As we approach the end of a very, very rocky year, it is fair to ask “Where are we and where are we going?” In fact, I get asked this question all the time. Obviously, we are not at the end of the rate-hiking cycle by the FED and that dominates the conversation.
Real Estate and its Relationship with Interest Rates
As I have related over past months, real estate is an interest rate sensitive industry, as it is driven by debt. Typically, the lender is investing 60% to 80% in a commercial property purchase, and up to 95% in residential. So the lender’s cost in the deal, being the interest expense, is a dominant factor in making a transaction “pencil”.
When interest expense doubles, lots of transactions are no longer as profitable and may be totally undoable. Couple that with big inflation in construction materials, the issue of scarce labor (how far down are you on your electrician’s list?) and the doubling of interest expense for a buyer, it is not a pretty picture.
Now the rebuilding from the Florida hurricane will use up lots of construction materials, which are then not available for new home construction. That being said, home mortgage demand is currently at its lowest since 1997!
This is a Recession
A Recession is two or more successive quarters of negative GDP. Q1 and Q2 2022 have been negative. However, Q3 was positive 2.6%; however, if you take out our shipments of LNG to Europe, Q3 GDP is also negative. So, we are in a Recession.
Multifamily is the Hardest Hit
I am a member of a brokers group that meets monthly. Recently, I asked how many had lost deals to interest rate hikes in the past couple of months and half raised their hands. Multifamily is the hardest hit, with some lenders withdrawing from the market completely and those still in the market are overwhelmed with deals from which to pick.
Industrial is still steaming along with about 8-milion square feet under construction currently. Nearly all industrial construction is speculative space, because that is what industrial developers do, but it leases up fast these days.
Q3 of 2022 marks the 8th consecutive quarter that demand (represented by net absorption) outpaced supply, a 9-year record, according to Partners Real Estate. However, Amazon stopped work on its Weidner I-35 site and the Loop 1604 Northwest Military site has never started; they are finishing their 1-million SF facility on Hwy 90 at Loop 1604 and similar on east side near IH-10 and Loop 410.
Retail leasing is still strong and pad site sales are strong, but new construction not so much as construction costs are up a lot and not coming down.
Retail lease rates are strong and rising. Centers have an ultra-low vacancy rate of 3.5%, despite nearly 1-million square feet of space being delivered to the market this year, 84% of which is pre-leased and another 850,000 SF in the pipeline, with 76% pre-leased.
So, underneath the slowing in construction is an increasing shortage of space. This will create a boom when rates lower.
Office Growth in San Antonio
Office growth in San Antonio is solid making us the 16th best in the U.S., with 800,000 SF of leasing activity per quarter, a very healthy pace, according to Co-Star Group. Sublease space (space that is leased but the tenant would like to find someone else to lease from them) has risen substantially through the Covid period.
Vacancies have increased from 9-10% last year to 12% this year, yet rents are still growing at a 2.2% pace. There is about 2-million SF of new office space under construction, according to Co-Star, about 2% of our total inventory.
This is a good pace, but not compared to Austin’s super-aggressive pace of 9.5-million SF of office space under construction, which is 7% of inventory. Meanwhile, a developer is breaking ground on a 72-story high rise, to be the largest in Austin and one of the largest in Texas.
Office Leasing Terms Shift
Overall in the U.S., office leases are getting smaller with shorter terms as companies seek to minimize their occupancy risk. The Work From Home trend versus back to the desk paradigm are still in conflict and may take another year for companies to sort out.
Apartment rents were up 5.2% for three months which ended Sept. 30th of this year, compared to 2021, and asking rents spiked 17.9% in the San Antonio area from before Covid, reaching $1,242 a month, according to CoStar. Capitalization Rates on apartments have moved from 3.5% up to over 5%, a whopping decrease in value (over-value?) of 40 percent.
Investment sales have slowed a lot, with many sellers and buyers going to the side lines now.
The Green Street Commercial Property Price Index® decreased by 7% in October. Rising interest rates have caused property prices to decline by 13% this year.
“It’s a simple story: higher yields on Treasury bonds equals higher cap rates,” said Peter Rothemund, Co-Head of Strategic Research at Green Street. “And as large as the decline in pricing has been, I don’t think we’re out of the woods. If the 10-year note stays above 4%, property prices are likely to keep falling.”
CBRE announced that the commercial investment volume has fallen 24% year-over-year this year.
San Antonio Ranks 3rd in Job Growth
San Antonio, however, is fairing better compared to the rest of the U.S. We are the third best city for job growth at 1.5%, with Austin hitting #1, making the Austin-San Antonio Corridor the top spot in the U.S. of A.! Interestingly, the largest job loser is San Francisco. In August our unemployment rate was a mere 3.7%, below Texas’ 4.1%. San Antonio actually has gained 170,000 jobs since the pandemic onset in April 2020, according to Partners Real Estate – and they all own a car and drive on Loop 1604.
So, our market is doing pretty good, despite the difficulties we are facing.
My slogan is: “Survive ‘23 to Thrive in ‘24.”
Will that work for you?