Every January brings a flood of predictions to advise private real estate investors. At Origin, we make predictions, too—but we go one step further by scoring our predictions from the prior year, acknowledging our wins and owning up to our misses. We believe that evaluating the accuracy of our past predictions is an exercise that demonstrates our acumen and ability to perform.
This is our third year scoring our top 10 predictions, and we’re pleased to note that we have called most real estate trends correctly every time. The scorecard on our 2021 predictions came in at 96%. But more significantly, we acted on our 2021 expectations, refining our business and acquisition plans to benefit shareholders.
Of course, none of us has experienced a prolonged global pandemic, and that accounts for our 2021 misses. Last year, two issues weren’t on our radar—or on anyone’s, to the best of our knowledge: significantly extended supply chain issues and unexpectedly substantial inflation. These issues top our 10 private real estate investing trends for 2022, and we deducted a point off our 2021 score for each issue. We lost two more points for our prediction on Qualified Opportunity Zones, which you can read about below. With that, our scorecard speaks for itself.
Prediction No. 1. We’re not in a bubble.
What We Said: Investors are willing to accept a lower return because the risk-free rate is zero. And because the stock market returns going forward are probably much lower than you think. Expected returns are going down in every asset class.
What Happened: That was accurate. The risk-free rate—the yield on government-backed bonds—is still very low, and the 10-year Treasury is only slightly higher at 1.7% (at this writing). But over time, historical stock market returns are 8% to 9%, not the 20% to 30% we’ve seen the past few years. That means eventually we’ll gravitate toward the historical returns, which will happen with negative or lower return years. No one can predict when that will happen, but stock market returns will be lower this year. That’s true of real estate, too. It doesn’t mean stop investing in it, but don’t expect 20% returns.
2. The exodus from major cities continues.
What We Said: If you’re sitting in New York City, Chicago or San Francisco, wondering how to stem the tide of people leaving, the answer is you won’t. It’s going to keep happening.
What Happened: Exactly that, and it will keep happening for three reasons: Virtual and hybrid work have become totally acceptable; the labor market is tight; and labor is mobile. A record 4.5 million people quit their jobs in November, and there are massive talent shortages. These fundamentals make virtual labor not only more acceptable but also the new normal. To get and keep workers, employers must offer hybrid jobs. That trend will continue to accelerate migration to warmer low-cost cities. It won’t stop until those warmer low-cost states become costlier, which is beginning to happen in massive growth cities like Charlotte, Denver and Phoenix.
3. Shift to low-cost, business-friendly states.
What We Said: Today you can work and get a New York City salary but live in Austin or Nashville. And Texas and Tennessee don’t impose state income taxes. Or you can work for a company based out of San Francisco and live in Denver, Phoenix or Charlotte. These are just some of the explosive growth cities that offer a better lifestyle, lower cost of living and better weather than New York City, Chicago and San Francisco.
What Happened: The virtualization of labor accelerated this trend beyond all expectations. But going forward, it will be muted over time by the rising cost of living. Affordability will become an issue. Take Phoenix, which is seeing growth from people leaving California for lower taxes and bigger, cheaper houses. Now home prices are going up—not through the roof yet, but also not that much cheaper than San Diego. The upside is the tremendous wealth being created by home ownership in places like Phoenix and Tampa. Some are doubling their equity in two years. That’s real wealth for those who have been able to tap into this trend at the right time.
4. Affordability will be the biggest driver in 2021.
What We Said: There’s mobility in the workforce because workers no longer must work in a big city office. People are going to keep moving to affordable cities because they can work virtually. There’s no need to worry about a one-hour commute anymore.
What Happened: The Tax Cuts and Jobs Act of 2017, which capped property tax deductions, initially accelerated this trend. People in high-cost states like New York, California and Illinois were already on their way out of state. Then COVID-19 hit and became a massive accelerant as work became virtual and workers headed for places with better weather, lower taxes and superior lifestyles. It’s creating enormous distortions in asset evaluations and rents. Eventually those distortions will become more muted, but we are years away from that. Today we’re only in the second inning of this trend.
5. Qualified Opportunity Zone rules are at risk of revision.
What We Said: You’re probably going to see some movement on revising rules governing qualified opportunity zones. I don’t yet know what exactly it’s going to be. New rules could require partnering with community groups to more onerous reporting. Or they could demand approval of projects by Treasury. And redrawing the maps is still on the table.
