CARLSBAD, CALIF. — As 2019 begins to take shape, commercial real estate investors across the country are starting to hedge their positions on the overall strength of the market, according to Real Capital Markets’ (RCM) 2019 National Investor Sentiment Report.
While investors remain optimistic about the overall fundamentals of America’s commercial real estate market, they are increasingly expressing cautionary tones, according to the report. There are still investment opportunities available as long as investors adjust their strategies, as suggested by survey responses.
“For the past decade we’ve experienced unprecedented levels of investment activity, with each year establishing another new record,” says Tina Lichens, COO of Real Capital Markets. “With words like ‘plateau’ and ‘flattening’ now entering the lexicon, it’s important to note how far the market has come and that in these good times, plateaus are part of a healthy cycle.”
Wayne Vandenburg, chairman and CEO at TVO Capital Management, an owner, investor and manager of multifamily assets globally, attributes the continued run in the investment markets to a strong U.S. economy.
“The only place you can be assured of business doing pretty well overall is in the U.S.,” says Vandenburg. “Due to the size of our economy, we aren’t insulated by the rest of the world. Comparatively speaking, we are the only country that is really rocking and rolling.”
The U.S. economy posted some of its strongest quarterly GDP growth of the cycle in 2018, closing the second and third quarters with 4.2 percent and 3.4 percent growth, respectively. Overall, GDP grew by 3 percent in 2018. American employers also added more than 300,000 new jobs in December 2018, ending the year of strong job gains on a particularly positive note.
Boom or Bust?
When asked to explain market dynamics, almost two-thirds of investors polled in the report said the market is not in boom-or-bust mode, but rather somewhere between those two extremes.
Buyers and sellers both expect overall levels of investment activity to gradually flatten, a trend that will likely be followed by price depreciation. Investors also view the fundamentals of the industrial and multifamily sectors as the most sound, thereby resulting in sustained, if not expanded, demand for those asset classes.
The fundamental need for housing continues to drive the multifamily market, regardless of broader market conditions. Approximately 36 percent of survey participants selected multifamily as the overall attractive asset class for investment.
Industrial real estate, with its stable outlook and increasingly close ties to e-commerce, remains a close second with 28 percent of the vote. The gap between multifamily and industrial for the gold medal did widen slightly over the last 12 months.
“The industrial sector continues to provide the stability and long-term growth that investors desire, particularly given the strong expansion in e-commerce,” says Steve Shanahan, executive managing director with RCM. “While investors are adjusting their criteria to account for market conditions, this sector should continue to be among the top performing asset classes.”
On a national level, a lack of overbuilding and a smaller supply of debt were key to the strength of the American office market. Investors noted that these trends represented challenges to the office market in past cycles.
“The market has been very good, but we are on the backside of the cycle,” says Jay Olshonsky, president and CEO of NAI Global. “We are already seeing a pullback in some areas, but we don’t expect to see steep declines.”
Interest Rate Factors
Despite rising interest rates, 65 percent of survey participants characterized their investment strategy for 2019 as “buy” or “buy but trending toward hold.” That sentiment is down from 2018, when 77 percent were focused on buying or buying/holding.
One prevailing school of thought on this strategy is that investment opportunities in primary and secondary markets are available, but often require more work to identify, underwrite and close.
Following the Federal Reserve’s most recent meeting in December 2018, the federal funds rate stands at 2.5 percent. Though the nation’s central bank has now executed nine consecutive hikes, rates are still at historic lows and most investors say the Fed’s monetary policy won’t change their position as buyers in 2019.
One perspective voiced by participants echoes a popular sentiment among investors of all types — strategies must evolve and adapt to changing market conditions. New approaches to buying include targeting properties with higher projected values at acquisition in order to maintain high debt-service coverage; buying different assets at higher cap rates to produce cash flow in the face of higher interest rates; and adjusting the amount of leverage on a property to keep capital costs lower.
Vandenburg of TVO Capital Management says further interest rate hikes will be detrimental to market activity. He believes increasing interest rates will cause the pace and volume of new construction to taper, slowing the economy and creating new challenges. At the same time, Vandenburg says that increasing interest rates make him want to accelerate the firm’s acquisition activity in the short run.
“Rates aren’t likely to get any cheaper in the near term,” he adds.
The RCM report concludes that at the start of 2019, commercial real estate investors are intently focused on identifying and creating opportunities that optimize the current market and economic conditions, while also looking ahead to some of the questions beginning to take shape. Regardless of the sector, investors continue to focus on deploying capital and fine-tuning their strategies to achieve the desired yields.
Read the full report here.
— Michael Millar