Grading Our 2020 Predictions for Commercial Real Estate

Topic:  • By David Scherer • January 11, 2021 Views

At the end of each year, we look back at the top 10 trends we thought would dominate the private commercial real estate industry at the start of the year and we assess what we got right and what we missed. We do this exercise to hold us accountable and as a sign of our commitment to integrity for our investors.

Looking at my 2020 predictions, it’s clear that one big headwind faced was missed: COVID-19. But let’s be honest, nobody saw COVID-19 coming. In many ways, COVID-19 caused massive disruptions to real estate, global financial markets, and everyday life. But in other ways, the pandemic only accelerated trends that we suspected would happen. For instance, look at the acceleration in the demise of office space. Or look to the record flows of capital to multifamily housing – Origin’s area of expertise.

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Though I didn’t see the global pandemic coming, I still scored a 9.5/10 in my predictions, which is pretty remarkable considering what a year 2020 was. I’m proud of how, in the face of COVID-19, the Origin team reacted and adapted to focus on what we do best: continuing to buy the right properties, leveraging our development expertise, and properly managing our investments. More importantly, my team used these insights to the benefit of our shareholders. Read on to see how I graded myself with each prediction.

Prediction #1: Welcome to hipsturbia.

WHAT WE SAID
“Millennials will discover suburbia,” we noted last year, and indeed they have—specifically those that have thriving downtowns with transit hubs, retail, restaurants and cultural offerings that exude urban vibes and promote walkability. One report called these vibrant suburban pockets “hipsturbias.”

WHAT HAPPENED
There’s been a demographic shift from urban to suburban. These are the areas that are walkable to the store, the gym, Starbucks, and the train. It’s less important right now because people aren’t taking the train into the city, but eventually it will matter.

Origin Prediction Score: +1

Prediction #2: Destination neighborhoods go a little flat.

WHAT WE SAID
With salary increases still lagging, hot urban neighborhoods will grow less affordable and landlords won’t have the same ability to raise rents.

WHAT HAPPENED
The highest priced rents in cities grew less and were pressured because of affordability issues. Then the pandemic only accelerated this trend. There’s been no ability to raise rents in your best assets in any city.

Origin Prediction Score: +1

Prediction #3: Opportunity zones hit reset.

WHAT WE SAID
Politicians may be getting buyer’s remorse over tax breaks for low-income neighborhood investment, and that may be reflected in future reporting requirements. But the program will stay in place despite concerns over who will benefit.

WHAT HAPPENED
I got this one right, but investors are nervous about what is going to happen. The new administration may change anything from reporting requirements being more stringent to requiring opportunity zone fund managers to partner with community groups. It could be more radical changes like using the 2020 Census to redraw the entire map because right now it’s based on 2010.

Origin Prediction Score: +1

Prediction #4: Affordability is the differentiator.

WHAT WE SAID
The new growth driver is affordability offered in places like Austin, Raleigh-Durham, Nashville and Charlotte. So despite comparable cap rates to high priced markets or gateway cities, these markets are still affordable. This means that rents are low enough to withstand raises, making them good investments.

WHAT HAPPENED
All of the quality housing available that was also affordable fared far better operationally and in terms of valuations. And by “affordable,” I mean it was below 25% of the average median income in the area.

Origin Prediction Score: +1

Prediction #5: Residents’ demand for rental housing will remain strong.

WHAT WE SAID
As Gen Z, the largest cohort to ever live, enters the rental market and downsizing Boomers return, the multifamily housing market will continue to stay strong.

WHAT HAPPENED
There was a massive shift away from New York, San Francisco, and Los Angeles. There was also a demand shift from urban to suburban, but overall demand was strong even given the pandemic.

Origin Prediction Score: +1

Prediction #6: Money will flow to multifamily housing and value-add will be overvalued.

WHAT WE SAID
Fannie Mae and Freddie Mac provide a liquidity edge for multifamily housing. This liquidity makes multifamily property pricing more stable and predictable. For 2020, we believe value-add real estate will be overvalued relative to core and core plus.

WHAT HAPPENED
In the second half of the year, there were tremendous amounts of capital showing up to buy private assets in multifamily, so my predication was accurate. In terms of value-add, it’s harder to measure. My sense is that value-add is the worst expected value in the multifamily category. I would rather buy core or develop.

Origin Prediction Score: +1

Prediction #7: Artificial intelligence will disrupt office space.

WHAT WE SAID
Midlevel office jobs are more vulnerable to being replaced by automation, and this is reflected in the softening prices of those generic suburban office properties built for midlevel bankers, lawyers and accountants.

WHAT HAPPENED
When I was thinking about artificial intelligence last year, there were many businesses that wanted to use technology to downsize their labor force and reduce costs. That trend continued, but a lot of new competition entered the market. These new competitors are Zoom, Microsoft, and Cisco WebEx, among others. These are substitute products and will continue to grow market share as they improve, and employers increasingly accept remote labor as a viable and lower cost option for them and their employees.

Origin Prediction Score: +1

Prediction #8: Rent increases will slow across property types.

WHAT WE SAID
Rent rates should moderate in the future even for tech-focused properties and Class A multifamily, although Class B will not slow. Instead, it will continue to go up driven by the need for affordability.

WHAT HAPPENED
My thinking before the pandemic was that affordability ratios were stretched, and people couldn’t afford higher rents. To some extent, that was happening early in the year. But then COVID-19 hit, unemployment spiked, and affordability ratios grew even more stretched. I was right, but might’ve been less right if the pandemic hadn’t disrupted the labor market.

Origin Prediction Score: +1

Prediction #9: Margins will tighten for real estate property owners.

WHAT WE SAID
It will be harder to earn high cash flows to equity because tax and insurance expenses will increase faster than rent increases.

WHAT HAPPENED
Insurance premiums increased four to eight times the rate of inflation. Markets that have exposure to hurricanes like Florida, New Orleans, the Carolinas, and South Texas saw the biggest increases in premiums.

Origin Prediction Score: +1

Prediction #10: Private capital will buoy commercial real estate.

WHAT WE SAID
Private equity real estate funds, banks and insurance companies would cause valuations to continue trending higher.

WHAT HAPPENED
COVID-19 disrupted capital flows for all asset classes across real estate in the second quarter. It was a shock and caused investors to dramatically shift risk preferences and funds. On the bright side, multifamily bounced back quickly and, by the end of the year, valuations were above pre-pandemic levels and trending higher.

Origin Prediction Score: +0.5

Total Origin Prediction Score: +9.5/10

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David Scherer

David Scherer formed Origin Investments in 2007, along with co-founder Michael Episcope. He has over 20 years of experience in real estate investing, finance, development and asset management.