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IN THE NEWS

🚧 The Apartment Market Hits a Construction Lull

In popular areas like Miami, Austin, Charlotte, Phoenix, and Nashville, a glance at downtown includes cranes — so many cranes. In some cities, there’s construction for new apartment buildings happening everywhere.

But those are outliers. The national trend suggests otherwise.

• The number of new apartments starting development is falling off a cliff. The cause is — ding, ding, ding! — higher interest rates. Declining rents and overbuilding have also driven the freeze.
• Apartment building “starts” fell to a rate of 334,000 units in August, a 41% decline from the pace in 2022. It’s one of the largest declines since the subprime housing crisis between 2007 and 2010 that contributed to the Global Financial Crisis.
• “We expect to see about two years of greatly reduced building,” said one real estate executive.

Sometimes, markets are all about momentum. We just had record apartment construction in the U.S., with more rental buildings opening this year and next than at any time since the 1980s. But that growth in rental supply has driven vacancies and caused rent growth to decelerate.

• In many areas, there are simply too many buildings already under construction. It’s time for a cooldown.

Also at play: Construction financing costs have jumped over the past year, and banks are lending less often. When they do lend, the rates are much higher. A new construction loan’s 4% going rate has become 8%, making apartment projects less economical.

Why it matters:

The big picture: The apartment construction slowdown comes as the housing market screeches to a halt, commercial real estate is facing all kinds of headwinds, and office buildings aren’t exactly in vogue (more on that below).

Builders also cite materials costs and rising expenses, including wages and surging insurance costs, as reasons for not launching new projects.

• Multifamily buildings have also experienced drawdowns. And, after years of rent increases, prices have stabilized in many areas not named New York City.
• “Everybody’s leery that if I build today, do I get enough rent inflation between now and when I finish it?” added another real estate exec.

Looking forward: We talk about the impact of interest rates on markets all the time, and here we go again: The future of apartment buildings hinges on what happens with rates.

Should they stay high, developers and lenders likely will remain cautious on new projects. But they might feel comfortable enough to move forward if rates come down.

• There is at least one trend working in favor of apartment builders: The high price for homes, which has driven demand toward rentals.

Read more

🏢 Investor Survey Warns About Crash in Office Properties

Few real estate investors want to bet big on old-school malls anymore. The same could probably be said for traditional office buildings.

Public opinion: A Bloomberg survey found that two-thirds of respondents anticipate a downturn in office prices, with the lowest point coming late next year.

• About 25% of commercial properties are office spaces. Refinancing will be tough sledding as prices have dropped 16% since their peak in March 2022, putting some borrowers underwater on their loans.

Not for sale: The Federal Reserve’s tightening measures adversely affect commercial property values by increasing one big ownership cost: financing expenses.

• Still, lenders attempting to pawn off their loans on troubled office properties are struggling. There’s a scarcity of investors who want exposure to office properties.

Troubles with regional banks haven’t helped, either. About 30% of office building debt belonged to these small banks in 2022, according to a March report from Goldman Sachs Group Inc.

But many regional banks got whacked by a banking panic earlier this year (involving Silicon Valley Bank and First Republic, to be specific.)

• That drama fueled a nearly 2% withdrawal of funds from regional banks nationwide, leaving them with less funding to support lending, especially in the troubled office space market.

Why it matters:

Rising interest rates’ impact on the $11 trillion U.S. commercial real estate market might be delayed.

Why? Because office building investors usually have long-term fixed-rate financing and extended tenant leases.

• Leases established now won’t adapt to decreased revenue expectations until 2027. If the present trajectory continues, revenues could be around 10% less than current levels by that time.
• Said one real estate investor, “It tends to be a slow reckoning for U.S. real estate when rates change. And the office sector is deeply distressed, which will take a long time to work out.”

Read more

👨‍💼 Financial Advisors Fight Against Irrelevance

“Financial advisers are in something of an existential crisis” — bold words from Bloomberg.

After interest rates’ dramatic rise through 2022 and 2023, it’s not uncommon for savers to earn near-5% returns with certificates of deposit and high-yield savings accounts.

• And with free money advice abound on social media, the stodgy business of financial advisory, with its customary 1% fee annually as a fraction of folks’ investments, has lost its broad appeal.

Young vs. old: While roughly one-third of U.S. investors rely on a financial planner, one industry veteran commented, “Gen Z clients see (financial advisory)…very different than their parents did.”

• For Americans with over $1 million in investable assets, the percentage using advisors jumps to 70%, according to Northwestern Mutual.
• But financial advisors aren’t a young bunch; nearly half of advisors with the Certified Financial Planner designation are 50 or older.

Bloomberg reports that advisers find it increasingly difficult to pitch their value to potential clients when returns on cash are so solid — why pay substantial fees for fancy investment products when basic savings accounts get the job done ‘good enough’ these days?

Why it matters:

While financial planners often help people navigate big life events, from the birth of a child to big stock-options payouts and retirement, low-cost robo-advisors are helping many with basic goals and long-term planning.

• Plus, many 401(k)s offer target-date funds, which automatically adjust their investment strategy and become more conservative as an investor nears retirement age.

Uncertain future: Of course, the need for financial help becomes more apparent later in life when assistance should be more personalized to remain relevant.

• Still, high returns on basic savings and AI’s growing role in robo-advisory are putting the industry on notice — to what extent Americans still value human relationships in financial advisory is something both savers and advisors alike are assessing.

Read more

See you next time!

That’s it for today on We Study Markets!

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