The General Economy
Despite hiccups caused by the Omicron variant of COVID-19, the fourth quarter of 2021 saw healthy economic expansion. Fannie Mae placed annualized Gross Domestic Product (GDP) growth at 6.9 percent for the quarter, more than triple the rate of the Delta-plagued previous three months. Consumer holiday spirit was evident and stores brought inventory “forward” to support early sales and shopping. Personal Consumption Expenditures (PCE) were estimated to have grown at an annualized rate of 5.9 percent. Business investment recovered as companies made some headway in unsnarling supply chains and building inventories. Accordingly, the labor market remained tight; unemployment shrank to 3.9 percent by year end and average hourly wage growth stayed high.
The downside of straining production and sustained demand was inflation. The Producer Price (PPI) and Consumer Price (CPI) indices for the last 12 months, at 9.7 percent and 7.0 percent, respectively, were the highest figures seen in years. Some economists noted that consumption-driven price increases are a good problem to have, but that didn’t take away the sting at the gas pump. For most of the past year, car and fuel prices, along with grocery bills, drove CPI increases.
Shelter, however, remains the largest single factor in the calculation of inflation. This term comprises both rents and “Owner Equivalent Rent” (OER) to determine home price appreciation. The OER answers the question, “If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?” Due to the way it is measured, the impact of the cost of shelter lags other factors. Rents were flat or depressed earlier in the pandemic, and this fact has been reflected in CPI numbers until recently. But rents in many markets rose later in 2021 and home prices kept climbing. Thus, the specter of inflation looks like it is going to hang around for a while.
The Real Estate Sector
The housing market’s activity was a pleasant surprise last quarter. While many thought that relentless rising home prices and creeping interest rates would moderate market interest, demand remained strong. Headline-grabbing talk of inflation and anticipated future rate hikes shifted some of 2022’s activity to the fourth quarter of 2021. Omicron’s emergence also reinforced the desire for more living space, as people realized they would not return to the office soon. The Mortgage Bankers Association (MBA) showed existing home sales and housing starts breaking into new territory for the year, and building permit activity improved in October and November. Unfortunately, there was no relief from the inventory shortage. Low forbearance and foreclosure rates did little to bump up available housing stock. Originations, while improved over original estimates, were impacted as refis continued their slide. The monthly average 30-year fixed rate rose 20 basis points from 2.9 percent in September to 3.1 percent in December. There was some softness in pending sales, reflecting concerns over COVID-19 and inflation, as well as continued diminishing affordability, especially for buyers of entry-level homes. Despite constrained labor and material availability, builder sentiment climbed throughout the quarter, boosted by evidence of persistent demand and a significant construction backlog.
Positive trends continued in commercial real estate at the end of 2021. The appetite for industrial properties remained hearty. Both the retail and hotel sectors showed improvement as the holiday season took hold. Consumers returned to stores, early and often, “revenge shopping.” Transactions and pricing for these sectors still have not caught up to pre-pandemic levels, but they were definitely in a rebound phase, according to Real Capital Analytics (RCA). Coming into the quarter, there were signs that the office market was firming up despite persistently delayed return-to-work dates. According to JLL, there were more tenants looking for longer term leases, and RCA reported that sales of suburban space surpassed the pre-pandemic pace.
The apartment sector took center stage over the past few months with record deal volume. Robust demand and increasing rents made these investments very attractive. Would-be home buyers encountered elevated prices, higher interest rates and low inventory in the single-family housing market, so staying put was more attractive. Many of the top cities, particularly tech hubs, saw a return of vaccinated young people. Further supporting this sector is the belief that real estate is an excellent hedge against inflation, and apartments are the most accessible of options for smaller investors.
A Glance Forward
The crystal ball for the first quarter of 2022 got cloudy when the Omicron variant arrived. As recently as November, GDP projections by Fannie Mae assumed that positive momentum at the end of 2021 would lead the first quarter to eclipse the last. Now, GDP growth is forecast to weaken to 3.9 percent as the seemingly unrelenting pandemic continues to impact consumer enthusiasm. The silver lining is that lower intensity of demand should give more “breathing room” for business investment as companies pursue workarounds for shortages and restock.
Inflation, as measured by CPI, is projected to peak in the first quarter of this year, eroding wage and production gains. Consequently, the Federal Reserve (the Fed) now has calming inflation squarely in its sights. In December, it outlined its plan to speed up its taper timeline for 2022. Reducing its bond buying program more quickly means the Fed is likely to increase rates sooner than previously expected. Rates have already risen early in January and are projected to continue rising – but should still be among the lowest on record.
Fortunately, the housing market seems to be immune to pandemic spikes. Some industry professionals point out that seasonality in the market just doesn’t apply this year, as building and buying look to persevere through the historically slow winter months.
According to the MBA, both housing starts and sales are expected to be strong compared to last spring. The MBA’s Chief Economist, Mike Fratantoni, stated at its annual convention, “Home builders will have more success overcoming current building material shortages and should be able to increase the pace of construction to meet the sizable demand for buying.” Lawrence Yun, Chief Economist of the National Association of REALTORS®, also foresees an unseasonably hot winter housing market. While the road of recovery has more sharp turns than anticipated, the path is still there.