What Happened: Nothing. Changes were proposed but partisan politics got in the way. The Biden administration has so much on its hands that it isn’t addressing QOZs. And before it does, it must get its own caucus to agree on stimulus, which is linked to unknowns—including COVID-19 mutations and infection spikes. Then it must deal with bipartisan politics, so I don’t see the laws changing in 2022.
6. Demand remains weak for office space.
What We Said: Even as the economy reopens and people go back to work, the office market will remain under pressure. The reason is because many employers now know they can operate a hybrid or virtual office without hurting productivity. And it’s much less expensive than paying for traditional office space. Let’s say you’re a mid-sized business in Chicago and you have 5,000 square feet of office space at $50 a square foot. That’s a $250,000 annual line item, plus another $50,000 in utilities, services and insurance. Or you could get a monthly license to Zoom or WebEx for about $100.
What Happened: That’s exactly what happened, and it will keep happening. The new entrants in the office space are Teams, WebEx and Zoom. These not only are great substitutes for in-person meetings but also are 100 times cheaper than renting office space or flying all over the world for meetings. If you can choose between spending a million bucks on office space or 100 grand on Zoom, you have an incentive to go virtual. When both labor and capital are signaling the same thing, there’s a future demand problem. There’s still money to be made in office, but it will be much harder.
7. Interest rates will not increase.
What We Said: The Federal Reserve fears a recession more than inflation. The Fed will keep suppressing rates until at least 2023.
What Happened: Interest rates didn’t increase, but they will this year. People demand a real return, so if you’re buying a 10-year bond at 1.6% and inflation is 3%, you’re locking in a negative return of 1.4%. That doesn’t work for investors. Inflation is much higher than the 10-year note yield due to volatility in commodity pricing and the supply chain. The question is how long this will last, and I think at least 12 to 18 months. It goes back to labor: There’s no one to unload freight or serve food in restaurants, and the only way to incent labor is higher wages. While that helps people, it’s also inflationary and not transitory—you can’t take higher wages away. So, inflation will be more enduring driven by higher wages, and interest rates will have to rise to curb it, hopefully in an orderly and measured way.
8. Urban and suburban multifamily valuations go higher.
What We Said: There’s a tremendous amount of equity that’s looking to invest in multifamily. The majority is flowing to suburban, but some is moving into urban. Borrowing rates are sub 2.5%. If you can generate an unlevered 4.5% on a core asset, for example, you’re looking at 6.5% returns. It’s interesting if you think there’s potential for rent growth on your property.
What Happened: Cap rate compression did drive valuations up in 2021. But in 2022 we’ll see lower appreciation. Rising interest rates will drive up borrowing rates and cap rates, and when cap rates rise, multiple on earnings falls. Cap rates range from 3.5% to 4% right now, so maybe we’ll see them rise to between 3.7% and 4.2%. That will still yield appreciation because rents will keep growing, which means higher earnings but slightly lower multiples.
9. Suburban multifamily rents will start showing real rent growth by spring.
What We Said: This trend will begin in spring and continue through the second half of the year. The multifamily real estate segment is where demand continues to grow. Additionally, occupancies are already tight. As the economy normalizes and incomes rise, multifamily is one segment where you’re going to see rents grow.
What Happened: That happened, and I’m confident rent growth will continue, with urban rents underperforming suburban rents. This time it’s a good thing. That’s the good part about inflation: People are getting higher wages and have more money to spend.
10. Multifamily rents in urban Class A will remain weak
What We Said: Even as people get vaccines and the economy recovers, there are too many people that have left cities for multifamily urban Class A rents to rebound. Plus, there are plenty of properties with many vacancies. A recovery will take time. It will be a process, not a singular event, and it’ll take through at least this year.
What happened: That’s exactly what happened; it took most of 2021 for Class A rents to rebound. In 2022 they will underperform suburban and urban class B but won’t be weak.
How We Apply Our Industry Knowledge
Origin’s predictions about the trends and issues affecting the multifamily real estate sector come from years of expertise and experience in the market. We apply the same expertise to the Funds we offer to our investors, and our performance as a top-decile fund manager speaks for itself.
Find out how we scored on predictions for previous years: