While the Commercial Real Estate (CRE) industry continues to navigate through the pandemic, there is no shortage of statistics on how it’s doing and opinions on where it’s headed. National and regional publications, professional organizations and industry experts have analyzed the data and made their best predictions for 2022. Overall, the outlook is cautiously optimistic, with a recurring theme of “pivoting” and “flexibility.” Here’s our recap of expert opinions on key topics that have and will continue to be factors affecting the industry’s future, followed by more specific updates affecting CRS’ service areas.
Effects of Inflation and Rising Interest Rates
Although the U.S. is experiencing the highest inflation since the 1980s, real estate remains a popular investment because CRE returns tend to rise more than the inflation rate. Inflation in desirable sectors such as medical office, industrial and multifamily means rents and property values will go up, demand won’t go down and, if you’ve locked in a low interest rate on your loan, your cost to own the building remains the same. With the Federal Reserve predicted to start raising interest rates soon and often, developers will likely build less and hold on to their existing assets, helping them hold on to their market share and giving them the advantage when setting rental rates and terms. Further discussion on the effects of inflation on CRE is in this informative NAIOP article.
Capitalization (Cap) Rates
By the end of 2021, the strong demand for CRE in many sectors has led to historic high prices and declining cap rates (the estimated percentage rate of return that a property will produce on the owner’s investment). The National Association of Realtors states the lowest median cap rate in 2021 was for multifamily at 4.9%, but regionally this fluctuates. A 2021 cap rate survey by CBRE Group, the world’s largest CRE services and investment firm, showed several states with historic lows (multifamily in the low 3s and industrial in the high 2s). Investors accepted lower returns because of rent growth, demand and high equity.
Nationally, CBRE predicts “cap rates to remain stable or slightly compress amid strong investor demand and abundant capital – even as interest rates rise.” Even so, investors will be looking for options that might offer better return and less competition in sectors such as self-storage, cold-storage, life science, hospitality in destination places and even film studios. All still come with their own risks, but regionally could also offer great opportunity.
Development in Major CRE Sectors
Following an initial paralysis caused by pandemic-related shutdowns, most segments of the industry began to recover in 2021 (some much more than others). Our Industry Expert Predictions for 2022 breaks down the status of and forecast for each of the major sectors.
Federal and State Incentive Programs
An influx of monies from the recently signed federal Infrastructure Investment and Jobs Act and individual state programs will help spur growth and bridge financing gaps for important commercial projects. For example, New Jersey’s Aspire program is a gap financing tool that will give much-needed assistance for qualified “transformative” residential and commercial projects in targeted areas where it has been historically difficult to build with consistency.
Supply Chain Concerns/Rising Construction Costs
The issues that plagued landlords and tenants in 2021 will continue in 2022, and will play a larger role in leasing negotiations across all asset classes, particularly in offices hoping to redesign space to attract workers back in. Continued challenges for both will include anticipating and planning for longer-than-usual construction timelines and supply deliveries.
End of COVID Relief Eviction Moratoriums
After several extensions and despite continued calls for more, the CDC’s moratorium on tenant evictions to provide relief to those in financial distress due to COVID-19 expired on October 3, 2021. Ending it will create a pathway for landlords to recoup losses they also suffered during the pandemic. However, some state or local eviction bans may still be in place; this comprehensive chart lists their status in each state (as of January). A list of federal, state, local, non-profit, and private sources of financial assistance and other resources for both tenants and landlords still struggling can be found here.
Changes Affecting CRS Services
Energy Provisions
The previously temporary energy-efficient building deduction known as 179D was made permanent last year as part of The Consolidated Appropriations Act of 2021. The change now enables energy-conscious developers to plan more confidently to take advantage of this savings with qualified HVAC, lighting and building envelope designs and materials. The proposed federal Build Back Better (BBB) bill could potentially make 179D even more valuable in certain situations, increasing the maximum deduction determined on a sliding scale.
Unlike 179D, the 45L energy-efficient home credit (for buildings three stories or less) technically expired at the end of 2021. Under the proposed BBB bill, this credit would extend through the end of 2031, make it more valuable and increase the credit from $2,000 up to $5,000 in certain situations.
Since the BBB is on hold, improvements to these energy provisions are yet to be seen, but if it happens we’ll be sure to update you! However, most experts do assume some sort of tax extender will pass before the end of 2022 to fix any expired provisions – good reason for investors to feel confident in making these kinds of upgrades and contact CRS to get them certified.
IRS Hiring Boom
As part of a $40 billion package passed by Congress, the IRS has hired more than 2,500 new auditors to make up for losing 17,000 auditors over the past 10 years and to crack down on tax reform for high earners. Just last month it announced it will also hire 200 more attorneys to combat “abusive tax transactions.” It’s more important than ever that investors can trust the professionals they hire to support their valid tax deductions are highly qualified. In terms of cost segregation studies, owners can be confident that a provider certified by the American Society of Cost Segregation Providers (ASCSP) can successfully defend their findings, versus others who may cut corners in terms of analysis and reporting.
Bonus Depreciation – Use it or Lose It!
If you know cost segregation, you know that a major benefit is the ability to apply bonus depreciation to qualified assets. The Tax Cuts and Jobs Act of 2017 increased the bonus rate to 100%. However, that percentage will start phasing down in 2023, reducing by 20% per year until it completely runs out or Congress extends / reinstates it at some point. If they don’t, 2022 could mark the last year in which taxpayers can apply the maximum bonus depreciation to a cost segregation study. As many experts predict, the commercial real estate market does not look to be slowing down soon, so it’s more critical than ever to contact CRS to see how we can help you gain the most return on your investment.
