Are We There Yet?

When on any long car trip, the most common question kids have been asking for years is “Are we there yet?” Many real estate professionals are asking the same question concerning the robust recovery in real estate. Is the market seeing the top of the recovery period, or do we have room to continue the incredible recovery in this asset class for a while longer? We’ve been on this trip for a while now, so let’s get out the map and see where we are. Overall, the current real estate market is posting impressive results in terms of rent growth, occupancies, overall construction and absorption levels that we have not experienced since 2007. In many markets, we are seeing absolute rent levels well past pre-recessionary peaks. A quick look at the four main real estate property types reveals that multifamily pricing is well above its pre-recession peak, retail and office are both gaining momentum but are still slightly below their previous peaks, and industrial pricing is very near its peak levels of 2007 with a robust 5% annual rent growth and near cyclical low vacancies. Let’s examine those four property types a little closer:

• Multifamily fundamentals have remained strong, but vacancies should begin to rise this year. New construction is expected to total roughly 220,000 units this year and 190,000 next year. Rent growth will likely slow from its current pace of about 3.5% but remain positive as the demographic trends that have fueled the multifamily market’s growth are expected to continue.
• Office fundamentals are still recovering slowly, but recent figures imply that strong job growth might finally be supporting a faster rate of office rent growth and absorption. As of the end of the first quarter of 2015, there was more than 108 million square feet of office construction.
• Retail vacancy in the United States was down to  6.1% in the second quarter – the 12th consecutive quarter of vacancy decline. Currently, there is only 60 million square feet of retail space under construction.
• Industrial properties are enjoying a broad-based recovery—both warehouse/distribution and flex/R&D are getting stronger each quarter. Vacancy rates declined to 6.8% at the end of the first quarter of 2015 with 148 million square feet under construction.
• Capital markets are getting stronger with each passing quarter. Transaction volume continues to reach post-recession highs while cap rates across major sectors hit post-recession lows.

Things look pretty good overall, but real estate doesn’t operate in a vacuum. We also need to look at the broad economy and what is ahead for the United States. A few facts we need to consider as we gauge the status of the market include:

• Economic growth is not slowing. The most recent quarterly reading of 3.7% GDP growth in the second quarter is well ahead of the first quarter’s 0.6%.
• The labor market continues to improve at a healthy pace. Job creation over the past 12 months has averaged 243,000 jobs per month—a healthy rate that doesn't signal a slowdown.
• The U6 unemployment/underemployment rate just reached 10.4%, its lowest level in 7 seven years—another indication that slack in the labor market continues to decrease.
• Inflation remains relatively benign and not indicative of an economy that is overheating. CPI is up only 0.2% over the past 12 months.
• The decline in energy prices during the past year or so has mostly accrued to savings and not spending. Therefore, the U.S. consumer has a lot of dry powder just waiting to be unleashed.
• Consumer confidence in August, as measured by the Conference Board, reached its highest level since January.
• Although new home sales have been flat since the beginning of the year, existing home sales of 5.59 million (annualized) are up to their highest level since early 2007 and are indicative of an economy in recovery, not one that is stalling.

We’ve put on a lot of miles during this part of the real estate cycle and the overall market appears to be in good shape. Are we at the top of the market? Based on current real estate fundamentals and economic data at hand, I would tell the kids (as parents have done many times), “No, we’re not there yet!”