yellow blue house
Commercial Real Estate Experienced a Strong Rebound in 2021
January 25, 2022
3 min read

One important lesson from the COVID crisis is that diversification across real estate sectors is as important as ever. Over the last year and a half, commercial real estate experienced a tremendous roller coaster ride of valuation dips and recoveries. While many sectors of commercial real estate have rebounded nicely from lows experienced in mid-2020, there remains a lot of uncertainty and unknowns.

For many sectors of commercial real estate, 2021 was a good year. As recently reported in the Wall Street Journal, “The FTSE NAREIT Equity REITs index was up 36% in 2021, compared with 26% for the S&P 500 as of Dec. 23, according to real estate analytics firm Green Street. REIT strength this year was partly a rebound after a bad 2020. With office, retail and other property types hammered by the pandemic, the sector fell 8% last year compared with an increase of 18.4% for the S&P 500, Green Street said.”[1]

While a strong 2021 was certainly great news, that does not automatically mean that 2022 will see a continuance of this strength. The hope is that the economy has already experienced the worst of the COVID crisis, and that the new year will mark a return to normalcy. Normalcy, in this case, would look like fewer business closures due to local COVID spikes, and more workers returning to office locations. However, as we enter the first quarter of the year, this is not a given. From the article: “Meanwhile, dangers are lurking in the REIT sector. Concerns about the Omicron variant of the Covid-19 virus already are dampening hopes that millions of people who have been working from home throughout the pandemic will return to offices in January.”1

Most experts agree that potential challenges from new COVID variants could likely be with us for the next few years. However, COVID is not the only potential challenge on the horizon for commercial real estate.

The US economy is currently experiencing the highest inflation rate in almost forty years. There remains a vigorous debate as to whether the inflation is transitory or more permanent. Only time will settle that debate. In the meantime, however, the Federal Reserve continues to message near-term interest rate increases. The direction of real estate valuations could depend upon the number and magnitude of these potential future rate increases. As detailed in the article, “REIT shares, like those of numerous other companies, also could face a bumpy ride in 2022 from inflation and rising interest rates. Headline risk around additional variants, inflation and interest rates will create significant volatility over the next 12 months, said a December report on REITs by Evercore ISI.”1

Inflation and interest rates have remained near historical levels for the last few decades. An increase in both inflation and rates does not necessarily indicate future trouble for commercial real estate. In fact, many investors are attracted to commercial real estate due to its ability to weather some inflationary pressures. From the article: “The rise in inflation, so far, has been good for REITs because it has helped drive up mergers and acquisitions volume, as well as sales volume and values of individual properties. Many investors consider real estate an inflation hedge because owners can raise rents to stay ahead or at least keep pace with rising prices.”1

In the end, much depends on the magnitude of rate and inflation increases. Minor increases in either (or both) can act as a stimulus to economic activity. However, large, rapid increases in either can catch investors flat-footed. As with many financial challenges, the determining factor is the use of leverage (or debt). Investors and properties that utilize a heavy amount of debt would stand to lose the most in a rapidly increasing rate environment. As summarized in the article, “But inflation may be painful for highly leveraged property owners next year if it sparks sharply higher interest rate costs. Inflation and higher rates also could lead to an economic downturn and drops in demand for a range of property types.”1

As most of you know, Aloha Capital focuses solely on the residential real estate market. However, as we have discussed many times in the past, we strongly believe in diversification within real estate. Commercial real estate investors experienced a very trying investment environment in 2020, that was followed up with a strong rebound year. Who knows what to expect in 2022 as COVID and inflationary pressures continue to work through the economy. In the meantime, the US residential real estate market continues to exhibit strong and persistent demand. Given the challenges that continue to face the economy, investors would be well-served to have diversified exposure to both commercial and residential real estate.

 

[1] “REITs Romped in 2021 as Property Values Soared” by Peter Grant, The Wall Street Journal, 12.28.2021

Chris Jones
Chris Jones

Chris oversees business development, investor relations, and capital partnerships. With 25 years of experience in alternative investments, Chris has raised $250 million in assets. He’s served as Chief Compliance Officer, co-managed a Fund of Funds, and worked in operations and trading. Chris has been instrumental in growing four companies. Through firms like Sapourn Financial Services, Dekker Capital Management, and Diamond Peak Capital, he’s delivered solid absolute returns across varied market cycles.