Why You Should Be As Optimistic
(As I Am)
About Commercial Real Estate for the Next Few Years
By: Craig Franzen
Real Estate Has Been a Star Performer:
- Over the last five years, high returns have been delivered on the back of strong and improving fundamentals and a gradually recovering economy.
- Real estate fundamentals continue to improve. Balance sheets of most firms have been steadily strengthening with increasing margins, profitability, and top line growth.
- Commercial real estate supply still remains quite low by historical standards. NOI is growing, which is supporting increased property values.
Factors Comprising My Optimistic Outlook
Economy and Interest Rates:
- Net Job Growth should be 2.9 million per year over the next several years, compared to the long-term average of 1.2 million. Expected drop in unemployment to below 5% in 2016 should lead to healthy wage growth.
- The 10-year U.S. Treasury Note will average 3.0% vs. a long-term average of 4.1%. Though this is an increase over the current low rate of about 1.76%, (as of February 8, 2016) it would be very low compared to the historical average of 4.1%. However, the forward yield curve still implies a rate of about mid-2%.
- The recent volatility and deflationary aspects of the oil price plunge probably indicate that the Fed’s announced ‘4 raises in 2016’ guidance will most likely be 1 or 2 raises—stay tuned.
Capital Markets:
- CMBS issuance should rise to $150 billion in 2017, compared to an average of $71 billion, but will remain well below the peak of $229 billion before the “crash”
- With banks and insurance companies also active, real estate lending will remain competitive and favorable for borrowers. This is good news for the many borrowers with loans coming due over the next three years.
Price Appreciation and Returns:
- Chicago-area has recorded $3.6 billion in retail sales, which is a 32% increase YOY, making it the third (3rd) largest U.S. market for investment activity, only behind New York and Los Angeles.
- Of the $3.6 billion in retail sales, $2.255 billion or 62% was sold in Cook County alone.
- Chicago is also the fifth (5th) market destination for foreign retail investment activity with $492 million in 2015, behind only San Francisco, Los Angeles, Manhattan, and Miami.
- Given the strong demand for commercial real estate, there does not seem to be a fear of commercial price correction. Plus NOI is growing, which is supporting increased property values.
- Chicago is also very appealing to investors because it’s relatively “cheap” compared with cap rates in coastal markets like New York (3.25% – 4%) and San Francisco (4.25% – 4.75%).
Conclusion – “Cautious” Optimism:
Don’t get me wrong; a lot of things could go awry. The current strong economic and property market fundamentals and the orderly wind-down of monetary stimulus may not last. In these latter days of the economic cycle, economic downturns, foreign crisis, interest rate spikes, geopolitical crises, and much more, events could derail this optimistic view. But even though any of those rough currents could surface, I believe we have a few more strong years ahead.