In Q4 2020, the impact of renewed lockdowns and social distancing measures stalled the economic recovery. Notably, in November consumer spending contracted, while in December employment gains ceased as non-farm payroll turned negative for the second time that year. While the economy’s near-term growth will likely continue to be held back by the resurgence of COVID-19, we expect to see a pickup of positive economic data in the second half of 2021 as warmer weather and the vaccine rollout take hold.

Growth in the first half of the year is likely to be uneven across different industries and economic groups. While manufacturing and construction should continue to perform well, the services sector, especially accommodation and food service, will remain under duress and operate at limited capacity.

Over the course of 2021, monetary policy is likely to stay highly accommodative with the U.S. Federal Reserve continuing to pursue quantitative easing and maintaining its key policy rate at the current level. This low interest-rate environment should further sustain asset values, consumer spending, and business investment.

Consumer spending index (Index January = 100)

Source: U.S. Bureau of Economic Analysis, Manulife Investment Management, as of December 23, 2020.

Unemployment rate (%)

Source: U.S. Bureau of Labor Statistics, as of January 8, 2021.

Investment markets in the United States have been on a gradual road to recovery since mid-year when reported sales volumes fell to their lowest level in the past ten years. Compared to the global financial crisis (GFC), the current downturn has been much less severe, with transaction volumes down by about 30% in 2020. This pales in comparison to the 2009 downturn when investment markets came to a near halt and transaction volumes fell by 90% relative to their peak. A critical difference between this downturn and the GFC is the impact on the commercial mortgage market. In the aftermath of the GFC, unavailability of debt financing caused by the evaporation of the commercial mortgage-backed securities market led to years of limited deal activity and falling prices, as bad loans were worked out over time. In the current downturn, the pressure on asset prices has been driven by net operating income erosion as a result of rent concessions and slower rent growth rather than increases in investment rates.

The multifamily sector has garnered the highest investment interest over the past five years and is still trending in this direction throughout the current pandemic. Multifamily assets were the chief beneficiaries of investment activity in 2020 at $132 billion, close to 40% of total transaction volume. Industrial has also been a favorite asset type in recent years, with the pandemic only increasing its investment appeal. It stands as the second most active property type in 2020, with investment volumes at $96 billion.

Economic uncertainty has clearly played into real estate capital valuation, but aside from the retail and hotel segments, which were both hit hard by pandemic social interaction restrictions, the impact to capital values has therefore far been on the mild side. As expected, stronger investment demand has led to better pricing for multifamily and industrial real estate, which continue to enjoy capital value stability.

Quarterly transaction volumes (US$ billion)

*Preliminary data

Source: Real Capital Analytics (RCA), as of Q4 2020.

Demand for office space plummeted in 2020 as business closures and widespread work-from-home initiatives left a sizable share of office space empty for most of the year. Office net absorption fell to negative 75 million square feet (SF) in 2020, the largest one-year occupancy loss on record. Even as mandated work restrictions and social distancing limitations held construction in check, we saw some renewed activity with developers managing to complete 46 million SF of net new office space over the year. This new supply combined with weak demand pushed average vacancies up 140 basis points (bps) to 11.20%.

Office supply/demand fundamentals

Source: CoStar, as of Q4 2020.

Facing weak demand for leasing, landlords are competing hard for tenants to maintain occupancy levels and as a result average national office asking rents fell by 1.10% in 2020. It’s clear that office rents will likely remain under pressure over the next 12 months, although the impact is likely to vary by building class. It’s possible new value placed on employee health and well-being could translate into greater interest in high-quality, well-located assets. Rents and occupancy levels for those assets may show more resiliency compared to the rest of the market.

Office rent growth (%)

Source: CoStar, as of Q4 2020.

While the recovery saw construction activity relatively constrained, it has nonetheless been trending upward in recent years reaching 157 million SF by the end of 2020—equivalent to 1.90% of total current office inventory. The tech hubs are appropriating most new projects—Austin, San Jose, San Francisco, and Seattle—locales better positioned to return to the upswing and absorb new supply once the economy starts to reenergize. However, faced with weaker demand and challenged by difficult logistics, the pace of new project completion will likely decline in the near term. This could have the benefit of reducing the impact of new supply on the market.

Office under construction as % of stock

Source: CoStar, as of Q4 2020.

