The outlook for the year in commercial real estate is cautiously optimistic, as several signs of excess that cause market corrections begin to amass, according to the 2018 edition of Viewpoint, an annual commercial real estate trends report released by Integra Realty Resources (IRR).
Annual job growth dropped from 2.3 percent in early 2015 to 1.4 percent in October 2017, while real weekly incomes rose only 0.4 percent for the 12 months ending in October 2017. Production and non-supervisory workers saw an even smaller rise of only 0.3 percent during this time.
These levels were not enough to spur consumption significantly in 2017, with personal consumption expenditures (69.4 percent of GDP) in the third quarter up only 2.3 percent from the prior year. If the market continues in this direction, corrections may be imminent, IRR warns.
“In the short term, we find the commercial property markets solidly in their ‘expansion phase’ in most areas of the country, but now is the time for real estate owners and investors to begin thinking about defense strategies,” says Hugh Kelly, veteran commercial real estate economist and contributor to the report. “However, it should be a less severe downside for the commercial real estate industry than the downturn in 2008 thanks to more disciplined buyers.”
Even with a slower market, commercial property prices rose on average 8.4 percent, signifying more cautious selection rather than any withdrawal of capital in the commercial real estate investment marketplace.
Office
The office sector saw another year of solid absorption in 2017, with the U.S. workplace continuing to see demand from finance, professional and business services, alongside start-ups utilizing co-working space.
A decline in office transaction volume through the first three quarters of 2017 — which included an overall drop of 6 percent or $94.5 billion — is evidence of greater buyer discipline, according to the report. The country saw a shift in investor demand from downtown offices to suburban properties as central business districts are becoming fully priced.
Heading into the new year, 48.4 percent of suburban markets were in expansion — the highest level since the financial crisis.
The report suggests that, while all is currently well, future demand may be attenuated for office space. The year ahead faces the constraint of a 4.1 percent unemployment rate and an employment-to-population ratio of 60.1 percent — the highest since 2010. Offices may be vulnerable in the years to come if the finance and tech sectors face a down-cycle, making defensive planning a wise decision moving forward.
Industrial
Industrial is cited as a “capital magnet,” driven by increasing levels of e-commerce and global trade. Entering 2018, the industrial property sector has outperformed all other property types with double-digit returns, high absorption rates, rising occupancy and rent growth.
Through the first three quarters of 2017, industrial transactions totaled $51.8 billion, up 23 percent over the same period in 2016. The report also shows that 83 percent of national markets are in expansion mode, with four markets expecting 5 percent market rent growth: Cleveland; Hartford, Conn.; Kansas City, Mo.; and Seattle.
As a sector, industrial seems to be in a mid-cycle stage rather than late-cycle, and appears to have the opportunity to sustain strong cyclical momentum through 2018 and beyond, IRR reports.
Retail
Trading velocity is slowing in the retail sector. Real Capital Analytics data for the first three quarters of 2017 tallied at $46.9 billion in shopping property transactions, down 19 percent from the same period in 2016. In contrast to office, the number of assets trading hands was down as well, declining 9 percent to 4,620 properties.
Aggressive asset management versus portfolio growth is the key to success for retail investors, according to the report, as retailers continue to be disrupted by e-commerce alongside shifting demographics and consumer spending habits.
The majority of markets in the Western United States are in an expansionary market cycle phase. The top markets ranked by year-over-year transaction growth rate are Las Vegas; Stamford, Conn.; Broward, Fla.; Austin, Texas; and Hartford, Conn.
For 2018, 66 percent of national markets are considered ‘in balance’ and an additional 25 percent are within two years of becoming ‘in balance.’ On average, markets are expected to see a 2.2 percent increase in retail rents over the next 12 months, and 74 percent of markets should expect to see cap rates remain stable, according to the report.
Hospitality
IRR predicts a slow in the hospitality sector after an eight-year bull cycle. Fundamentals remain strong enough to forecast stability, but slow growth is expected during 2018.
Hospitality transaction volume dropped 25 percent over the first three quarters of 2017 to $31 billion. Industrial consolidations are expected to continue, as brands believe that a larger system can lower reservation costs and expenses.
IRR predicts that asset value growth will be seen in 75 percent of hotel markets during 2018, while cap rates will remain constant in 71 percent of markets and rents will grow at 3.3 percent.
Multifamily
Momentum is slowing in the multifamily sector, as displaced demand from the single-family housing sector has now been accommodated and the pace of employment growth is decelerating.
Overall transaction volume from the fourth quarter of 2016 to the third quarter of 2017 was $150.6 billion — down year-over-year by 9.8 percent. The report shows that 91.9 percent of markets are in expansion phase, with a shift to hyper supply due to strong development volume seen in Baltimore; Washington, D.C.; and Atlanta.
Integra predicts that market rents will increase on average by 2.45 percent, and 24 percent of markets are forecasting higher cap rates for the year ahead.
— Katie Sloan