A Skyline Littered with Cranes
February 13, 2017
We often get asked about the health of the real estate market. This interest is not surprising given our firm is located in the heart of an epicenter of real estate development, Atlanta, GA. The skyline of midtown is yet again littered with construction cranes, with over 20 mid rise and high rise projects under construction. Moreover, an additional 20 projects are in the pipeline, but have yet to break ground! That sounds like a pretty good market, but is this a real estate bubble? To answer this question the real estate market must be separated into two sectors: commercial and residential. Let’s look at both, starting with the current state of the residential market.
Following the subprime housing blowup, and the resulting fall in house prices, we have seen a slow and steady recovery that may be on the verge of heating up. The extra inventory from The Great Recession has been absorbed by home buyers, or by value driven investors looking for places to deploy capital. Recently released home price surveys show that the market continues to recover. The Case-Shiller House Price indices are now showing an impressive post recession recovery. In some of the hotter markets, home prices are up 10% or more compared with pre-recession levels. With the unemployment rate now down to last month’s 4.8%, no one should be surprised at a renewed demand for housing. On top of that, with the improvement in the job situation, many Millennials are finally entering the housing market. There are some near term concerns. One is a potential lack of inventory which would lead to this being a seller’s market. Another is the potential headwind of rising interest rates, coupled with the possibility that the Fed will begin to liquidate their $1 trillion in mortgage backed securities they hold.
The commercial market is a completely different beast to consider. Institutional capital, the backbone for the development of commercial deals, continues to fuel funds for commercial projects of all types. A current risk is whether there will be continued funding as interest rates rise, and there is much uncertainty over the rate of increase. Capital can be turned off quickly in the commercial market. Another risk is the extent to which potential tenants of these new spaces will continue to be willing to pay ever increasing rents. As cap rates rise, developers will need to be able to increase rents in order to maintain valuations on properties. Watchful participants are looking closely at this market for early signs of problems. The activity level in the commercial sector is clearly more heated than in the residential arena, and caution is the prudent course for commercial real estate investors. The residential market seems to be fine for the time being. As long as interest rates move in an orderly fashion, which is consistent with market expectations, and prices continue to be affordable, the residential market should be in excellent shape.
Carl Gambrell
