Origin Investments Predicts Inflation is 2022’s Biggest Risk Factor for Commercial and Multifamily Real Estate, Impacting All Other Issues and Trends

Today Origin Investments, a leading real estate fund manager, identified inflation as the biggest economic risk for private real estate investing. It tops Origin’s 10 private real estate predictions for 2022 and will impact or in some cases impair all other investment trends in 2022, which range from the course of inflation and interest rates to multifamily valuation and appreciation movements.

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Origin Investments top 10 private real estate predictions for 2022 (Graphic: Business Wire)

“These predictions are based on our 15-year track record as a private equity real estate fund manager. We’ve executed more than $2.6 billion in deals across four funds with zero losses,” Origin’s Co-CEO David Scherer said. “They will help commercial and multifamily property investors position themselves for both short- and long-term success this year and beyond.”

Origin’s predictions are also informed by an AI-powered model it developed two years ago with the help of university data scientists. “The analytics support and inform Origin’s market analysis and investment process and also give us deep insight into emerging regional and national market trends,” Scherer added. Origin’s 2022 top 10 private real estate predictions are summarized below; read an expanded version here.

1. Inflation is the biggest economic risk and will impact all other trends. In private real estate, sustained inflation will affect everything from value-add and ground-up construction to capital expenditures and cap rates. Inflation surged 6.8% for the 12 months ending in November 2021, the fastest rate since 1982. Supply chain costs could extend volatility pricing well into 2022, but higher wages will have a prolonged impact that the Federal Reserve may miss a chance to rein in. “It goes back to labor and the supply chain,” Scherer said. “The only way to incent labor is higher wages, which is good for workers but also inflationary. Yet higher wages are one directional; inflation and the volatility pricing it breeds will be more enduring.”

2. Interest rates will increase in 2022. Interest rates will rise this year based on where inflation stands now. The Fed may start raising rates in May or July of 2022, much earlier than previous expectations of sometime in 2023. Interest rates tied to inflation are not necessarily bad, but we hope rates will rise in an orderly way by less than a full percentage point. Somewhere between 2% to 2.5% is a good thing, and you don’t want massive moves like a whole point.

3. COVID will continue to impact real estate, changing where we live and how we work. COVID-19 spread change across the whole economy. People didn’t work from three, six or even nine months, then had to find new jobs. Or they wouldn’t risk a return to retail or office locations. Many found viable remote work options. A record 4.2 million workers quit their jobs in September. These massive labor shortages are inflationary. Whether at a harbor, construction site or fast-food restaurant, wages are higher and won’t come back down. Workplace changes aren’t transitory either; a hybrid environment may be the only route to attracting the most in-demand candidates.

4. There will be a lower level of appreciation in 2022. Valuations are at the high end of their expected range. It’s a time to be cautious, use low levels of leverage and buy only assets with potential for good cash flow. The historical return on the stock market is only 8 or 9%, so over time we will migrate to lower returns. When the risk-free rate of return is zero, private real estate investors cannot expect 15-20% returns to endure for the next 10 years. That doesn’t mean a correction in 2022, only that profit expectations will moderate, Scherer explained.

5. Low-cost, business-friendly states continue to gain and grow. Continued virtual and hybrid work will accelerate the migration from gateway cities to warmer Southern states with lower housing costs and lower taxes. A tight labor market encourages hiring remote workers. Housing costs are rising in Charlotte, Denver and Phoenix—cities that offer a better lifestyle, lower housing costs and better weather than Boston, Chicago, Los Angeles, New York City or San Francisco. “Affordability eventually will moderate these price distortions, but that moderation is years away,” Scherer said.

6. Qualified Opportunity Zone benefits will not change. Congressional gridlock has stalled changes in capital gains taxes and even marginal tax rates. It is unlikely QOZ incentives for private real estate investment will be scaled back in 2022. The U.S. Treasury and Internal Revenue Service may exercise their rulemaking authority, but no QOZ rules will change in 2022. Democrats like the fact that it creates investment in developing communities, while Republicans will defend its tax reductions, Scherer explained. He also noted that QOZ funds have raised more than $20 billion, reinforcing continued investor interest.

7. Multifamily will see modest valuation appreciation and strong rent growth, with suburban outpacing urban. The environment for rent growth remains strong for 2022 and properties will see modest appreciation, but less than over 2021. Higher interest rates will put upward pressure on borrowing rates and cap rates, and if cap rates go higher, it will reduce the multiple on earnings. Playing into this, there still are a tremendous number of investors looking to put equity in multifamily housing. However, the prospect of inflation suggests rents will continue to rise as higher wages give workers more money to spend. Remote and hybrid workplace trends support the need for larger and better accommodations, which in turn favors suburban growth over development near urban cores.

8. Multifamily rents in the NE and MW will underperform the SE, SW and TX. In 2022, higher wages and more disposable income will drive both urban and suburban rent growth, keeping multifamily real estate a robust investment. But suburban rent growth will continue to outpace urban. At the same time, urban Class A buildings remain strong but still will underperform urban Class B and suburban properties due to the latter’s affordability.

9. Value-add is giving way to ground-up construction. For the past few years, with so much capital drawn to value-add projects, their cost basis has exceeded that of ground-up construction of projects of similar location and quality. That environment makes it difficult to achieve the returns investors expect because new construction always commands premium rents. Further, a landscape of lower price appreciation shifts the risk and reward balance in favor of new construction. “There still will be value-add opportunities,” Scherer said, “but because acquisitions now are priced at or above replacement cost, value-add renovations must have real competitive advantages to warrant private equity investment.”

10. The pace of ground-up construction will increase in 2022. Lenders are very interested in loaning to multifamily housing projects. The pace of new construction will increase, Scherer noted, because development fundamentals are favorable for both equity and debt financing, and there’s so much capital to put into these investments. “For now,” he added, “ground-up development can fetch 10% to 30% above replacement cost while value-add is trading at or just above replacement cost.” Ultimately, as land and construction costs rise, demand will drive down the margin for new development and the market will shift back to value-add. But for now, “ground up construction is here to stay,” Scherer maintained.

About Origin Investments

Origin Investments helps high-net-worth investors, family offices and registered investment advisors grow and preserve wealth by providing best-in-class real estate solutions. They are a private real estate manager that builds, buys and lends to multifamily real estate projects in fast-growing markets throughout the U.S. Since its founding in 2007, Origin has executed more than $2.6 billion in real estate transactions and its principals have invested more than $60 million alongside investors. Origin prides itself on offering unparalleled service to investors and its performance ranks the firm in the top decile of the best performing private real estate fund managers ranked globally by Preqin, an independent provider of data on alternative investments. Earlier this year Origin raised $265 million for its QOZ Fund I. The firm is currently accepting new investors for its open IncomePlus, Multifamily Credit and QOZ II Funds. To learn more, visit www.origininvestments.com.

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