Expert: 'The underlying fundamentals of real estate are quite strong'

On the surface, it seems like the real estate industry is struggling. It's easy to see why. The industry, for instance, was ranked as the S&P 500's third worst-performing sector in 2022. But appearances can be misleading: the real estate business is a lot stronger in reality, according to Todd Henderson, Co-Head of Global Real Estate DWS Group.

Henderson contends that the market broadly, from rentals to home buyers, is doing well with one exception: commercial office buildings.

“The underlying fundamentals of real estate are quite strong,” Henderson told Yahoo Finance. (Video above)

The real estate market saw mixed reviews throughout 2022. In the first half of the year, homeowners benefitted from the highest level of growth recorded in twenty years — U.S. year-over-year home price growth reached a tad above 20 % in April 2022, according to CoreLogic’s Monthly Home Price Index. But activity slowed by some measures as mortgage rates increased. In November 2022, home prices nationwide, grew 8.6% year over year compared with November 2021, the lowest rise in 2 years.

Meanwhile, the total value of U.S. homes decreased 4.5% from a record high of $47.7 trillion in June to $45.3 trillion at the end of 2022, according to a recent report from the real-estate brokerage Redfin — the largest June-to-December percentage decline since 2008. And, the S&P CoreLogic Case-Shiller U.S. National Home Price index fell 0.8% in December compared to the previous month, according to data released earlier this week.

“What has happened in the real estate industry over the last year, we really had a tale of two markets,” Henderson said. “The first half of the market for the private real estate sector performed very strongly, whereas the second half of the year, we saw the market capitulate to what was occurring with the Fed's movements of interest rates.”

Still, he said, the real estate market ultimately remains strong. Rental vacancies finished last year at 5.3%, the lowest vacancy rate on record since 1988, according to Henderson. Better yet, the rental industry saw 7.5% income growth in 2022, the highest historically except for during the recovery from COVID.

“So, what we've seen is a fallback in pricing, but what has endured are the fundamentals,” Henderson asserted.

Henderson also noted another positive development — an increase in millennial homeownership, which he said has and will continue to bolster housing market activity. From 2016 to 2021, nearly every U.S. state saw an increase in the number of young adults aged 25-44 forming new households, according to recent Pew Research. For instance, in New Jersey, the number of households occupied by people aged 25-44 grew 13% between 2016 and 2021.

“I think that that will continue, but housing prices are a bit challenged as a result of the cost associated with owning homes, in particular, the cost of mortgage financing,” Henderson said. “We have seen, however, some slowing. And I would call it more normalization, frankly, of demand in the rental market here, as consumers, as renters, as homeowners are starting to feel the cost of increased goods and the cost of increased mortgages around the housing market.”

Henderson also noted that the market has seen a precipitous increase in cash buyers. Americans bought one of every three single-family home and condos with cash in 2022, according to data analytics firm Attom.

“It stands to reason that if you think that mortgage rates are up temporarily, that if you can afford to buy a home un-leveraged, you would buy a home unleveraged, and then leverage it at a later date at the point in time when financing costs are significantly less,” Henderson said.

Going forward, Henderson offers a mixed prognosis. For instance, he is particularly bullish on neighborhood shopping centers, which have reached their lowest vacancy levels since 2007, according to a recent report from Cushman & Wakefield.

"You see a lot of service oriented retail in neighborhood shopping centers, which is very difficult to dis-intermediate through e-commerce," Henderson said.

Conversely, he’s pessimistic about office real estate, which saw a national vacancy rate of 16.5% in January, up 80 basis points from January 2022, according to the real estate software firm Commercial Edge.

"The hybrid working or work from home environment has an impact as well on demand for office,” Henderson said. “So we do expect office to trail the other three major sectors. And we expect to be underweight, but where we will own offices in, again, those cities and areas that have strong job and population growth and will own the best-in-class office buildings in those locations.”

Dylan Croll is a reporter and researcher at Yahoo Finance. Follow him on Twitter at @CrollonPatrol.

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