GM. In today's email: Rent growth is slated to slow and eventually decline through 2023 as most rental units could become unaffordable for potential tenants. Publicly-traded REITs are expected to outperform nontraded REITs in 2023 after lagging behind last year.

Meanwhile, total construction spending rose in Q4, driven mostly by private nonresidential projects, but it is not likely to compensate for the expected decline in residential construction spending.

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Watch: Pacaso CEO Austin Allison discusses the feasibility of turning second home co-ownership into a business (and the criticisms he’s faced for trying to do just that). 

Listen: Northwestern Mutual Real Estate Director Brandt Foster discusses Manufactured Housing Communities (MHCs) and why he thinks they’re one of the safest CRE investments.

Rent Growth Expected to Decline Nationwide Throughout 2023

The apartment rent growth boom of the past two years is coming to an end as sky-high rents disqualify potential tenants and the market receives its biggest wave of new apartments in 40 years. It doesn’t help that rising interest rates make rental properties less attractive to investors, either.

Got rent? In some ways, the apartment market has become a victim of its own success. Rents climbed 25% from 2021 to 2022 as young people moved out of their parent’s homes all at once to rent their first apartments. Many had no choice because they couldn’t afford to buy homes. The remote work trend contributed to growth, too, as well-paid Northeasterners moved to the Sun Belt to save on living expenses.

Saw it from a mile away: Rent growth exploded as inflation and rising rates made it impossible for most Americans to buy their first home. Sadly, many apartments also became too expensive. Unsurprisingly, areas that saw rent gains of over 30% in the past two years have recently seen declines. The rent downtrend is likely to accelerate throughout 2023 as nearly 500K new apartment units hit the market.

➥ THE TAKEAWAY

Got affordable housing? Apartment demand will stay high as long as housing prices do, but only for affordable units. And there’s a shortage of those. Developers and investors working in the luxury apartment sector are likely to see higher vacancy rates and would do well to redirect their resources to building more affordable housing. Some analysts believe that 2023 will see negative rent growth every single month if migration and new household formation remain low.

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TALE OF TWO REITS

Public REITs Projected to Catch Up to Nontraded REITS in 2023

Publicly-traded REITs had one of their worst years ever in 2022, while privately held REITs posted gains. But current economic conditions, historical trends, and analyst predictions all suggest that this gap is likely to narrow in 2023 by a lot.

Mind the gap: By Q3 2022, publicly traded REITs had lost 28.2% of their value while private ones posted overall returns of 13.1% (that’s a 41.3% gap). The fact that private REITs have unique purchase and redemption policies that limit withdrawals helped prop up their values during this period while investors in public REITs sold lots of shares.

Close the gap: But this boon has come back to bite private REITs. They’ve performed so well relative to public REITs and the rest of the economy that private investors have tried to cash out while they still can. So many tried, in fact, that big private REITs like BREIT and SREIT limited withdrawals, shaking investor confidence—and leading many to bet on public REITs in anticipation of a correction that brings the two markets closer together.

➥ THE TAKEAWAY

Trading places: Many analysts expect public REITs to basically trade places with private REITs, hitting their stride and rebounding as private REITs finally tank. Historically this tracks—going into recessions, public REITs usually lag behind private REITs before outperforming them later on. Most sources believe public REITs will rebound in the second half of 2023, but don’t really know what to expect for private ones.

SILVER LINING

Total Construction Spending Rose in November, But Gains Won’t Last

Total construction spending across the US rose just 0.2% since last November to $1.8B, giving builders a degree of optimism. But losses in some sectors practically canceled out gains in others, so it’s unlikely this pleasant surprise will rescue residential construction from the pits.

Private works: Nonresidential construction is looking good, up 8.5% YoY from last November and with most builders reporting a backlog of projects. While spending increased in 9 out of 16 nonresidential subcategories, the lion’s share of revenue came from big construction projects devoted to chip manufacturing facilities and conservation projects.

Not in my house: Residential spending, on the other hand, isn’t doing so hot. Although it’s still higher than in 2021, residential spending declined throughout Summer and Fall 2022. Single-family spending was hit particularly hard, dropping 2.9% this November and down 10.2% YoY from 2021.

➥ THE TAKEAWAY

Kicking the can: Since rising rates are what caused developers to slow down or hit pause on new projects in the first place, things aren’t likely to improve much in the residential sector so long as rates remain high. A related issue is that banks will become far stingier lenders this year, as long as we’re approaching or in recession. Blame it on the Fed!

• Nuveen’s new look: CRE titan Nuveen Real Estate (JRS) has decided to branch out into online crowdfunding to grow its investor base.

• Fewer places like home: Pending home sales fell 38% YoY this November, declining for the six straight month as a shortage of affordable homes forces potential homeowners to rent instead.

• More for lease: After a strong 2022, the industrial sublease market is slowing down with the rest of the economy, and more and more warehouse space has become available.

• Build Back Lesser: The US manufacturing sector contracted in December, but weak demand and high borrowing costs have also counteracted price inflation.

• No one REIT answer: New York City REIT (NYC) has decided to diversify its portfolio and consider new types of investments in 2023’s tougher CRE environment.

• Decimated: Salesforce (CRM) will lay off 10% of its workforce and cut office space as the company receives less business from customers. Benioff admits they hired too many too quickly.

• City slickers: The National Association of Realtors has posted its list of the top 10 real estate markets it predicts will outperform the rest in 2023.

• Malkin gets burned: New Zealand’s after Empire State Realty Trust (ESRT) chairman Tony Malkin after his NYE fireworks burned 53K acres of surrounding land.

• Pricey remedy: In a joint venture, Remedy Medical Properties and Kayne Anderson Real Estate purchased a $131M medical office portfolio from Montecito Medical Real Estate.

• Red-hot Herndon: The EPlus headquarters in Herndon are slated to be redeveloped into a multifamily complex amid a slew of other redevelopment projects happening around the Silver Line.

• Final Four: The city of St. Petersberg released the plans of four competing finalists seeking to develop the Rays’ Tropicana Field site and the rest of the Gas Plant district.

• So long, Sears: Residents of the Coral Gate community are in talks with a developer about converting the last Sears in Miami into a multi-use apartment and retail complex. RIP.

• The Flaherty Four: Flaherty & Collins reveal four planned affordable housing developments scheduled to go up in Indiana and Missouri for an expected $80M.

• Cash in reserve: Broker CBRE facilitated the $48.65M sale of a 164-unit multifamily complex, Reserve41, from Norpointe LLC to Yellowstone Property Group.

• Plan B, just in case: Goldman Sachs has decided to lease 130 KSF of office space in its new downtown Dallas tower to other companies to make some quick cash.

• Titanic transaction: Transwestern Real Estate Services just added 12 MSF to its CRE portfolio with the acquisition of MB Real Estate for an unknown amount. No biggie.

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DISCLAIMER: None of this is financial advice. This newsletter is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. Please be careful and do your own research.