In 2021, the commerical real estate (CRE) market experienced a rebound that surpassed even the most optimistic forecasts. National property values soared the most in more than two decades as secular growth sectors (apartment and industrial) combined with cyclical rebounds (retail and suburban office) to create a powerful price growth cocktail. Investors, enticed by rapidly improving fundamentals and relatively attractive yields, flocked to the space, driving sale volumes to an annual record. The 2021 experience was one of a supercharged early-cycle environment, supported by a strong recovery in rents, excess liquidity, and low interest rates.
As we look ahead to 2022, many of the same supports remain, but the starting point has changed. Property valuations experienced a sharp uptrend, leaving them potentially more vulnerable to rising rates. Both monetary and fiscal policy are set to tighten over the coming months, while inflation remains a crucial macro concern. In short, 2022 will welcome a new market expansion phase, typified by strong fundamentals and a more even balance of upside and risks. Opportunities for investors should remain across both debt and equity as dispersion across regions and sectors persists.
- 2021 was a record year for the U.S. CRE market, with price growth and transactions volumes setting new highs.
- COVID beneficiaries such as apartments and industrials continue to grow rapidly, while signs of a rebound in the more cyclical sectors have become apparent.
- 2022 will likely feature a more even balance of upside and risks.
As we head into 2022, the setting for the U.S. CRE market appears upbeat. The U.S. economy likely grew at a 5.6% pace during 2021, which would mark the most rapid growth since 1984.1 A strong economy generally benefits real estate, and this time was no different: Annual CRE sales volume crossed $600 billion for the first time ever through November, and 18.4% property price growth underscores the soaring demand for investment in the space.2 The pandemic has also driven changes in consumer and business behavior, such as e-commerce and remote work, that have disproportionately benefited some of the largest sectors in the real estate market. Despite robust fundamentals and sentiment, the CRE market remains disciplined from a financial standpoint, with leverage low and cash plentiful for borrowers to pay debt service. Finally, while the latest omicron-driven wave of COVID cases presents risks, vaccination has placed the world in a much more advantageous position compared to one year ago.
While the starting point for the market looks benign, macro risks are likely to become more prominent in 2022. The primary and most dangerous of these risks is inflation, both for its direct impacts on the economy and the reaction it elicits from monetary authorities. Headline CPI is running near 7%, a four-decade high, while core CPI of 4.8% is the highest since the early 1990s.3 Companies have largely been able to pass through rising costs and retain their margins, but inflation has delivered a blow to consumer confidence. While CRE has historically been a reliable hedge against inflation (see our CRE 5 for ’22), elevated inflation that persists throughout 2022 introduces the risk of an economic deceleration. Additionally, it could force the Federal Reserve to act more aggressively, pushing interest rates upward and challenging cap rates. On top of inflation, the global economy continues to deal with new variants of the virus, supply chain shortages, and a slowdown in China, all of which are driving uncertainty.
With this backdrop in mind, we will use this space to provide a broad overview of the CRE market heading into 2022. In particular, we will focus on a broad theme that has, in many ways, been the defining characteristic of the COVID-era CRE market.