Invest Wisely, Create a Hedge Against Inflation
April 12, 2022
Commercial Real Estate Prices
And the race is on! Which will go higher faster? Gas Prices? Inflation? Interest Rates? Property Appreciation? Property Values were in the lead, up by 21% annualized over the past 12 months, but are these returns sustainable? “Commercial property prices have stopped going up,” said Peter Rothemund, Co-Head of Strategic Research at Green Street. “That’s quite a change from last year, but one look at the yield curve and it’s easy to see why. The yield on the 10-year Treasury is up 100 basis points since December and borrowing costs, whether that’s mortgages or unsecured notes issued by REITs, are up even more.” However, it is very important to remember that Commercial Real Estate should be a long march, not a short sprint, even though we have had a nice sprint since the Covid lows of 2020. The real money in real estate comes from long term compounding of value, over years of careful holding and curating of the property.
The Best Investments to Hedge Inflation During Uncertainty
One thing is certain in the near term, and that is uncertainty. The country is apparently entering a period of slower growth, which can be expected after the torrid pace of the past two years. However, higher interest rates will definitely impact housing, as are the supply chain problems, including the unaffordability of developable land. I heard that mortgage interest rates would have to get to 5.75% before the housing market will really stop, and we are at about 4.75% now. While higher borrowing costs should cause commercial property prices to at least stall, the compression of cap rates has actually increased, largely because of the “inflated” amount of money looking to get invested. Alternative investments such as cash, which loses value at the rate of inflation, and the stock market are looking pretty dicey right now. Everyone knows that real estate is a good inflation hedge because it is a hard asset and rents can be increased at the rate of inflation at least, causing values to rise. Consequently, commercial real estate has been, is now, and will probably remain a very hot haven for investment dollars.
Soft Landing or Recession?
But what happens if we really hit a recession because the Federal Reserve can’t engineer what is known as a Soft Landing? A Soft Landing means they raise interest rates enough to cool off the torrid inflation, but don’t tip the economy into a recession. If the FED engineers a Soft Landing this year, it will be one of the few times, ever, that they pulled it off. The uncertainties of this year, known and unknown, are not likely to help them in their mission.
My response is that God Blessed (Central) Texas! Austin is the fastest growing metropolitan area in the U.S. and San Antonio is third place, with Phoenix #2. Our San Antonio-New Braunfels Metropolitan Area grew 1.4% last year, and has now reached 2.6-million residents. Most of the growth has been in New Braunfels and Comal County with a growth rate last year of an astonishing 7%, according to estimates released by the U.S. Census Bureau. Co-Star Insight said, “Combined, the two main markets of Central Texas welcomed more newcomers than any area in the country outside of Phoenix. This is despite the fact that nine other areas are larger than Greater Austin and San Antonio combined.”
Commercial Real Estate Investments and Development Remain Positive
So, with this population inflation solidly in our favor, it would appear that commercial real estate investment and development will remain positive even if we experience a slowdown or minor recession in the coming year or two.
Retail Center Market
The retail center market remains tight with a 4.7% vacancy rate, according to NAI Partners. Foresite Research says, “San Antonio’s average multi-tenant retail asking cap rate … is 6.46%, down from 7.0% in Q3 2021.” However, in Austin the cap rate is under 6%. In San Antonio there is almost 1-million square feet under construction with nearly 1-million delivered in 2021. Now comes Kroger Grocery to our market, which you may remember closed all of their stores here years ago. They are bringing a new concept apparently, where they open up distribution centers in industrial areas and cater only to direct home delivery, by-passing the expensive retail stores like HEB and Wal-Mart. They are using robots and artificial intelligences to fill online grocery orders. This will create some very interesting dynamics for shoppers.
Industrial, Investment, and Office Markets
In San Antonio, industrial property cap rates are now in the 4’s and investment properties are in very short supply. However, the office market has seen an increase in vacancies, up from 10.9% last year to 12.1% this year, according to NAI Partners, with rents up about 30 cents per square foot to $22.04. There is currently about 1.4-million square feet under construction.
Property Taxes in Texas on the Rise
Property tax increases are continuing to be a big factor in tenant costs. While the Appraisal District felt like they were being gentle the past two years, because of Covid, they are putting everyone on notice that this year will be rough, considering increases in property values.
Cap Rates in San Antonio and Austin
Cap Rates on Apartments in San Antonio are in the 4’s, down from the 5’s last year, while in Austin cap rates are in the two’s (that is not a misprint). We know one builder moving his operations to New Braunfels because he can no longer find buildable and affordable lots in the capital city. Wanna start an argument? Tell someone from New Braunfels that they are “South Austin.” Buda and Kyle have long accepted that as their fate, and probably San Marcos, too.
Austin Residential Market
I was talking to an Austin residential realtor recently. It is the general “wisdom” that you must offer $10,000 over asking price just to get your name in the hat on an available property. Last weekend, she put a property on the market for $599,000, and had multiple offers with the final contract going that weekend for $720,000! Keeping Austin weird, my friend.
But God has blessed (Central) Texas, indeed!