Oregon Office of Economic Analysis

Commercial real estate remains a key risk to the medium-term outlook. The combination of business closures, less foot traffic, and demand for office space points toward less new construction activity in the years ahead. Leasing demand for retail, office, and leisure and hospitality will need to rebound considerably for vacancy rates to decline and rents increase enough to justify the cost of new construction. Overall the strength in residential demand is expected to largely offset the weakness in nonresidential activity. As such the risks are predominantly to the downside depending upon the severity of the declines in commercial real estate.

That’s what our office wrote in the latest forecast (PDF pg 16, report pg 12).

A new report by PwC and the Urban Land Institute shows Portland’s relative ranking across the country plummeting when it comes to the real estate outlook. H/T to Willamette Week for flagging the report. Specifically in the new 2021 report, Portland’s overall real estate prospects rank 66th out of the 80 markets surveyed. This is a big drop from where Portland is normally ranked. As seen in the chart below, Portland tends to rank in the 60-80th percentiles of the annual reports, meaning the local prospects are expected to be better than around two-thirds of all markets in the report. The ranking of 3rd best in 2017 is an outlier. Even so, the drop in ranking is huge.

Note that the number of markets surveyed as changed over the years, going from 42 to 45 to 51 to 75 to 78 to 79 and finally to 80 markets in the last couple of reports. As such I am showing rankings on a percentile basis to keep the comparisons as apples to apples as possible.

Now, there is a bit of underlying data in the report. The survey asked real estate professionals to grade each market on a scale across different categories. In past reports these scores from each category were generally added up to create a total score, which was then ranked from highest to lowest. (The 2021 overall rankings don’t fit this pattern exactly, and I don’t see any methodology notes, but it’s still fairly close.)

What I was wondering was how does the Portland market compare to the median market in the reports. The next chart shows Portland’s composite score compared to that median or midpoint market. As you can see Portland tends to score 10-20% better than the typical market. Again, 2017 being an outlier. In the latest report, Portland scores 6% below the typical market. One interpretation here could be that Portland’s fall from grace in the overall rankings actually means it’s a little below the typical market’s prospects.

If we look at each individual category the markets are scored on, you can see that Portland is below the median market for each one. Portland’s average score for investor demand, availability of debt and equity, and the local economy are all about 4% below the median score. Portland scored 8% below the median for local public and private investment, and 10% below for development/redevelopment opportunities.

OK. So what does this all mean? That’s a bit hard to say. I think there are a number of factors at play.

First, commercial real estate tends to be more of a coincident or lagging indicator of the economy. I think you can see that in the Portland rankings in the first chart. By the mid-2010s Portland had already experienced one of the strongest economic recoveries in the country. Which, of course, then made it a ripe market for new commercial real estate investment in the latter half of the decade. And there was a lot of local development, particularly in multifamily in the urban core, and hotels as well. Despite being pretty small on a national scale, the Portland market consistently ranked among the top handful for the number of cranes being used for construction projects. With all the new developments, that alone would start to make Portland a little less desirable for new projects because of all the new space already coming online. As I’ve been telling audiences during presentations on the outlook, it’s going to be awhile before we build another office building, let alone a hotel. In the 2019 and 2020 reports, Portland had already dropped back down in the rankings.

Second, to the extent these rankings are predictive of future commercial real estate investments, the relative rankings may be more informative than the actual market scores. What I mean is that even if Portland doesn’t rank too low in the underlying data (see second chart), the fact that it ranks 66 out of 80 may be more a hurdle to overcome. While market fundamentals and financing matter, a good amount of real estate investment is also based on confidence. Outside investors — and a lot of large projects rely on them — can pick and choose from opportunities around the country. If Portland, for whatever reason, is deemed a bit more risky or less desirable, then those investments and projects flow to other markets.

Third, there are multiple narratives out there on what is impacting the Portland market and they can be a bit hard to disentangle. On the one hand there are the policy changes enacted by both elected officials (things like the state’s new corporate activity tax, local regulations regarding inclusionary zoning and renter relocation costs) and by voters at the ballot box (increased property taxes for the region, and a new income tax in Multnomah County). Each policy is certainly worthy of a debate on its merits, and the voters have spoken as well. Even so, to what extent do these changes impact the attractiveness of the Portland market? That’s really hard to tell today based on available data, but we need to be mindful of the potential impacts and trade-offs.

On the other hand, the other narrative is touched on in the new report itself. “[Portland, Louisville, and Seattle] markets were the sites of some of the most vigorous protests (and counter protests) over police brutality and racial equity — a possible reason for their lower rankings. Of course, there is a reasonable debate about whether these big shifts are permanent or temporary — and if temporary, how long they will last.” I would add in the wildfires as well, which is mentioned elsewhere in the report.

So if one were just looking at the rankings in the first chart, it’s clear that something happened in the past year. All of the other factors are ongoing and will have different sorts of impacts, but the abrupt change certainly seems to be more about what 2020 hath wrought. We talked a lot about this in our September forecast (starting on PDF pg 10).

In terms of the outlook, I think the report summarizes it well, both in terms of whether Portland’s ranking is temporary, but also in the overall outlook for larger metro ares. “While large cities are likely to struggle for several years, the COVID-induced pause in their appeal is not likely to be permanent… But, like many of the changes that have occurred due to the pandemic, the ultimate impact on the desirability of large cities will be on the margin.” That’s certainly our office’s and the consensus of our advisor’s baseline. We expect Oregon to remain an attractive place to live and work. However, the real threat to the economic and revenue outlook is what happens to our reputation longer term, and whether fewer migrants choose to live in the region.