Changes in office workspace planning are a risk factor for the sector, although it’s not clear whether demand for office space will be substantially affected. The widespread work-from-home experiment prompted by COVID-19 is proving that many employees can continue to work from home and still be productive. While we do envision employers will generally be more flexible around the employee workplace arrangement, it’s unlikely the role of the physical office in company operations will diminish. Priorities such as preserving a firm-wide culture and maintaining collaborative/creative functions are advanced by having employees under one roof, and the right office space can help attract talent, establish credibility, and provide prestige. Furthermore, changes in workspace planning—de-densification of office space and increased provision for social/collaborative space—should offset some of the impact of the expanded work-from-home arrangements. We also expect some structural shift in demand balance as the desire for shorter commutes and economic constraints could give a boost to suburban markets.

The surge in online shopping continues to foster demand for industrial real estate. Competition over shorter delivery means that retailers must build out their distribution network, and this has been especially beneficial to warehouse properties near dense population centers. The pandemic has only accelerated this trend and encouraged demand for industrial space despite the economic slowdown.

Industrial market net absorption appeared unaffected by this downturn, in fact growing by 27% in 2020 to 204 million SF. The pandemic has also done little to slow the steady pace of new supply with annual net completions of 290 million SF—the highest on record. 

Industrial supply/demand fundamentals

Source: CoStar, as of Q4 2020.

Construction remains elevated at near historic highs. At the end of 2020, there was 325 million SF of industrial space being built, equivalent to 1.90% of the total market. 

Industrial under construction as % of stock

Source: CoStar, as of Q4 2020.

New supply, however, is concentrated in a handful of national and regional distribution centers, with the top five markets accounting for a third of all new builds. This upward trend over the past two years has helped reduce supply-and-demand imbalances, as well as gradually moderate industrial rents. Economic unpredictability has only given a push in this direction, limiting overall rent growth to its lowest since 2013 at 3.70%

Industrial rent growth

Source: CoStar, as of Q4 2020.

The real bright spot is that the steady build-out of retail distribution networks and e-commerce fulfillment platforms has helped bolster demand for industrial space, from both existing and new tenants. Large-bay, high clear height warehouse space, as well as smaller, lower clear height facilities near urban areas that can serve as last-mile delivery stations are the key beneficiaries of e-commerce-related demand. 

Industrial real estate could also see a demand boost driven by structural changes in manufacturing and supply chains. With COVID-19 challenging global trade and supply chain networks, for example, businesses are likely to turn to local manufacturing and the build-up of inventories in nearby markets. These innovations could be net positive demand drivers for industrial real estate in the long term.

A sharp third-quarter rebound helped stabilize demand for multifamily residential on a year-over-year basis. This turnaround originates from pent-up demand during the first half of 2020 when pandemic lockdowns greatly slowed down leasing activity. However, 2020’s near-record new supply of 423,000 units has put some pressure on the vacancy rate which rose by 40bps to 6.90%.

While demand for multifamily tends to be less cyclical than other property types, recent job losses and social distancing measures may continue to affect leasing activity going forward, although the impact to different product types will likely be uneven. Economic constraints combined with here-to-stay workplace flexibility may shift some demand away from expensive high-end urban-core stock to suburban products that offer larger and more affordable units. High-priced urban accommodation also faces competition from new supply that may further pressure occupancy and rent growth in that segment

Multifamily supply/demand fundamentals

Source: CoStar, as of Q4 2020.

Overall, the outlook for multifamily is on the plus side. The federal government’s relief package included direct payments to low-income households, which is helping to cushion the impact on multifamily rental income. Multifamily rental also benefits from several secular demand drivers that are moderating occupancy volatility: an overall shortage of housing options, home ownership affordability issues, and demographic trends such as an increase in both the median age of marriage and the number of single-person households.

National average multifamily rents were relatively flat in 2020. Average figures can be deceptive, however, as they mask variations across product types such as expensive high-end urban-core products, encumbered with less favorable supply-and-demand conditions, are experiencing rent pressure, while cheaper suburban products are showing greater rent stability.

Multifamily rent growth (%)

Source: CoStar, as of Q4 2020.

Even as construction activity experienced a slowdown over the past year, near historic highs still prevail. As of the end of 2020, there were 556,000 units under construction, equivalent to 3.20% of current stock.

Multifamily under construction as % of stock

Source: CoStar, as of Q4 2020.

1. All market fundamental statistics, including vacancy, absorption, completion, under construction, and rent growth sourced from CoStar, as of Q3 2020. All capital market statistics, including transaction volumes, cap rates, and price index sourced from Real Capital Analytics, as of Q4 2020.