This Analyst Believes CRE Revenue Growth Will Revert to its Usual 3% to 6% Annual Gains

Commercial real estate investments usually deliver stable returns over longer hold periods, such as a five-plus year horizon, allowing time to iron out common cyclical bumps and potholes that may affect single-year returns, according to John Chang, senior vice president and national director research and advisory services for Marcus & Millichap.

In times when the economy and sector are relatively normal like between 2014 and 2019 most property types delivered total revenue growth between 20% and 25%. But during crisis points, revenue growth has understandably faltered and in some cases certain sectors have taken years to recoup lost ground.

For example, coming out of the Great Recession, retail struggled mightily in the face of e-commerce and overdevelopment. It took about 10 years or so to recover as it tried to reinvent itself, gaining about 11 percent over that 10-year stretch leading up to 2020.

Between 2010 and 2020, apartment revenues increased by 58%. Hotels delivered a 60% gain, industrial climbed by 49%. Downtown office rose by 44% and suburban office went up by 27%.

“But the relatively steady 4% to 6% annual gains we experienced over those 10 years were completely disrupted by the pandemic,” Chang said.

“And while everyone thought retail would be one of the hardest hit sectors, it actually delivered some of the most stable revenue gains, advancing about 10% over those three years.”

Hotel revenues, on the other hand, were hit hardest by the health crisis.

In the span of a year, hotel revenues were cut in half but the next year the sector bounced back with RevPAR almost fully recovering to pre-pandemic levels and the gains continued in 2022.

As of Q1 this year, hotel revenue stood 16.6% higher than they were in Q1 2020.

Office has struggled mightily since COVID and the minimal return to the office since. Downtown office revenues now stand 11% below their pre-pandemic level.

Two sectors have taken off like a rocket since the onset of the pandemic, Chang said.

“The pandemic-driven surge of e-commerce sales together with increased retailer safety inventories drove industrial space demand,” he said.

From the first quarter of 2021 to the first quarter of 2022 industrial property revenues increased by 14%.

Then over the next 12 months, they climbed by another 16% but it looks like the pace of industrial revenue growth will level off over the next couple of years as e-commerce sales flatten, retailers reduce their safety stocks and as a record, 400 million square feet of additional space is added this year.

As for apartments, from the onset of the pandemic through Q1 2021 average apartment revenues fell by about 1% as eviction moratoriums and other challenges impacted the sector.

That was followed by a year of dramatic 16% revenue growth as household formations surge at the tail end of the pandemic.

“Basically, during the pandemic, people moved in together,” Chang said. “Then as the pandemic came to an end those households de-bundled and apartment demand surged.”

What conclusions can the industry reach after reviewing this brief history?

Change believes that barring a significant recession or a major black swan event average revenue growth should revert to its normal pattern of 3 to 6% annual gains for most property types.

He does add some caveats including there will likely be substantial variance from market to market. Also, investors need to monitor the local supply and demand balances for each property type they invest in.