By Jim Fraser
When we talk about commercial real estate, people outside of the industry usually think of buildings used for visible business purposes. They picture corporate campuses and other office spaces, retail stores, restaurants, and hotels. However, those spaces leave out another big segment in the broader CRE category: housing. Consider apartment buildings, subdivision development, rehabbing and repurposing existing buildings for multifamily occupancy, and so forth—each of these forms of housing reside under the umbrella of CRE.
It’s also currently the rising tide for CRE activity overall. Other segments of CRE—office space, hospitality, retail—have been significantly affected by the COVID-19 pandemic. Those sectors may continue to lag even as conditions improve. Housing, on the other hand, is white-hot and plays a key role in CRE development and lending, as well as geographic trends in the market.
We see this when we look at recent transaction data on the Built platform. The top markets aren’t anchored by bellwether cities like New York, Chicago, or Los Angeles. The top five states right now in terms of CRE construction and lending, based on our transaction data, are North Carolina, Florida, Texas, South Carolina and Tennessee. Housing markets in these and other states are booming, and this is a big driver of CRE construction and financing right now. The overall increase is beneficial to the market as a whole because, again, other mainstays of the CRE industry may take a longer time to recover from the negative effects of the pandemic.
There’s a confluence of significant trends that help put this market in context, and they all come back to housing. The first is relatively straightforward: we remain in a long-term period of historically low interest rates. This lull continues to create favorable borrowing conditions for developers, builders and homebuyers alike, which does not appear likely to change in the foreseeable future. The second trend is a more recent change, the paradigm shift to remote and hybrid workplaces, along with other pandemic-related factors, is powering significant changes in how and where people decide to live. Many people are now no longer tied to a particular location because of their job. As a result, they’re basing their choice of where to live on other factors, including cost of living, weather, family proximity, available space and other variables.
More than seven million households moved counties in 2020, according to a recent report in The Wall Street Journal. While some migration occurs every year, this was roughly 500,000 more households than in 2019.This shift in particular helps explain why the hottest real estate markets, based on CRE transaction activity, may surprise some people. It bears out in data from other sources, too. Tennessee ranked first on U-Haul’s 2020 in-migration growth report, which the company calculates based on the net difference between one-way truck rentals into and out of a state. Texas, Florida, Ohio and Arizona rounded out the top five inbound markets. Full-service moving companies like Atlas Van Lines reveal similar patterns, with states like North Carolina, Tennessee, and Texas all showing greater inbound traffic, while states like Illinois, New York, and California had more outbound shipments. Migration patterns can be positively correlated with the pandemic and shift to remote work for many households; that helps to explain many of the geographic trends.
The third trend, coming off the tailwinds of very low interest rates, helps explain why housing is the major driver of CRE activity right now: There is simply an insufficient supply of housing stock in the U.S.
After the market bottomed out after the 2008 financial crisis, new housing construction never returned to its previous levels. From 2010 through 2020, you can reasonably estimate that developers were building roughly 500,000 fewer housing units (including apartments) per year compared to historical levels. Over that decade, we built around 5 million fewer places to live than the market would bear. Housing demand is far outpacing housing supply.
These overlapping factors explain why housing, not office or retail, is the top driver of CRE lending at the moment, whereas the debt market for new hotels and office space remains relatively subdued, residential lending never really slowed down during the pandemic. Rather, it continues to rise, fueled by that trio of trends. We’re now in a market where developers are actively evaluating use changes to existing hospitality and office space and repurposing them as multifamily residential buildings.
We may see other niches in the overall pick up faster than other CRE segments, too. These include areas like last-mile logistics, which includes the development of small warehouses and small storage space for e-commerce supply chains in more rural areas, for example. The infrastructure market for 5G network rollouts, such as data centers, co-location facilities, cell towers, and so forth, poised for growth. And, we will hopefully see steady (but bumpy) recovery in areas like hospitality, too.
But for now, the data point very clearly to one driver: housing, housing, housing.
Jim Fraser is director of commercial real estate strategy at Built, a Nashville-based company that ABA endorses for its construction loan management software.