Previewing Friday’s Jobs Report and What It Means for Real Estate

[From June, 2021] The May jobs report will be coming out on Friday and may have large implications for the future path of interest rates and real estate valuations. Consumer prices recently jumped the most since the summer of 2008, 4.2% for the year, up from 2.6% in the prior month. April’s jobs report was unexpectedly weak, the economy only added 266,000 nonfarm payrolls, well below the forecasted 1 million jobs that economists had expected.

Friday’s report will be the first sign of whether or not April’s anemic jobs report was an aberration or the start of a broader trend. Economists expect that the American economy will add 674,000 nonfarm payrolls. While this would be a significant increase over the April jobs number, at this pace it would take the U.S. labor market one more full-year to return to its pre-pandemic employment levels. 

Friday’s jobs report is especially important for real estate. In April, residential housing starts fell 9.5% month-over-month and single-family housing starts fell 13.4% month-over-month. New housing starts are being held back by high material costs, a scarcity of labor, and supply-chain constraints. A strong May jobs report could budge the Federal Reserve closer to tapering its $120 Billion bond buying program. A decrease in bond purchases from the Fed will most likely lead to a rise in borrowing costs for most Americans and companies. 

Last month the U.S. median home price leaped 19.1% year-over-year to a record $341,600. About 90% of single-family homes that were sold in April were on the market for less than one month and in January and February, 28% of single-family homes sold above their list price according to Zillow. This is up from an average of 14.2% of homes that sold above their list price in 2019. 

A big driver of rising single-family home prices has been low interest rates, the result of accommodative monetary policy from the Fed. Any suggestion of a change in this policy from Federal Open Market Committee members, the monetary policy-making body of the Fed, will be sure to increase benchmark borrowing rates. 

Randal Quarles, the Fed’s Vice-Chair for Supervision recently said, “If my expectations about economic growth, employment, and inflation over the coming months are borne out… it will become important for the Fed to begin discussing our plans to adjust the pace of asset purchases…”

The Fed will be looking to the May jobs report to try and find the perfect equilibrium between labor supply and demand. As federal enhanced unemployment benefits start to expire over the coming months, the Federal Reserve will be hoping that the country’s labor force participation rate starts to pick up. If the labor force participation rate does not start to rise, labor shortages will push wages, and as a result property operating expenses and total development costs, up even further. 

The potential of rising borrowing costs and wages increasing at an even more accelerated pace than they are now, present a plethora of challenges for real estate owners. What is fueling the current housing boom for single-family and multifamily properties, could also be what ultimately leads to its demise. If interest rates start to rise, any person or company that bought a property when borrowing costs were historically low, could have a tough time refinancing or selling their property. A string of strong jobs reports may lead to this situation sooner than most economists were anticipating.   

Think of a value-add owner, a company who goes in to buy a property with the intention of renovating the asset and raising rents, and subsequently refinancing the original loan and equity out at a higher valuation. If a value-add multifamily buyer purchases a property today, using excess leverage to buy an asset at a historically low cap rate, with the intention of refinancing their investor’s proceeds out in 24 months, they could easily end up with a property that is worth less than the remaining principal on the outstanding loan. 

Rising cap rates fueled by higher borrowing costs would cause valuations across property types to compress. Rising prices would also lead to higher operating expenses, resulting in lower NOI, and as a result even lower asset prices. 

While April’s jobs report was unexpectedly weak, March’s was stronger than expected. What real estate companies should be looking for in the upcoming jobs report is whether, April’s report represented a temporary deviation and expanded unemployment benefits were encouraging workers to stay home or is the economic reopening post-Covid a more turbulent process than economists forecast. 

If May’s report turns out to be a blockbuster one, showing that the economy and labor market is recovering swiftly from the Covid induced recession, fixed-income yields and interest rates should remain muted for the time being. This would appease worries about the effect of expanded unemployment benefits on the labor market.

If the jobs report misses to the downside for the second consecutive month, investors and monetary policy makers will start to believe with more conviction that the cause of the slowing labor market recovery is rooted in expanded federal unemployment benefits. This could lead to a more permanent uptick in long-term inflation expectations, due to longer-lasting rather than transitory labor shortages, and rising interest rates in the coming months.

Either way, real estate professionals should pay close attention to how May’s and subsequent labor reports will effect borrowing costs and pricing pressure. Both variables will have a direct impact on valuations and how operators go about executing their business plans on properties going forward.