INSIDER FEATURED ARTICLE
America's red-hot housing market is about to kickstart the Great Commercial Building Boom
By
Neil Dutta
Let us know what you think about receiving full articles in your inbox by filling out this short six-question survey.
America's housing market has gone haywire over the past two years. Home prices shot up in major and secondary metro areas, rents in many cities skyrocketed, and tens of thousands of Americans went to wild lengths —forgoing due diligence, buying homes sight unseen, even begging sellers with personal notes — to secure a roof over their head.
At the same time, the rest of the real-estate market has been ice-cold. With the pandemic keeping people out of the office, commercial-real-estate construction collapsed. This slowdown in CRE building, formally called nonresidential structures investment, even showed up in the highest-level macroeconomic data. Since the first quarter of 2020, this type structures investment has cut US GDP growth by an average of 0.4 percentage points per quarter — a sizable drag.
But there's good reason to think the bad news for commercial real estate is behind us. The housing-market boom of 2021 is about to lead to a great American commercial-building boom as more shopping centers, doctor's offices, and supply stores go up across the country — providing a big boost for the US economy.
As booms Wichita, so booms the Wichita shopping center
The collapse in commercial-real-estate building in 2020 wasn't much of a surprise; at the start of the pandemic, nearly every sector collapsed. But while residential real estate and plenty of other industries have bounced back, CRE has not. Even as other types of business investment, such as equipment purchases and intellectual-property investments, have come back to prepandemic levels, structures investment remains stubbornly low.
This sluggish CRE rebound may seem confusing given the strength of the overall economy, but the gears of construction for things like shopping centers and dentist's offices are typically slower than for homes and apartments. CRE investments generally demand a higher proportion of borrowed funds than other types of investment, so banks have to get more comfortable with the economic conditions before extending these large loans that often come with a small down payment. But despite these headwinds, there are a few reasons to think a commercial construction boom is on the horizon.
On a technical level, commercial real estate has the chance to bounce back in a big way because it never really took off before the pandemic. Structures investment represented about 3% of GDP after the 2008 financial crisis, broadly in line with long-term averages. But it didn't have the renaissance that other industries have enjoyed, even before the huge bust of the pandemic. And now structures investment relative to GDP has rarely been lower over the past three decades. Eventually this long-pent-up need for more commercial buildings is going to reach a tipping point and lead to a massive boom in construction to make up for lost time. And the tipping point is likely to come this year.
The most promising case for a CRE boom is easy to see: Just look at how many new homes are being built around your neighborhood. CRE construction tends to follow residential building — the growth of new residential communities prompts the building of new commercial enterprises. Household formations, a technical term for the creation of new families or people moving in together, have picked up, and new-home sales have jumped during the pandemic, particularly in the South. These new households will require new businesses: grocery stores, clothing retailers, barbershops, and beauty salons. Much of the housing shakeup has been driven by the rise of remote work, which means the types of commercial buildings that go up will be slightly different — fewer office buildings and more open-air shopping centers with a supermarket as an anchor tenant.
As cities, suburbs, and towns grow, they will need the infrastructure to support expanding populations: power plants to light the new residents' homes, local factories to produce goods nearer to these new hubs, and hospitals for when people inevitably get sick.
As more people and more businesses move in, the necessary commercial-real-estate construction will help boost local economies and, more broadly, our national GDP. This has important labor-market implications: Construction workers for commercial building make an average of $6 more per hour than their counterparts in residential construction.
We're already seeing the first signs of the coming CRE boom. One is that the American Institute of Architects' Architecture Billings Index, which measures nonresidential construction activity, has been expanding for the past 11 months. The index has a lead time of roughly three to four quarters, which means construction usually starts to surge about a year after the index moves into expansion. If that correlation holds, we should see a serious pickup in commercial real estate in no time.
Another sign is the explosion in architectural and engineering employment over the pandemic. While the number of employed workers in the US is still millions below its prepandemic peak, architectural and engineering jobs are up nearly 5% compared with December 2019 levels.
Even the Fed can't rain on this parade
While all the ingredients for a CRE boom are in place, some problems could spoil the broth. For one, costs have surged. According to the
Federal Reserve
, commercial-property prices are up roughly 13% from last year. Second, the Fed has hinted at interest-rate hikes; higher interest payments on loans needed to build a commercial property eat into its expected annual income, making building less attractive. So given the higher up-front cost of land and the higher long-term cost of interest, could the commercial-building boom turn out to be a bust? Probably not.
For starters, rising rates are due at least in part to the improving economy. Soaring economic growth is good for real estate, since tenants will generate higher sales and therefore be able to pay more rent. But importantly, the profit an investor can make by building and owning a commercial development is still higher than what the same investor could earn on safer types of investments, most notably US Treasuries. So for those investors looking to grab higher yields, these sorts of CRE properties still make a lot of sense.
Commercial developments typically take several years to complete. Since conditions can fluctuate over an economic expansion, CRE construction tends to lag behind the
business cycle
. Early in the cycle, developers want to be sure the recovery is entrenched before breaking ground on new projects. While the current growth cycle has been short, we are much further along the path back to "normal" than in previous recoveries, so developers may decide to go ahead with a project even if there is a jump in interest rates or a stumble for the economy later in the year.
Lastly, there is one area of structures investment that is poised to boom but does not exactly qualify as a traditional form of commercial real estate: mining structures such as oil wells and rigs. This sector accounts for roughly 16% of total nonresidential investment, compared with 14% for office buildings. The drilling of new mining wells is highly sensitive to crude-oil prices, so with the recent surge in energy prices, a sharp pickup in mining structures will not be far behind. Indeed, the number of American oil and gas rigs in operation has recently accelerated.
The nearly two-year slog for commercial real estate is coming to an end, and stronger structures investment is on the way in 2022. Between healthy growth in billings and the engineering hiring boom, we have all the evidence we need to expect nonresidential construction to take off. That's great news for the cities and towns where these buildings will begin to rise, and great news for America's economy as a whole.
|
Suggested reads
- Top 4 ways of generating income online without any initial money down: A 32-year-old whose company generated $1.7 million in sales last year shares the methods he uses.
- I’m part of the Lost Generation of millennials. Here’s why Gen Z is having a way better start to their adult lives — and may even live longer.
- 'The firm': Royal org chart shows 1,133 people who work for the Queen.
|
|
