One of the characteristics for successful real estate investing hinges on being selective. As an asset class, real estate has shown time and again to be a meaningful source of income generation, an effective inflation hedge and to offer ample capital appreciation potential. These attributes—along with the tangibility that’s inherent to investing in physical properties—have been a boon for advisors navigating the volatility of the post-pandemic market. While the prospects for traditional holdings like stocks and bonds have suffered under the currently shifting market, the long-term outlook for private real estate remains promising.
However, many advisors and investors make the critical mistake of regarding real estate as a single, monolithic, and undifferentiated asset class. Because real estate investing requires taking a long-term perspective (i.e., there are no “quick trades” in real estate), advisors need to be deliberate when assessing the macroeconomic conditions at play, the ensuing tailwinds they might produce and the specific types of properties that stand to be propelled the furthest by them. The inflationary, positive economic and monetary policy factors that made 2022 a lucrative year for real estate investing have simmered into what many are perceiving as a comprehensive cooldown. Investor sentiment may not accurately reflect underlying investment fundamentals though. For advisors keeping a close eye on real estate financial analyses and valuations there’s a lot to be optimistic and even outright bullish about.
One of the most visible domains of opportunity within real estate right now is the industrial sector. Although the economic cycle has been defined by uncertainty in recent months, the long-term, structural demand drivers at work within the market have situated industrials for sustained success for the foreseeable future. This is largely due to the continued structural prevalence of e-commerce: despite the widespread strain many consumers are feeling in their wallets, online shopping has only expanded its foothold as brick-and-mortar businesses have fallen behind.
Beyond the indispensable role that warehouses and industrial properties play within distribution channels, this sector is poised for considerable growth driven also by other fundamental factors. While the expectation for more direct-to-consumer delivery services to operate at ever-increasing speeds is a key facet, the reality is that the supply is simply not there to match the demand. Industrial vacancy rates are presently well below their historical average, while the significant rise in material and labor costs is making it cost-prohibitive for many developers to construct new developments. With e-commerce projected to become increasingly adopted amid this disparity, the value and necessity of existing industrial real estate will only increase in the coming years. In addition, according to independent estimates, there will be demand for approximately two billion total square feet of new industrial space within the next five years, all of which must be integrated into the supply chain long-term, effectively hedging against inflation and ensuring prolonged net operating income (NOI) growth in the process.
A similar supply-versus-demand dynamic that is lifting industrials’ investment potential also factors into the residential sector. Since the Great Recession, there has been a significant shortfall in the housing market: not only are fewer homes being developed, but what’s been offered has failed to keep up with the overall demand and growing demographics (driven by the large millennial population) that previously would’ve produced increased homeownership rates. This housing shortage has most acutely affected millennials, who are not only facing a dearth of options, but extraordinarily high premiums and costs tied to the limited number of homes that are available. As these conditions are exacerbated by inflation as well as historically high mortgage rates, many are set to remain priced out of homeownership for the foreseeable future.
This void in homeownership has created an inverse need for rental units. The record low percentage of U.S. adults currently able to afford a home and the limited supply of residencies should continue driving apartment and single-family unit rents higher in the near future, making residential properties a lucrative area of investment. As the traditional thinking around homeownership has changed and more people have come to rely on rentals, there has been a corresponding shift in how consumers regard non-permanent dwellings. Many have come to prefer rental units thanks to the greater degree of mobility they provide, their lack of maintenance costs, as well as their proximity to desired metropolitan areas. Likewise, apartments and rented single-family homes often carry the benefit of providing amenities such as pools and gyms in addition to not burdening residents with insurance costs. Based purely on numbers, investing in residential properties is a promising avenue for future returns.
Looking even further ahead, the life sciences sector is also well-positioned to flourish. As a sizable portion of the population ages, there will be a growing demand for the development and manufacturing of new therapeutics that address the inevitable increase in age-related ailments. This in turn will naturally require increased laboratory and manufacturing real estate space for development, research and production. However, the life science sector carries unique regulatory and building requirements that few developers are experienced in, creating a significant barrier of entry for construction, let alone conversion. As with industrials and residentials, this is an area where the demand is likely to outstrip the supply.
Additionally, life science properties are boosted by their geographic concentration and abundance of intertwined capital. With the life sciences market largely confined to certain metro areas such as Boston/Cambridge, the Bay Area, San Diego, Seattle and the Tri-City area, the in-demand real estate and accompanying construction regulations of these regions translate into greater pricing power for building owners. Furthermore, as both the public and private sectors invest heavily in life sciences R&D, there is a reliable stream of demand for these sorts of specialized properties as well as a substantial array of resources available for maintaining them.
Ultimately, real estate investing demands the same perceptiveness and consideration expected of any other asset class: it requires looking beyond the sector itself to identify how it fits into the greater market as well as how it can address consumer needs and demands. Fortunately for advisors and investors, there are plenty of real estate needs to be met in today’s market and plentiful opportunities to engage with them.
Miguel Sosa is a research strategist at Bluerock.