Bubble watch: Will landlords’ winning streak last?

“Bubble Watch” digs into trends that may indicate economic and/or housing market troubles ahead.

Buzz: Talk about a winning hand. Last year, all 11 slices of one commercial real estate index posted gains — and 10 niches had double-digit increases.

Source: Green Street’s Commercial Property Price Index tracks values of large, “institutional quality” income-producing real estate across the nation.

The Trend

As the economy adjusted to life in the pandemic era, a buying binge for commercial property made the task of separating the industry’s winners and losers a study in the size of appreciation rates.

It may have been a tough year for landlords, operationally speaking. But property owners were rewarded, at a minimum, with appreciation — that’s the increase in asset values — whether tenants were consumers or corporations.

Commercial property values in all segments tracked by Green Street rose 24% last year to a record high — a sweet U-turn from an 8% drop in the nine months of 2020 following the coronavirus outbreak.

Why? Heavy demand for space slashed vacancies in many real estate niches. As a result, rents jumped, whether the properties housed people or goods. And investors wanted to get into the game.

So, in yet another of the pandemic era’s odd real estate twists, the 2021 price rebound put Green Street’s all-property benchmark up 14% since COVID-19 smacked the economy.

The Dissection

We should note that it’s not been a universal, one-way road higher for property owners and investors?.

Consider how the 11 commercial property niches tracked by Green Street fared, ranked by their 2021 price gains; how the categories did in a harsh 2020 once the pandemic’s business chills struck; and the total value change during the pandemic era.

At a minimum, these rankings are a fair summary of which properties have been most in demand over the past two years  …

No. 1 Self-storage: When lives are disrupted — such as the pandemic and its short, steep recession — folks find places to stuff their goods. That’s why this niche was up 66% in 2021. That followed a flat performance in 2020 in the months after the arrival of the virus. It adds up to a pandemic era gain of 66% — the No. 1 performance among the 11.

No. 2 Industrial: Everybody wanted everything yesterday, so companies needed space to move and store goods, too. Values of warehouses and factories surged 41% in 2021 after rising 9% in virus-chilled 2020. Pandemic era total? A 53% increase — No. 2.

No. 3 Lodging: Once lockdowns ended, many folks wanted to get out of town. Those urges to travel powered a hotel rebound. Values rose 32% in 2021 after falling 25% in 2020. For the pandemic era, though, hotels are still down 1% — the second-worst performance as business travel remains dead.

No. 4 Strip malls: Online shopping isn’t for everybody or everything. Goods not typically delivered (think groceries); and services (think medical, beauty or dining) fuel neighborhood shopping centers. After early pandemic losses — falling 13% — this niche rebounded to a 30% gain in 2021. So for the pandemic era, it’s a 13% value increase — No. 6.

No. 5 Apartments: People have to live somewhere. With ownership pricey and roommates dicey, rental demand — and rents — grew. Values rose 29% in 2021 after falling 5% in 2020. Pandemic era? A 22% increase — No. 4.

No. 6 Malls: The most surprising property revival may be because many big shopping centers are likely more valuable dead than alive. Values rose 27% in 2021 after a 20% fall. So it’s a 1% increase for the pandemic era — No. 9 performance — for a niche that owned a challenging future well before COVID-19.

No. 7 Individual stores: Owning the real estate that is home to those stores in a shopping center’s parking lot has become a popular “net lease” investment. This category rose 26% in 2021 after falling 7% following coronavirus. Pandemic era? A 17% increase — No. 5.

No. 8 Mobile home parks: Any residential property was hot last year, and this niche jumped 24% after rising 8% despite 2020’s coronavirus disruptions. Pandemic era? Up 34% — third-best performance.

No. 9 Student housing: Back to school (on college campuses, that is) improved this category’s outlook. Dormitory values rose 16% in 2021 after falling 6% as most students studied at home in 2020. Pandemic era? 9% increase — No. 7.

No. 10 Healthcare: Troubles in senior-care facilities were a huge challenge, but patients visiting doctors as restrictions loosened helped owners of medical properties. This group’s values rose 10% in 2021 after the niche’s initial 5% drop. For the pandemic era, a 5% increase — No. 8.

Lastly, office space: Will they or won’t they? Workers returning to offices, that is. The risk of tenant losses kept gains at 6% in 2021 following a 9% loss immediately after the virus hit. Pandemic era? An industry-worst performance with a 4% decrease.

How bubbly?

On a scale of zero bubbles (no bubble here) to five bubbles (five-alarm warning) … FOUR BUBBLES!

Reminder, big price gains aren’t just happening in commercial real estate. Stocks are up 40% in the same period, and U.S. homes appreciated 30%. You might find some “cheap” income-producing assets at the bottom of this ranking.

But overall, are the outsized gains in many commercial real estate niches largely the byproduct of extra demand created by the “new normal” economy? Or is it investors overreacting to temporary changes in spending, working and delivery habits?

Also, was the eye-popping appreciation largely due to a buying spree fueled by investor thirst for income-producing properties? And will that appetite dramatically reverse itself as interest rates rise on less-risky assets in 2022 and beyond?

Jonathan Lansner is business columnist for the Southern California News Group. He can be reached at [email protected]