EP232: Real Estate Danger Zone: DO NOT ENTER!

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Some sectors of real estate are MUCH more risky than others… We’re calling these the danger zones today – AKA types of properties and regions you should definitely avoid if you want to succeed in real estate investing!

We know that the last few years have been nothing short of chaotic for real estate investors. Certain assets have not been able to bounce back from the struggles of 2020, while there seem to be new, stress-inducing scenarios popping up left and right.

Well, we’re here to clear up the confusion today. Let’s lay out the caution tape so you know exactly what real estate sectors are off limits on the way to wealth, what regulatory and economic factors have led us here, what dangers lurk ahead for investors and how to avoid them.

But don’t worry, we’ll also offer up the ultimate safety net by sharing what assets and strategies will help you not just survive the current real estate conditions, but actually thrive!

We may be about to travel through perilous territories, but finding the right path to tread will lead you to a goldmine of wealth-building opportunities! Let’s get started!

Do you know what lives in the center of our So Cal gal hearts? In-N-Out burgers. Yep… we’re talking burgers for a sec, but stay with us.

As far as burgers go, In-N-Out offers a classic, easy choice for us, every single time. But burgers actually have some things in common with real estate. You see, there are tons of different types of burgers with differing sizes, tastes, price ranges, and experiences, much like you’ll find in real estate! If you want to buy a burger or a real estate property, you’ve got plenty of factors that may affect your choice.

Now, we could banter over burgers all day, but let’s imagine we’re the equivalent of a burger critic in the real estate landscape. We’re about to scope out the areas with the lowest health score, taste, and ingredients, so our fellow investors know to stay away! We’ll also point out the juiciest, best bang–for-your-buck investment asset of them all. Sounds fun, right?

First, let’s get into the nitty-gritty details of what actually contributes to real estate risk these days. Because a LOT has been going on.

As of 2023, the job market has become a strong catalyst for driving economic momentum forward. The unemployment rate is down to 3.7%, consumerism is up, and the labor market stands tall, with about 6.1 million jobs created since the pandemic!

In addition to the unstoppable labor market, we’re also seeing inflation taking a nice, deep breath, and dipping down to 3.1% as of November, 2023.

Hey, it’s not at the Federal Reserve’s goal of 2% yet, but it’s a huge improvement from where it was, at 7.1%. Plus, inflation is definitely trending downward, and is expected to lower further in 2024, mainly due to a slowdown in rent growth across the board.

And while that’s all fine and dandy, you might be wondering what the deal is with interest rates, and how that will affect real estate investors moving forward. Put on some shoes you can move in, because we’re anticipating a bit of a dance with interest rates this coming year.

We saw a one-percentage-point hike to 5.5% from the previous year, but the tide looks to be turning, bringing about interest rate cuts in 2024, and breathing fresh life into commercial real estate investments.

What’s the beacon of hope that has stayed consistent through all the interest rate hikes and inflation we’ve faced? Consumer spending! We’ve seen the US economy steadily growing, with an expansion rate of 5% in the last quarter of 2023. This supports the idea that interest rates will continue to lower, giving investors more opportunities to take on new real estate ventures.

Of course, where there’s a beacon of hope, there are often shadows also peeking around the corner. In this case, it’s the CRE debt that casts a looming presence over commercial real estate prospects. With CRE loans hovering at about $880 billion, charting banks will be treading cautiously, pointing towards more nuanced lending patterns ahead.

With all these effects on commercial real estate, it might seem like it’s a possibly risky area for investors, but we’re the type of people who like to hear the good news before the bad, always. So, in this case, we want to share about the one area of the commercial sector that has a very, very bright future, and we’d like to start there.

Due to increasing mortgage rates, home ownership has become less and less attainable for middle-class individuals, and there has also been a shortage of affordable housing for low-income households.

What does this mean? Well, it means that there’s a rapidly growing need for affordable, flexible housing options, like multifamily apartment properties.

On a micro level, the multifamily sector is one of the few commercial real estate markets that has a steady rent growth.  That’s a pretty big deal considering the economic factors we’ve been discussing!

So, while potential homeowners may find the current market challenging to navigate, do you know who’s feeling good about it?

Multifamily apartment investors, of course! Let’s look at some of the data here. In the last 12 months, we’ve witnessed an absorption of 313,416 units, reflecting a 114% year-over-year increase, which surpasses the 10-year median.

