US Real Estate Investment Landscape

The continued upward trajectory of the US economy paves the way for a moderately bullish real estate market. Sustainable GDP growth, declining unemployment, rising interest rates, increased lending and other macroeconomic indicators provide a strong foundation for expansion. This article examines the current state of the US economy and consequential trends in the real estate sector. The contractionary effects of political instability, interest rate competition, affordability concerns and inventory shortages will also become apparent. Structural changes in the industrial real estate sector will be drawn into focus. In particular, the remodelling of distribution channels resulting from the proliferation of e-commerce and online consumerism should acquire greater exposure. Ultimately it is suggested that there is impetus for optimism in the real estate sector.

Economic Outlook

Current fundamental economic data underlying the US real estate market makes for a favorable investment market. GDP growth will rise to a sustainable 2.1% in 2017.[1] The unemployment rate will drop to 4.5%, which is significantly less than the 6.7% target set by the Fed. The core inflation rate will closely track the targeted rate of 2%. Furthermore, proposed deregulation of the financial sector[2] will stimulate lending in the banking sector and provide additional leverage for investment in real estate assets. From a macroeconomic standpoint, market indicators certainly provide for a favorable investment landscape.

Interest Rate Hikes versus Fundamental Growth

Although domestic economic indicators warrant investor optimism, it is also necessary to consider the counterbalancing effects of a rising interest rate environment. In particular, last month the Fed raised the overnight funds rate by 25 basis points and has forecasted several additional rate increases over the coming 12 months. For investors in real estate investment trusts (REITS), this is discouraging as higher bond yields reduce the attractiveness of this type of investment. Traditionally, one advantage of investing in a REIT is the comparatively higher dividend yield provided by the underlying assets. As interest rates rise, bond yields will increase as prices decline. More investors will gravitate towards higher yielding fixed income securities as interest rates increase. However, one must remember that higher rates are being driven by a fundamentally stronger economy. This itself may lead to higher housing prices and rental income, which in turn will drive REIT performance. Last time the Fed raised rates, REIT performance actually outstripped the S&P as the demand for rental properties drove up rental income and property value. It is necessary for investors to balance the contractionary effects of interest rate competition against fundamental growth in real estate markets before altering their asset holdings.

Barriers to Growth

Aside from interest rate competition, there remain other impediments to growth in the real estate sector. In particular, supply concerns continue to persist. The amount of homes available for sale has dropped 20.1% from 885,106 in July 2016 to 707,207 in March 2017.

Screen Shot 2017-04-15 at 9.44.20 am Source: https://www.redfin.com/blog/data-center

Affordability concerns also remain as the 30 year fixed mortgage rate of 4.1%[3] continues to exceed annual wage growth of 3%. House pricing pressure is further compounded by higher costs associated with a shortage of construction workers.

Political landscape

Stagnation in the political domain is delaying the introduction of anticipated expansionary fiscal policy measures. For instance, there has been disagreement over the financing of the Trump administration’s proposed 1 trillion dollar infrastructure spending program. Democrats are largely calling for the government to foot the bill, whereas Republicans are pushing public-private partnerships. This bipartisan divergence, coupled with global instability could put a harness on growth in the real estate sector.

The ‘Last Mile’

The outlook for the industrial real estate sector looks particularly bright. Much of the growth in this area can be attributed to the continued restructuring of consumer distribution channels. The growth in the e-commerce industry and online purchases is increasing the desire for short delivery times. Rather than construct large centralized distribution factories, online retailers are moving towards smaller dispersed distribution centers in densely populated areas. The rationale being to reduce the delivery time for the final portion of the transaction, the so called ‘Last Mile’ of the delivery process from the distribution center to the buyer. The structural changes in this part of the market should divert more capital to industrial real estate assets in the coming years.

Final Word

The outlook for the US real estate sector is positive. Despite interest rate competition from fixed income securities, political disagreement, affordability pressures and supply concerns, investors should maintain confidence in this sector of the market. Strong macroeconomic trends coupled with expansionary fiscal measures provide support for continued growth in this sector. Investors should remain hesitant from withdrawing from real estate ETF’s and REITS due to a favourable economic climate for the underlying assets. In particular, industrial real estate should continue to expand due to the growth in online purchases and the associated demand for smaller dispersed distribution channels. A moderately bullish sentiment should shape activity in this asset class and drive activity in this sector for the coming months.

[1] According to forecasts released by the Federal Open Market committee on March 15. This is below the 4% rate targeted by the Trump administration, which many argue amounts to irrational exuberance

[2] Refer to an article I wrote on March 2nd entitled “Proposed Deregulation of the Financial Sector: Commentary and Analysis”

[3] https://ycharts.com/indicators/30_year_mortgage_rate

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