the housing market, particularly in single-family and multifamily construction. As investors seek insights into the changing landscape of residential development, understanding these trends is crucial for informed decision-making.
Led by larger urban metro markets, single-family growth rates are displaying signs of a turnaround, buoyed by moderating mortgage rates and a lack of existing inventory. The latest data from the NAHB Home Building Geography Index (HBGI) for the fourth quarter of 2023 highlights a gradual upward trend in single-family construction across various urban and rural geographies. This positive momentum reflects a shift from double-digit production declines in the previous quarter to modest growth rates, driven by factors such as the 'lock-in' effect of low mortgage rates, which dissuades homeowners from listing their properties.
Conversely, the multifamily sector is witnessing declines, particularly in large metro suburban counties, marking the tail end of an apartment building boom. The fourth quarter HBGI data reveals a negative % growth rate of 20% in new multifamily buildings in these areas, contrasting with the highest levels seen in over 50 years. This decline underscores a shift in market dynamics, with growth rates exhibiting the strongest readings in lower-density areas.
Analysis of U.S. coastal counties reveals notable trends in both single-family and multifamily construction. While approximately 25% of single-family construction consistently occurs in coastal counties, multifamily production in these areas has experienced a decline. In contrast, non-coastal areas have seen an increase in multifamily market share, attributed in part to the impact of the COVID pandemic and a preference for more rural, outlying areas.
The market share for single-family construction in coastal and non-coastal counties has remained remarkably steady since 2014, with coastal counties accounting for around 25% of new home building. However, the market share for multifamily construction in coastal counties has declined from 36.6% in 2014 to 30.3% in the fourth quarter of 2023. This shift underscores a broader trend of multifamily growth rates declining in larger markets and increasing in rural, outlying areas.
Homebuilder stocks rise after Fed projects three interest rate cuts this year
In recent market activity, there has been a remarkable surge in single-family homebuilder stocks, surpassing broader market gains. This surge coincides with signals from the Federal Reserve indicating potential interest rate cuts, setting a positive tone for the housing sector. Investors in real estate are witnessing a notable trend as new homes emerge as a bright spot amidst current economic conditions.
The performance of the SPDR S&P Homebuilders ETF (XHB) reflects this surge, experiencing an impressive increase of approximately 10% since the year began. This uptrend underscores the growing demand for newly constructed homes, a trend reshaping the dynamics of the housing market.
High borrowing costs have dissuaded potential sellers from listing their homes, especially those locked into low mortgage rates. With a significant portion of homeowners enjoying mortgages below 5%, well below the current average rate of around 7%, some are reluctant with their properties. Consequently, newly built homes have taken on a more substantial role in housing supply, accounting for approximately 30% of active listings, a notable increase from historical levels.
Builders have responded to the challenges posed by high interest rates by adapting their strategies. They are offering incentives such as rate buydowns and developing smaller, more affordable homes to cater to evolving buyer preferences. Despite the hurdles, builders have successfully sustained demand for new homes by aligning their offerings with the changing needs of buyers.
Anticipated rate cuts by the Federal Reserve are expected to gradually decrease mortgage rates throughout the year. Economists at Wells Fargo project a decline from current levels, potentially reaching 6.15% by the fourth quarter. This reduction in borrowing costs is crucial for stimulating housing demand, especially considering the persistently high rates observed during the pandemic. Lower mortgage rates enhance affordability and incentivize prospective buyers, leading to increased activity in the housing market.
In the face of these market dynamics, single-family homebuilders have demonstrated robust performance, with earnings growth outpacing broader market trends. The industry's resilience, combined with favorable market conditions, has resulted in significant gains in stock value. Furthermore, indicators suggest a strong spring selling season ahead, with companies like KB Home reporting substantial increases in net orders.
Source: Yahoo! Finance
Building Momentum: Homebuilding Stocks Surge Amid Economic Resilience
This year, there's been a clear and noticeable increase in the value of stocks related to homebuilding. In the article “This winning sector could see even more upside once the Fed starts cutting rates, according to State Street,” Samantha Sabin quotes Matthew Bartolini, a managing director and head of SPDR Americas research at State Street, saying, “The thesis just comes down to economic resilience that is fueled by a strong labor market and a healthy consumer,” Bartolini sees more potential for growth in homebuilding stocks as the Federal Reserve prepares to lower interest rates. Bartolini emphasizes the economic strength supported by a strong labor market and positive consumer sentiment.
At the forefront of this surge stands the SPDR S&P Homebuilders ETF (XHB), which has soared nearly 17% year-to-date and a staggering 70% over the past year, reaching unprecedented highs earlier this month since its inception in 2006. Spearheading this remarkable rally are notable contributors like Williams-Sonoma and Installed Building Products, boasting surges of approximately 57% and 42% in 2024, respectively. Alongside them, Carlisle Companies, Builders FirstSource, and Toll Brothers have each experienced a surge of about 25% this year.
At the heart of the homebuilding story is a bet on a strong economy, according to Bartolini. He highlights how the sector has performed better than the overall market in the last year and a half, along with impressive growth in earnings per share. Furthermore, the expectation of rate cuts from the Federal Reserve is seen as a major factor driving potential gains. This anticipation suggests that mortgage rates could decrease, which could unleash pent-up demand in a market constrained by limited supply. Bartolini sees these rate cuts as a significant boost, likely to awaken demand that has been dormant. As Wall Street prepares for these potential cuts, Bartolini predicts a positive ripple effect, with stocks related to home furnishing also poised to benefit from the current positive consumer sentiment. Bartolini remains optimistic about the broader housing industry, thanks to a strong economy driven by a healthy labor market. He predicts ongoing prosperity supported by resilient consumer behavior.