Gray Report Market Summary and Highlights: Week of August 18, 2022

Adam Neumann was ousted as CEO of the office-sharing company he founded, but Andreessen Horowitz’s $350 million investment in Neumann’s multifamily-focused venture, the largest first-round investment in Andreessen Horowitz’s history, is a substantial second chance for Neumann. It is not surprising that more investors are entering the apartment investment market, as multiple reports published this week continue to illustrate its resilience and elevated rent growth, but Andreessen’s insistence that the rental market is “soulless” and in need of ground-up transformation ignores the significant progress and already-existing technologies in the multifamily industry that continue to improve the lives of renters and their apartment communities.

Newmark: “Capital Markets Report” – https://www.nmrk.com/insights/market-report/united-states-capital-markets-report

• A really great report. I have been hoping to find a report on the fuller scope of the CRE markets, and this 25-page report is much more than a simple flyby summary.
• Yes, you might not get the same level of detail as a multifamily-focused report, but multifamily does not exist in a vacuum, and a lot of these real estate sectors have a lot of influence on each other, whether that’s through directly attracting investors or through more indirect effects on a market or the economy.
• Now, as far as comparing the investor attention of different types of commercial real estate, multifamily and industrial real estate are clear leaders.
• Page 3 on CRE performance and inflation
  • “Only in the 1991 and 2009 recessions did CRE fail to beat inflation.”
  • The “only” in that sentence is doing a lot of work, but to put it another way, since 1979, there have been 6 years when real estate returns did not beat inflation.
  • Now, the graph here represents the average returns for all commercial real estate, but there’s a 4-year period from 1990 through the end of 1993 where real estate returns did not outpace inflation.
  • Berkadia actually covers similar territory here in a report from earlier this year that we mentioned last week. Those studies actually support Newmark’s take, that CRE as a whole is an inflation-resistant asset class, with multifamily on the more-inflation-resistant side.
  • 1991 though. Four years of sub-inflation returns for CRE. But, as the earlier Berkadia report shows us, those years were consistent stagflationary periods.
• Looking at the allocation over time, it’s interesting to see how industrial investment has not continued to grow at the same rate as multifamily. 
• Page 9 has an interesting list of top markets for each property type. Dallas has the most office and industrial sales. Manhattan is by far the leader in office sales. L.A. is the retail leader.
• Actually, the graph on the previous page (8) is a little more interesting, and it includes the year-over-year difference in addition to the total sales volume for H1 2022. What I’d love to see would be a list of top markets with the highest growth in investment sales. The biggest markets here are several times bigger than many of the other markets in this list, which kindof muddies the waters a little bit.
• Now, among the markets in this graph on page 8, Manhattan is the clear leader in year-over-year investment increase. Does this mean we have recovered? That’s a pretty big increase.
• Manhattan is a little bit of a bounce back given how hard it was hit in the pandemic, but the strong year-over-year increases in Nashville and Charlotte are also worth noting. The DC/VA suburbs, having that as its own market seems like cheating.
• We’ve looked at cap rates and interest rates before, but the environment is always changing, and Newmark provides a very useful update on Page 14 – Essentially their point is that the BAA Corporate Bond Rate is a leading indicator for cap rates, and it has gone up recently, which suggests that we’ll see upward cap rate pressure for CRE assets in the future. I’m not 100% sure that this will play out this way in the multifamily market given the investor competition, but it could.
• Page 17 shows the returns for 2019-2022 sorted by property type. Industrial did very well in the past two years, and multifamily was a solid second, but was nowhere near the returns for industrial assets. The only negative performers, and this was for 2020 specifically, were retail at -7.5% in 2020 and hospitality at -25.6% in 2020.
• Another gauge of potential investment interest: There’s more dry powder. $254B is earmarked for CRE investment, up from $241 in 2021 and up 25% compared to 2019.
  • I wonder, again, how much of this dry powder is waiting for a perfect project that may not emerge. The majority of this money, 62%, is intended for investment in opportunistic or value-add projects, and it may not be the perfect environment to find an ideal project for a lot of this dry powder.

RealPage: “Is U.S. Rent Growth at a Peak?” – https://www.realpage.com/analytics/is-u-s-rent-growth-at-a-peak/

