The most powerful predictor of real estate returns may not be what you think. It’s less about what people think, and more about what they feel.

The most sophisticated acquisition guys (they were all guys at the time) used to fly in, tour a property and then sit in their rented car in the parking lot, consult their HP-12Cs, and figure out their price. We Haystack editors came up under these guys, with their quick math and expert intuition. They were great mentors but buy and sell decisions aren’t made in parking lots anymore.

We've been taught that sophisticated real estate investing means managing complex financial models and finding an edge so you buy and sell at the right times. Institutional real estate investors typically seek information on supply (permits, starts, completions, etc.) and on demand (migration, economic growth, household formation) to inform these decisions. Larger investors all have analytical models that factor in economic, demographic and MSA-specific data. That feels appropriate, but since what we do is still a young science, part of the institutionalization of real estate investing is seeking other meaningful, if less intuitive, drivers of returns, and factoring those into the models and investment decisions.

Well, here’s some surprising science on what drives returns: Research indicates we should be paying attention to what consumers are thinking because, per economist Zhi Dong, “the total return of commercial real estate is better explained by consumer sentiment than by macroeconomic indicators.” That feels like a new idea - it was new to us - although other studies have barked up similar trees. A different study also focused on overall drivers of returns in private real estate noted early on that one of their “most important” findings was that one of the fundamental drivers of value for commercial real estate was the growth rate in real per capita consumption - a metric that historically has largely moved in sync with sentiment.

A little background before getting a little deeper into the findings: Consumer sentiment researchers get random groups of regular people to provide views of the economy, of their own economic situations and of the future. Importantly, sentiment is fully distinct “from the direct impact of commercial real estate performance.” In other words, these regular people aren’t asked about and probably aren’t thinking about real estate at all when they are surveyed. As Zhi Dong writes, the sentiment numbers we all read about can be broken down into two components¹:

Sentiment derived from economic fundamentals – the part of what the studied subjects say that correlates with widely reported economic drivers like GDP and inflation.

Residual sentiment – the "extra" sentiment not tied to fundamentals but driven by perception.

With those two pieces of sentiment in hand, Dong mapped them against real estate returns. She used the institutional lens of measuring total return as income plus appreciation. The research clearly found that total return and appreciation both were explained better by overall consumer sentiment than any other measured factor of the many she tested. That’s an interesting finding. More interesting was that residual sentiment—the component of how people feel that isn’t explained by economic news—explains the bulk of fluctuations in appreciation.

Income return was different, was not as well explained by sentiment, but was well-predicted by macroeconomic indicators. Income return is a function of leases and operating expenses, which the author posits are a function of the economic environment, as opposed to purchase and sale prices, which this study reveals are also influenced by exogenous factors (a thought that this newsletter has begun to explore as well).

A caveat to this is the scope of the study. The author used data only from New Zealand, where she is a professor. She used the same summary measures of income and appreciation and total return that US institutional investors use (e.g. NCREIF). Also, her analysis reviewed industrial, retail and office property transactions; multifamily and hospitality were excluded. Our editorial opinions when we read this were “Whoa” and “Others should confirm what she’s discovered.”

The take-away: Relative to other asset classes that have long and deeply studied histories, commercial real estate is young and drivers of returns are still being explored. That means non-intuitive truisms are still ripe for discovery. Such it may be with consumer sentiment - this study was quite clear in its results.

If you want to fold consumer sentiment into your modeling, a good place to start that journey is this longish but informative Brookings article. Also following the two major indices of consumer sentiment would be smart; they are here and here.

The Rake

Three good articles.

• Rents Start Turnaround as Permits Plummet - Globe Street

  Multifamily in the top 50 metros may be on the cusp of a significant shift. Dramatically reduced permitting has created supply constraints in many metros where rents are already rising. Demand for larger rental units remains strong, with two-bedroom units experiencing 18.3 % rent growth, likely driven by barriers to home ownership.

• Industrial Firms Increasingly Choose Ownership Over Renting - BisNow

  Industrial property owner-occupier sales surged 32% in 2024, with 2,504 transactions totaling an average sale price of $152.42 per square foot, driven by long-term cost savings and customization opportunities.

• Colorado Lawmakers Target Condo Shortage - CRE Daily

  Colorado lawmakers are advancing a bill to revive the state's condo market by modifying construction defect laws, proposing to better shield builders from lawsuits and reduce legal risks. The legislation aims to address the dramatic decline of condos, which now make up only 3% of the housing stock.

The Harvesters

Someone making real estate interesting. They don't pay us for this, unfortunately.

Who: Flock Homes

What: Flock acquires homes in 721-exchange transactions, which means sellers can fully defer capital gains taxes while trading their houses for ownership interests in Flock’s diversified portfolio of homes. Home “sellers” exchange their single idiosyncratic asset for shares in a professionally managed fund. The shares are easy to split up for estate purposes and get a step up in basis when the seller passes away.

The Sparkle: Flock is one of several companies doing things like this, but its core competency is making the process easy, fast and inexpensive for the customer, something Flock’s competitors aren’t focused on. Flock’s transparency is admirable.

From the Back Forty

A little of what’s out there.

From the fascinating world of physics.

Underwater gliders are real. Without propulsion, they change their buoyancy to move vertically in the water while the wings translate that force into forward momentum. They can quietly travel 25 miles in a day and stay under water for weeks at a time.

Link: https://oceanservice.noaa.gov/facts/ocean-gliders.html

Editor’s Note: The Real Estate Haystack believes in sharing valuable information. If you enjoyed this week's newsletter, subscribe for regular delivery and forward it to a friend or colleague who might find it useful. It's a quick and easy way to spread the word.

1  Zhi Dong (21 Jan 2025): Which Is More Helpful in Explaining Commercial Real Estate Return: Fundamentals or Consumer Sentiment?, Journal of Real Estate Portfolio Management, DOI: 10.1080/10835547.2024.2443881