As 2022 begins, we thought it would be helpful to provide our perspective on current investment conditions along with a forecast for the rest of the year. Hopefully this will provide useful context as you consider specific near-term investment opportunities from us and others.
The bottom line is that we expect it will be challenging to find “easy” investment opportunities in 2022 because of substantial countervailing forces buffeting the economy as a whole and our industry in particular. (Of course it is never easy, but we think 2022 will be even harder than usual.) While we still intend to deliver solid investment prospects, proforma returns are likely to be at the low end of our target range and anchored more by long-term belief in the specific property rather than dramatic mis-pricing or an obvious short-term return catalyst. This won’t be unique to our industry though — all investing will probably be harder in 2022!
This is because two broad dynamics that have unduly influenced the recent investment environment are likely to change this year. First, the excessive money creation by the Federal Reserve should end. Second, Covid-19 should change from a pandemic that dramatically disrupts our society and economy to an endemic disease that allows daily life to get back to “mostly” normal.
The end of excessive money creation
Since the Great Financial Crisis of 2007-2008, the Federal Reserve (along with many other central banks around the world) has engaged in aggressive quantitative easing at a level that is unprecedented in modern times. During this period, the Fed purchased approximately $8 trillion of securities (primarily treasury securities but also mortgage-backed securities), which nearly tripled the number of US dollars held in cash, checking accounts and short-term deposits and eliminated a bona-fide free market in long-term low-risk debt instruments. While this process was occurring before the Covid-19 pandemic began, it dramatically accelerated thereafter and has continued to this date with the Fed STILL purchasing $60 billion dollars of securities a month (although this should end soon). Meanwhile, trillions of additional dollars of fiscal stimulus were injected into the economy by the several pandemic relief laws passed during the Trump and Biden administrations.
This excessive money creation has led to dramatic asset price inflation for many years (see the stock market) and recent inflation in goods and services, with the consumer price index from December '21 (the most recent data available at time of writing) reflecting a 40-year high of 7.0% per annum. Apartment rent growth in many markets exceeded 10% last year and current capitalization (or “cap”) rates that determine apartment prices are lower than they have ever been. (The lower the cap rate applied to property income, the higher the price)
Policy makers finally seem to be acknowledging that printing this much money is unsustainable and are now openly discussing a rapid reversal, ending asset purchases and raising short-term interest rates. But with trillions of dollars of cash “sitting on the sidelines” it is likely to take years to undo what took a decade to create. Private real estate prices in particular tend to be sticky.
We expect to see the following conditions continue in 2022 as a result of the excessive money supply:
Strong rent growth
Higher interest rates (both short and long term)
Low cap rates.
In theory, higher interest rates should cause cap rates to increase and prices to decline (or at least plateau). As the “risk free” rate increases, investors should seek a higher premium for riskier investments like real estate. And we do expect a gradual cap rate increase over time. In 2022, however, we think that the weight of money looking to invest in apartments will be the dominant factor and that prices will stay high even with higher borrowing costs. For a leveraged investor like Glencrest, this means that equity returns will be lower, all else being equal.
At the same time that excessive money creation comes to an end, Covid-19 should move from a pandemic to endemic state later this year. While the virus has proven to be unpredictable and there are no guarantees, we share the view of experts like Dr. Christopher Woods of Duke University who recently said “I do feel that we are moving into a transition phase in the pandemic . . . with a major move to endemicity”. In our country and around the world, more people have achieved some level of immunity through vaccination, infection (especially with the transmissible Omicron variant) or both. Meanwhile there is (i) better understanding of how the virus works and therapeutic options for people who get sick from it, and (ii) less tolerance amongst the general population for lockdowns and highly restrictive containment measures due to psychological fatigue.
Covid-19 endemicity should allow businesses to recover, people to move around, schools to be open consistently, fewer government restrictions, etc. All of this should be good for the apartment industry, with more households being formed and strong housing demand. But all this positive activity could also stoke the already raging inflation fires and keep asset prices high . . .
Why it makes sense to keep investing in apartments
Despite the change and uncertainty that will be driven by the evolution of monetary policy and the Covid-19 pandemic in 2022, we think it makes sense to continue investing some portion of one’s investment dollars in well-located quality multifamily communities. Sitting in cash is certain to deliver a negative return if inflation persists, and many other investment alternatives feel risky right now due to the forces described above. Housing remains a fundamental need that is less susceptible to technological disruption than many other areas of the economy and apartments offer attractive income tax attributes plus a strong inflation hedge as rents are generally reset every year.
We will work hard in 2022 to find multifamily investment opportunities that offer superior relative returns, acceptable absolute returns and appropriate risk mitigation. While we expect to succeed, we do think this will be a year of more modest opportunities (in all investing areas) and ask that you set your expectations accordingly.
If you have any comments or questions about these thoughts, please feel free to reach out.