• When there is unusual growth, there has to be a starting and ending point to that growth, otherwise it would just be usual growth. 
• The question “Is rent growth at a peak?” does not have to be a scary one, and anyone who has paid attention to the apartment market this year will know that rent growth is not as high as it was in 2021. So, yeah, it probably has peaked, and rent growth will not be as strong as it used to be.
• The question here, is what are things going to look like coming off of this peak?
• The article does not give a definitive answer other than to suggest that in-place rent growth will likely recede in the coming months after posting 14 straight months of gains.
• The chart that accompanies this report is quite interesting, and while the article is mainly concerned with overall rent growth trends, it serves as a quick primer on the different ways to measure rents and the typical trends associated with these measurements.
  • Let’s start with a common measurement, asking rents. Asking rents are what landlords charge new renters, and this number peaked at around 15% in early 2022 before settling down to around 13.7%. Did you notice that word choice? It’s not falling or sinking, it’s settling down. Like a gentle feather.
  • Next is a similar measurement, given the lengthy-but-accurate name “True New Lease Rent (Trade-Out)” but commonly referred to as new lease trade-outs. While asking rents measure the price a new renter would pay this year against the price a new renter would have paid last year for the same unit, new lease trade out compares the new renter price against the price that the previous renter was paying. 
    • Because the rent growth for renewals lags behind asking rents, you’re going to see bigger swings in new lease trade outs, and this chart bears this fact out perfectly.
    • Before the pandemic, new lease trade outs almost perfectly follow seasonal trends, increasing in the Spring and Summer, and decreasing in the Fall and Winter like a reliable sine wave with a peak around June and a trough around December of each year.
    • At the start of the pandemic, new lease trade outs were the first to trend downwards for those initial months, and it was the first to climb upwards in late 2020/early 2021. One thing that I thought was really interesting is that even though you’d think that the rent growth of 2021 flattened out the peaks and troughs of seasonal patterns in favor of a strong upward slope, you can still find traces of a seasonal wave. There is still a low point in December of 2020 at -3%, but then, instead of going up 3% or 4% to the seasonal peak, new lease trade outs went up 21%. That’s 21% in 6 months. Oh, but then, we actually do see that same, typical 3% dip heading into December 2021, then there was a 3% rise until June of this year, and now its heading down again. 21% change in 6 months for the national average. New lease trade outs really amplify the swings in rent growth.
  • The next measurement has less exciting swings but has a little more potential. They call it “True Renewal Rent (Trade-Out),” which I’ll shorten to just “renewals” here. This is the difference between what a renter is paying now and what that same renter paid last year for the same unit. Basically, if you’re a renter and you’re renewing your lease, how much is your rent going up? That is what renewals measure.
    • Renewals are as steady and stable as new lease trade-outs were wavy. Additionally, the trends for renewals shift at a later period than other measurements. Is this what is meant by a lagging indicator? For example, the reactive new lease trade-out measurement was the first to dip down at the start of the pandemic, then asking rents dipped down about a month later, and then renewals dipped down a couple months after that.
    • My suggestion here is that renewals could have a few more months until they reach a peak, and given the resistance of this measurement to big swings, renewals could remain elevated for longer and will likely surpass the growth rate of new lease trade outs and asking rents as the year progresses.
  • The next measurement is “In-Place Rent,” which is the average of asking rent and renewals. In-place rents show some seasonality but are a little more stable than new lease trade-outs. 
    • I’m a little more confused about this figure, to be completely honest, but I’m going to trust RealPage that they’ve measured in-place rents as an effective average. Either way, this is the rent that RealPage suggests has peaked.
    • In-place rents do not move as predictably as new lease trade-outs, renewals, and asking rents. This in-place average was the last to dip down at the start of the pandemic and the last to rise again, but its peaks and troughs are much steeper than renewals. 
    • I’m getting further into the weeds than I should, I am a little confused about the typical trends for in-place rents pre-pandemic. Renewals shows a stable but like, minimally squiggly line. These squiggles are miniscule. Same thing for asking rents. But then, average these two minimally squiggly, mostly stable lines, and you get a far more herky-jerky line for in-place rents. I think I am misunderstanding how they’re calculating in-place rents.
  • Finally, there’s the least volatile and likely slowest-to-react measurement in this RealPage chart, which is CPI Rent of Primary Residence. It’s by far the most stable measurement in the chart here. 
    • Every other metric dipped into the negatives briefly in late 2020 or early 2021, but CPI Rents gradually drifted down from 3% to 1.5%.
    • From that 1.5% low point, CPI is now at 5.8% and is projected to climb even higher. 
    • As we have said in earlier episodes of The Gray Report, rents are driving inflation, and they will drive inflation even more in the coming months.
• The question about peak rent growth is relevant and important, but the information here on trends in different rent measurements is just as engaging for me.

MSCI: “How US Real Estate Purchases Changed During the Pandemic” – https://www.msci.com/www/quick-take/how-us-real-estate-purchases/03335631862

• A couple of charts from MSCI looking at real estate performance in 2020 and 2021 show how office investment declined and how suburban assets took off during the pandemic.
• While most investors tended to invest in more industrial and multifamily assets, “Real estate investment trusts (REITs), notably, recorded a greater share of office — and lower share of industrial and apartments/residential — purchases in 2020-2021 compared to 2019. The share of retail purchases also increased slightly for closed-end funds.”
• “Purchase activity also shifted away from larger coastal gateway markets toward secondary and even tertiary markets. In 2019, purchases in Boston, Chicago, Los Angeles, New York, San Francisco and Washington, DC, accounted for 24.3% of total volume, but this declined to 19.7% in 2020-2021.”
• This is more of a confirmation of trends that we saw developing throughout last year and the year before, but it’s nice to have the additional supporting evidence here.
• And for the trends toward greater investment in the suburbs, the rising mobility associated with the pandemic and working from home, that mobility may not be reversing course.

