Halfway Home

Alec J. Pacella, CCIM

As hard as it may be to believe, half of 2023 is in the review mirror. And what a first half it’s been! It seems as if everyone in the real estate biz has had eyes on the Fed, the banking system, the stock market, and inflation. Throw in that pesky debt ceiling and it’s been enough to make a person crazy.

A common question on everyone’s mind is “where are things heading” and while there is no flux capacitor to help us out, one of the next best things is Dr. Glenn Mueller. He produces a quarterly publication called the “Real Estate Market Forecast,” which is widely followed and has historically been uncannily accurate. I last profiled Mueller’s thoughts in the early days of the pandemic and, given the current uncertainty surrounding the commercial real estate market, figured it was a pretty good time to revisit.

The crux of Mueller’s analysis is based on a 16-point real estate cycle. As illustrated in Figure 1, the cycle is broken up into four distinct phases. Phase 1, classified as “Recovery” can be considered the bottom of the market, characterized by negative rent growth and supply drastically outweighing demand. As conditions improve and the market crosses over the long-term occupancy average, it enters Phase 2. In this “Expansion” phase, rent growth turns positive, demand begins to out-pace supply and, in the later phases, new construction occurs in earnest. At point 11, the market is considered to be in equilibrium, with supply and demand in balance. After this point, the market slides into the “Hypersupply” phase. New construction continues but demand begins to fall off, which results in slowing rent growth in the early states followed by flat rents in the later phases. Once point 14 is hit, which again represents the long-term occupancy average, the market slips into the last phase, “Recession.” This phase is characterized by negative rent growth, curtailed new construction and supply met with little to no demand.

Each quarter, Mueller surveys the office, industrial, retail, multifamily, and hotel sectors for 57 metropolitan areas, including Cleveland, Cincinnati, and Columbus. His most recent report is as of the first quarter 2023, so if you want to know what the soothsayer thinks, read on.

Office

If any sector can be defined as a complete wildcard, it’s the office sector. Initially battered by COVID and very slow to recover, this sector continues to be a topic of which everyone has an opinion. And Mueller is no different – as of the Q1, he has metropolitan areas spread across nearly every point of the cycle. Austin, Charlotte and San Francisco are bottomed out at point 1 while New Orleans, Palm Beach, Richmond, and Riverside are in equilibrium at point 11. Ohio is also a coin-flip, with Cleveland in the Expansion phase point 7 while Columbus and Cincinnati are both in the Recession phase at point 15.

Industrial

And if any sector can be considered surprise-free, it’s the industrial sector. Four distribution powerhouses in Atlanta, Memphis, Nashville, and Salt Lake City are sitting at point 10. The remaining 53, including Cleveland, Columbus, and Cincinnati, are at point 11, which Mueller considers market equilibrium. I’ve been following Mueller’s reports for a couple decades and while it’s not uncommon to see so many markets tightly clustered, I can’t remember a time seeing such a vast dichotomy between two real estate sectors as there currently is between the office and industrial sectors.

Apartment

There is a little more diversity in the apartment sector. The majority of metropolitan areas are at point 11, which is equilibrium. These include Cleveland, Columbus, and Cincinnati. However, several markets have slipped into points 12 and 13 of Hypersupply, including Austin, Las Vegas, Nashville, Phoenix and Tampa. Mueller includes broad-based commentary to accompany the charts and one of his thoughts for the apartment sector was this: “The national apartment asking rental rate may increase by 2/3% in 1Q23 and be up 15.9% year-over-year.

Retail

The profile of this sector is unique in that all 57 metropolitan areas are situated at the exact same point 11, which is considered equilibrium. Mueller’s general comments include this: “We expect demand for space to continue to grow at 15 million square feet per quarter through 2023, with supply growth being slightly lower, thus keeping occupancies high.” But there is a lot brewing in this sector that is just below the surface. Mueller also produces supporting cycles, including one that profiles subsectors. And while neighborhood/community center subsector is at point 11, first-tier regional malls and power centers are one click back at point 10 while second-tier regional malls are back in the Recovery phase.

I had the opportunity to meet Mueller last summer and spent about an hour discussing the actual analytics involved in developing his quarterly analysis. And it is impressive to see exactly how the sausage is made. He maintains multiple databases, many of which have auto-mated data “scrapers” to collect the raw information. Data sources range from municipal building departments to commercial brokerage firms to national subscription-based vendors. This information is then rolled up and run through various algorithms based on his 16-point cycle. And out the other side pops the end result – an estimation of where each of the 57 metropolitan areas are expected to be as of that quarter. It’s quite the operation and requires several people, mostly graduate students at the University of Denver’s real estate pro- gram, to make sure the hamster keeps the wheel spinning.

I know what you are thinking right now – how much does the information cost to subscribe? Brace yourself, because it’s absolutely free. There are a variety of places that it can be retrieved – just Google ‘Mueller real estate cycle 2023.’ For those who want to take a deeper dive, Mueller does offer subscription-based analytics, which he performs for a variety of clients. Again, while nothing is a completely accurate predictor, the breadth of data sources, sophistication of modeling and over 30 years of continual improvement results in a pretty good resource. The proof is always in the pudding, so bring on the second half of the year!

What I C @ PVC  

TURN OUT THE LIGHTS Last month, Sokolowski’s University Inn was sold. The well-known restaurant was shuttered and put on the market in October 2020 in the wake of the pandemic. The new owners, an affiliate of WXZ Development, paid $1.5 million for the property, which is expected to be redeveloped. –AP

Alec J. Pacella for July Properties Magazine