What Fed rate hikes mean for the real estate and rental markets

Marcus & Millichap CEO Hessam Nadji joins Yahoo Finance Live to talk about the outlook on the real estate market, housing sales growth, anticipating the Fed’s interest rate hikes for renting and homebuying, and the most sought after real estate markets.

Video Transcript

EMILY MCCORMICK: As the broader market continues to languish in the red this afternoon, let’s get a check of real estate stocks. This morning, existing home sales came in much higher than expected, in fact, reaching the highest level in a year at a seasonally adjusted annualized rate of $6 and 1/2 million. That was good for a 6.7% month over month increase. Now on the heels of that, the S&P 500 real estate sector, as you can see on the screen, is still lower on the day, but also off session lows and also outperforming the broader S&P 500.

Now for the year-to-date, however, the sector is still the worst performer after communication services, with prospects of higher interest rates weighing on many real estate stocks. But taking a look at two homebuilders specifically, we are seeing shares of KB Home, as well as Toll Brothers, coming well off session lows. Toll Brothers shares have actually now turned positive. So one part of the market that we’re continuing to watch closely is that real estate sector.

RACHELLE AKUFFO: Well, lots of data there. We know that existing home sales jumped 6.7% in January to a seasonally adjusted annual rate of $6.5 million. Now this also comes amid record low inventory, with homes often getting snatched up in a day or two, and leaving less affluent buyers out in the cold. Well, to break down what’s happening with the housing market, let’s welcome Hessam Nadji, Marcus & Millichap CEO. Thank you for joining me.

HESSAM NADJI: Thanks for having me on the program.

RACHELLE AKUFFO: So I want to first start by getting your reaction to some of this data. Obviously, looking at this 6.7% surge in existing home sales. Median existing home price is up 15.4% on the year to $350,000. In this competitive market, though, what opportunities do you see?

HESSAM NADJI: Well, first of all, the number is not surprising, given the trends that we’ve seen over the last year, in that the housing market has had a supply shortage. Unlike the 2008, 2009 crisis, where overspeculation had actually created a vast majority of the credit problems that led to that downturn and a recession, real estate on this side of the cycle has actually been a contributor. And there’s been no oversupply in housing or in commercial real estate.

And of course, the effect of the pandemic has created so much demand for people to work from home, expand their living spaces, and so on. We’re seeing the same phenomenon carry out in apartment rentals, which are also registering record demand and rent growth.

So where does it go from here? We do have some concerns in that affordability is becoming an issue. Less and less people will be able to afford the 15 and 1/2%, 16% price increase that you just mentioned on a year over year basis. On top of that, as interest rates go up, of course, that affordability becomes even more acute.

But the supply side of the equation is still constrained by the supply chain issues, labor costs, and so on. So, again, supply-demand is going to be fairly balanced. We don’t expect prices to continue increasing for the for-sale market at the same rate they have been, so some cooling off of prices. But nonetheless, the market is fairly stable.

On the commercial real estate side of the equation, because of low interest rates and the fact that commercial real estate as an investment vehicle has always been viewed strongly as an inflation hedge, we continue to see record demand from investors wanting to invest in apartments, office buildings even, shopping centers, and in self-storage assets, every category of commercial real estate.

RACHELLE AKUFFO: So then as we talk about the Fed here, you said that a significant rapid increase in interest rates by the Fed could weigh on commercial real estate investment. What sectors are the most exposed? And how are you advising your clients to really brace for potentially four to seven rate hikes this year?

HESSAM NADJI: Well, first and foremost, you have to remember, the 10-year Treasury yield has already ran up quite a bit this year, and the market has adjusted fairly well. Lender spreads have come in, and what’s really important for commercial real estate investments and valuations is the pace by which interest rate increases are met with rent growth increases. If the income and occupancy of these assets are healthy and growing at, at least the same pace, if not faster, than the rate of increases in interest rates or the cost of debt, valuations are well supported.

So far, that’s what we’re seeing. The biggest risk is if the Fed goes too far too fast or has to react even more aggressively than anticipated to basically fight inflation. And I think we need some time to see if that’s going to be necessary or not. Let’s not forget that we’re coming off of a significant recovery in jobs last year. Now the pace of job growth is slowing. Therefore wage growth should probably begin to crest a bit. And the supply chain at some point is going to start easing again. So it’s not a foregone conclusion that the Fed will have to really overplay its hand.

RACHELLE AKUFFO: Now I want to talk more about commercial real estate and, really, the record breaking amount of investment, we saw last year. Investors bought more commercial real estate in 2021 than ever before and a record $335 billion just into apartments across the United States last year. But then you also have renters who want to become first-time buyers because the rents are increasing and a lot of leases are coming to an end. So what is your outlook for the apartment market in 2022? And what are some of the headwinds that you’re watching for?

HESSAM NADJI: The outlook for apartments is quite robust because as I mentioned earlier, the for-sale housing affordability issue is going to become more of a problem. If you look at some of the metros like Austin or Salt Lake City, Phoenix, Los Angeles even, San Jose, the Inland Empire here in Southern California, they’ve registered price increases of this 19%, 18% to 28% on a year over year basis. A lot of consumers are going to get priced out of the for-sale housing market and will have to continue renting.

And a lot of consumers, we’ve seen over the last five years, pre-pandemic, really were choosing to be renters, to have the flexibility and the lifestyle that they’ve enjoyed as renters. And the apartment development community has responded by building product that the 30 somethings, 40 somethings, couples without children or empty nesters really want to rent. Those trends have captured more renters than ever before. And for those reasons, the outlook for apartments is quite robust for 2022 and really– and beyond.

RACHELLE AKUFFO: And speaking of trends, we’re seeing obviously Omicron-related COVID rates continuing to fall in the US. We’re seeing a return to either in-person work or some sort of hybrid work from home, in-person model. What are you watching for in the office market? And what are you seeing with the best and worst performing markets for vacancies?

HESSAM NADJI: The office market still has a lot of cloud over it, especially in urban America, where the vacancy rates are still very high. And of course, the pandemic affected urban markets much more severely than suburban markets. And the outmigration that we’ve seen was happening even before the pandemic. The millennials that were really fueling the demand for urban housing and professional service jobs, office jobs, were beginning to enter their 30s, forming families. 60% of them are now in their 30s. And they were already moving to the suburbs before the pandemic, and the pandemic, of course, accelerated that trend.

So the office outlook is somewhat mixed in that you still have leases on average in place where the tenant has to pay the rent for another four years. So we have plenty of time for there to be a recovery in demand. But public transportation, getting people comfortable to come back into the office is going to take some time. We believe it’ll happen over time, but the hybrid solution, workplace solution is here to stay. We’re experiencing it. Every one of our clients, in some ways, is experiencing it. So it will reduce office space demand.

But let’s not forget that places like New York, Los Angeles, where the leading job creators in the last 12 months– 300,000 jobs in LA, 200 plus thousand jobs in New York. Dallas was the third largest job creator. So the urban markets are beginning to come back. And I think business formations that we’re seeing at record levels will eventually bring new demand to the office market. But it’s going to be a bit of a transition. And we’re seeing a lot of opportunistic investors take advantage of office right now being the diamond in the rough.

RACHELLE AKUFFO: We’ll certainly have to keep an eye on that. We’ll have to leave it there. Thank you so much. Hessam Nadji there, Marcus & Millichap CEO, thank you so much.

BRAD SMITH: Just minutes–