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Nearly every monthly job report this year has been followed by one sentence: “job gains were higher than expected.” Despite the Federal Reserve’s attempt to stymie economic growth and drive down inflation, strong employment has persisted. In January, job gains were so strong that the unemployment rate fell to 3.4%, the lowest point since 1969. In May, the professional, business, government, and health care services industries led job growth, contributing to the creation of 339,000 new jobs when economists expected gains of only 190,000. Overall, the nation has publicized job growth for 29 straight months.
Typically, this would be great news. A strong labor market is a sign of a healthy economy, and it’s welcomed by commercial real estate players. But in the current environment, employment gains can be confusing.
Alongside strong employment, there is widespread economic instability. A high inflation rate and an aggressive monetary policy have pushed the prime rate up rapidly in the last 14 months, and this unique mix of economic fundamentals is creating a lot of uncertainty.
Rest assured, overall, that job growth is still good news. Here’s what the recent strong jobs reports can mean for commercial real estate investors and developers.
An outperforming job market is a marker of economic strength, despite the surrounding headwinds. Becky Frankiewicz, president and chief commercial officer of Manpower Group, told CNBC in May, “The US labor market continues to demonstrate grit amid chaos—from inflation to high-profile layoffs and rising gas prices. “With 339,000 job openings, we’re still rewriting the rule book and the US labor market continues to defy historical definitions.”
In other words, the labor market remains a central indicator of economic health, even as other fundamentals deteriorate. In fact, Federal Reserve Chair Jerome Powell has been confident in pursuing aggressive interest rate growth due to the strength of the labor market. He initially sought to raise interest rates high enough to decrease inflation while achieving “soft landing,” an economic term for reducing growth without triggering a recession. The strength of the job market has created that opportunity.
Cap Rate Stability
Commercial real estate transaction volumes are down nearly 60% for the year. Although there is a healthy appetite for investment, buyer-seller disparity on pricing has stalled deal flow. When interest rates rise, buyers expect a comparable adjustment in pricing, but owners - particularly those who made recent purchases - have held steadfast. In a typical market, cap rates rise in step with interest rates, with a six-month lag in between. However, more than a year has passed since interest rates started to increase, and guidance from the Federal Reserve suggests that the days of zero interest rates are permanently over. Still, prices haven’t corrected.
The strong labor market could be driving the pricing gap. Asset value is only half of the cap rate equation, with net operating income representing the other half. Employment and wage growth have helped to drive strong occupancy and rent growth. Multifamily vacancy has held steady at about 5% nationally, while rents have grown 4.5% year-over-year. Industrial rents grew by 11% and retail rents grew by more than 4% year-over-year. Strong cash flow and occupancy would help to stabilize cap rates, or at least mitigate a drop in pricing. As the country continues to add jobs, owners have increased confidence in occupancy, cash flow and the overall operational performance of an asset.
Demand for New Development
For developers, the jobs report is an important metric for analyzing market health and underwriting a prospective project. In a typical market, job growth supports consumer spending, business expansion and an active housing market, and that’s true today. With the exception of the office sector—which is experiencing a cultural shift due to remote work trends—commercial real estate has healthy occupancy and rent growth, a great sign for developers.
The pandemic and current economic headwinds have suppressed new construction activity. The construction pipeline has contracted across all four major commercial property types; however, although leasing velocity has slowed, all property sectors continue to see positive absorption, demonstrating real estate demand. While inflation will certainly affect the viability of real estate development, job gains help promote positive demand fundamentals that support new construction.
Higher Interest Rates
While an expanding labor market has benefits, in today’s environment, it can also exacerbate problems. The Federal Reserve’s primary goal is to bring inflation under control, but that task remains an uphill battle while employment continues to grow. After the jobs report in February, Powell said, “We didn't expect it to be this strong. [It] shows why we think [bringing down inflation] will be a process that takes quite a bit of time.”
While the Fed declined to increase rates at the June meeting, for the first time in more than a year, strong employment will almost ensure that interest rates will continue to rise. In fact, Powell promised as much in June, saying, “Looking ahead, nearly all Committee participants view it as likely that some further rate increases will be appropriate this year to bring inflation down 2% over time.” For commercial real estate players, higher interest rates will continue to increase capital costs and upset transaction and investment activity.
Investment in automation and new technologies promises to continue to strengthen the job market as well. Data from the World Economic Forum estimates that technology will create 12 million more jobs than it eliminates by 2025. Because automation reduces or eliminates low-value administrative tasks and increases efficiency, companies can reinvest in professionals who will innovate and support core business practices, creating top tier jobs in the market. We have already seen that effect this year, with business and professional services jobs leading employment gains. Technologies like Northspyre are a prime example. Northspyre has reduced administrative tasks by up to 70%, saving developers tens of thousands of hours. That is time and money they are able to reinvest in professional resources for their businesses, creating higher paying jobs that fuel economic growth.
A strong job market is a sign of economic resiliency, even (and probably especially) when there is instability in other areas of the economy. The road ahead will likely be choppy, but with a strong employment market, commercial real estate stakeholders can find a reason to feel confident about the future.
Want to learn more about how to avoid common development obstacles that derail project timelines and create budget concerns? Download our Guide to Overcoming Real Estate’s Greatest Obstacles to access strategies you need to achieve more predictable and profitable development outcomes.
Tag(s): Real Estate Development
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