Redfin: “Housing Migration Trends: Record Number of Homebuyers Want to Relocate” – https://www.redfin.com/news/july-2022-housing-migration-trends/

• Mobility, or at least an interest in mobility, is at record levels.
• This is a very interesting trend, and the story isn’t really finished here.
• Right now, 33.7% of homebuyers are interested in relocating. The pre-pandemic number was 26.3%.
• When the pandemic started, people’s imaginations moved much faster than people were actually moving. There were a lot of predictions of remote work unlocking a whole new fluid state of being, transcending the workplace, a kind of work-from-home nirvana unshackled from the home office. For the most part, that really didn’t happen. There was some movement out of bigger cities like New York, but more people ended up moving to a nearby suburb than to a completely different city.
• Now, on the other side of the pandemic, having been underwhelmed by the initial weaker migration trends, I’m a little surprised to see a steady increase in homebuyers interested in relocating.
• Instead of remote working itself, this uptick has got to be linked to a much more positive job market. We’ve seen reports in the past that show how higher income individuals are far more likely and able to relocate compared to lower incomes, and if a strong job market is raising incomes, then you could see more people seriously considering the possibility of relocating and buying a home somewhere else.

Adreessen Horowitz: “Investing in [Adam Neumann’s] Flow” – https://a16z.com/2022/08/15/investing-in-flow/

• Before we get into this story, I want to be sure that we’re approaching this as dispassionately as possible. When I comment on Adam Neumann’s new business venture, I want to avoid the idea that, just since we already have a presence in the multifamily industry, we are not discouraging young entrepreneurs who want to build a new business and career in the space. It would certainly seem like “punching down” to try to undercut a humble new company in the multifamily industry, and, I don’t know, maybe I feel a little like a parent here. I want to care for these newborn businesses. I want to hold this—it’s Adam Neumann, right?—I want to hold this Mr. Neumann’s hand as he takes his unsteady first steps into the apartment market.
• WeWork was a previous company that Adam Neumann founded and was later ousted from a little more than 3 years ago for inappropriate behavior and irresponsible business practices. For a quick-and-dirty snapshot, here’s a wonderful paragraph that comes at the end of Adam Neumann’s Wikipedia entry: 
  • “The Wall Street Journal reported in 2019 that Neumann had aspirations to live forever, become the world’s first trillionaire, expand WeWork to the planet Mars, become Israel’s prime minister, and become “president of the world”.[54] A September 2019 Vanity Fair article reported that Neumann made claims that he convinced Rahm Emanuel to run for the presidency of the United States, used JPMorgan Chase’s CEO Jamie Dimon as his personal banker, convinced Saudi prince Mohammed bin Salman to improve the standing of women in Saudi Arabia, and claimed to be working with Jared Kushner on the Trump administration’s peace plan for the Israeli–Palestinian conflict.”
• Needless to say, these lofty dreams had very little basis in reality, but who’s to say that Neumann’s next dream won’t be realized? Certainly not Andreessen Horowitz, which has invested $350 in its biggest-ever first round of funding.
• Adam Neumann is going to disrupt housing. Not in the horrible way that he disrupted the lives and livelihoods of the people working at WeWork. I’m assuming it’s a better way than that.
• The Andreessen Horowitz blog explains the current playing field as it stands for housing by laying out two models: 
  • You’re buying a house with a decades-long mortgage and “then, you’re now stuck—you can’t move, even if your economic opportunity or life path wants to take you somewhere else.” I seriously, seriously think this underestimates homebuyer mobility, but moving on to model two:
  • “[Y]ou rent an apartment, but: it’s a soulless experience; do you even meet your neighbors? . . . Does it feel like home? . . . Are you proud to bring friends and family to visit?” Apartment renters, aren’t you grateful and excited? Flow is going to solve all those problems that Marc Andreessen just told you that you have!
• There’s not much in this blog post to explain how this is going to be done outside of vague statements about changing everything from the ground up. Here’s a paragraph that I think gets the closest, and I am going to hazard a guess on what it could mean:
  • “Doing this requires combining community-driven, experience-centric service with the latest technology in a way that has never been done before to create a system where renters receive the benefits of owners. This means rethinking the entire value chain, from the way buildings are purchased and owned to the way residents interact with their buildings to the way value is distributed among stakeholders. And given the fragmented nature of the ecosystem today, we can only hope to accomplish any of this by bringing every aspect of the living experience together.”
  • I bet there’s some NFT or cryptocoin, or blockchain involved in this. 
  • In May of this year, Neumann received 70 million dollars from Andreessen Horowitz for a separate project called Flowcarbon, which is, as far as I can tell from Neumann’s descriptions, a cryptocoin connected to carbon credits, or as Neumann himself says, “[o]n-chain carbon credits represent an innovative primitive that can be integrated into the existing DeFi ecosystem”
• Flowcarbon the crypto venture, and now Flow? The articles I’ve read say that these two ventures remain distinct, but come on. It’s totally crypto.
• You’re going to earn some kind of NFT or token or cryptocoin by paying rent. Maybe you’ll earn more if you’re a good neighbor and invite your parents to your apartment and do all of those things that Marc Andreessen was saying that renters can’t do. I’ll be really interested in watching this one. I think it’s too much to hope for a metaverse component, right?