Even with this absorption growth, rent growth hit a 10-year low, with only a 0.6% increase compared to the previous year’s 3.9%, according to national data. But the cool thing to keep in mind, is that every multifamily market is different, and the location plays a huge role in the multifamily demand.

In fact in our Arkansas $77 million property saw a rent renewal growth of 8%, even without spending any money capex! The market forces helped us big time here.

Some of the major urban hubs, like New York, Washington DC, Houston, and Dallas-Fort Worth absorbed over 10,000 multifamily units in the past year. And, even though rent growth lowered in many regions, the Northeast actually experienced rent growth above 5%.

In fact, if you look at vacancy rates, you’ll see that the data shows a 10-year high at 7.4%, an 0.9% increase from the previous year. But, here’s the thing, there was also a 22% hike in 12-month new unit deliveries, which definitely explains the higher vacancy rates.

So, while it’s important to look at the data, it’s also important to take all these different factors into account, which tells us that the multifamily market offers tons of exciting opportunities for real estate investors to grow lasting wealth.

Now, you might be thinking about the dreaded “what ifs”, right?

There’s always a potential for markets to shift, and the projected decline in mortgage rates may sway some renters into homeownership, but we’re really not worried about it. These types of shifts happen very slowly, and aren’t expected to cause a dramatic shift in the multifamily housing market.

We can’t say the same for some other real estate sectors, though. If the multifamily market represents our classic, favorite, In-N-Out burger with its dependability, quality ingredients, and outstanding taste, it’s now time to point out the real estate markets you definitely wouldn’t want to take a bite out of right now and why.

First up, let’s discuss a market that was hit really hard by the Pandemic, due to a huge increase in work-from-home work models.

Yep, you guessed it. We’re talking about offices.

Office properties are still suffering from high vacancy rates, but especially in prominent technology centers such as San Francisco, Houston, Dallas-Fort Worth, Austin, and Washington, DC.

There are still some favorable vacancy rates noted in the Southern region, with Savannah, GA, and Wilmington, NC, leading with vacancy rates under 2%, but the overall demand has gone down.

The decrease in demand has, of course, lowered property values as well, resulting in property owners and investors suffering the consequences.

We’re currently seeing about 50% of pre-pandemic office space utilization, even though corporate offices have been striving to bring more people back into office spaces.

Based on how things are going, it looks like employees want to keep their flexibility and transition out of the traditional office environments.

All that to say… the office building sector of real estate is a definite danger zone!

Next on our no-fly list is in the trucking and warehousing sectors within commercial real estate, which suffered during the pandemic, but had a pretty big growth year in 2023.

The industrial real estate boom was brought on by consumer spending, e-commerce competition, and the goal of bringing big operations closer to home – which sparked an all-time high of industrial building construction levels.

Now, we know, we know… that sounds great, right?

But we wouldn’t dive into scooping up these properties anytime soon..

Because it looks as though its current growth will start softening, due to the normalization of consumer behavior and a potential recalibration of supply chain strategies.

For us, this one’s a danger zone too! Do we have any retail therapy fans out there? Because we personally love a good shopping trip to clear the mind and raise the vibes, but that doesn’t mean we’re about to dive into retail real estate.

Here’s why: More and more retail stores are filing for bankruptcy due to difficult market conditions. And yes, stronger companies are still popping up and taking the weaker chains’ places, but overall, the outlook for 2024 shows more consolidation than actual growth in this sector.

There are still areas of strong retail real estate growth, like Chicago, Phoenix, Houston, and Dallas-Fort Worth, and retail stores combined with grocery needs are expected to keep growing. But the risk in retail rests in the companies who aren’t willing to adapt to the current trends, and want to stay with the old model of doing things.

You know what we’re going to say… with the future of some types of retail properties in jeopardy, we’re calling this a danger zone.

This next real estate sector was also hit hard by the pandemic, and has struggled ever since.

Hotels are currently holding at an occupancy rate of 2.7% behind the pre-pandemic benchmark, with sales acquisitions declining from $66.6 billion to $26.6 billion within a 12 month cycle.

The hope for hotels was being placed in hotel to apartment conversions, because apartments really are the future of commercial real estate, but these plans have hit a snag. More and more of these undertakings are being overturned, with properties being handed back to the lender.

You know what that means? Hotels will continue to be in the danger zone.

We hope you found this info helpful in choosing where not to invest in real estate! For more real estate investing guidance, be sure to check out this episode…