Every year, the Lancaster Commercial and Industrial Real Estate Council hosts High Real Estate‘s review of the local commercial and industrial real estate market. High always presents an extensive, well-researched and thought-out presentation. In addition to just showing charts and graphs, the speakers from High really understand the Central Pennsylvania market and are willing to share their thoughts on what the numbers mean.
When I go to this presentation each year, I ask myself, “What would I tell a client who was not here to watch the presentation?” This year, the ideas that stuck with me are:
1. If I could invest in any real estate, I’d want to own existing apartments or warehouses in places like Lancaster County.
One of the speakers mentioned that pre-COVID, the average daily work commute was around 30 minutes. Today, it is an hour. He explained that as more people are spending fewer days in the office and working more from home, some people do not mind making a longer commute a few days a week.
Because more people can work from wherever they want, a growing number of people are moving out of the biggest cities into the suburbs and smaller cities. This means they can move into bigger, more expensive houses and apartments because of the lower costs of living.
High said that apartment rents nationally have increased 11% this year. In Lancaster, the rents have grown by 7.8%. (They mentioned areas in North Carolina where rents have increased by 25% in the past year.) New renter income is up 11%. And vacancy rates for apartments are about zero.
It is no secret that people shop online more than ever. What is not as obvious is that transportation costs are high and on the rise. Online retailers like Amazon are more interested in putting their distribution centers closer to the consumers to minimize these costs. In the industry, they call this the “last mile” distribution. Rents for industrial warehouse space have increased over 9% last year.
All this means that apartments and warehouses close to those apartments are great investments.
2. COVID and the workforce are still the two big questions for the economy.
Many businesses are going to be limited by whether they have enough workers. Hotels are a great example of this. The occupancy rates for hotels are getting back to where they were before COVID. But the restaurant and hospitality industry lost 1.3 million workers during COVID. The ones who have remained, though, have seen their pay increase by 16%. Hotel owners now may not have enough people to do the work, while at the same time they have smaller margins due to increased labor costs.
While hotels and hospitality, in general, are the most glaring examples of the effects of the workforce, every business and industry is affected. Due to COVID, lots of people still have unreliable child care and that potentially takes both workers and consumers out of the market. These issues may take years to completely stabilize.
3. There is a lot of money out there, which makes investing difficult.
The first point showed that investing in apartment buildings is great. Of course, if I understand this, lots of other people understand this too. Because these kinds of properties are in high demand now, the capitalization rates (“cap rates”) on them are being “compressed.” High reported seeing cap rates as low as 2.6% on warehouses and 3.0% for apartments.
A low cap rate is great if you own the property. It is (to vastly over-generalize) a much safer investment than a property with a high cap rate. But if you are looking to make an investment, buying a warehouse at such a low cap rate means that the purchase price of the property is going to be higher (for a stable operating income). So an investor needs to pay relatively more for a property than they did five years ago.
It also makes for a more difficult exit strategy. When cap rates increase, (for a stable operating income) the market value of the property is going to decrease.
The low cap rate issue is why I started out saying that I’d much rather have an existing apartment building than try to buy one today. I’d much rather renovate an apartment building and increase the rent than try to buy or build one right now.
These three takeaways are only a fraction of what High Real Estate covered. I did not even mention office or retail commercial real estate, interest rates, or many of the other topics that were discussed. Follow us here at the Lancaster Law blog as we continue to track the trends in the Lancaster County market.