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Commercial Real Estate Markets notch another record in Q4 2019

Posted by Jeff Finn on Feb 24, 2020 8:17:20 AM

On February 20, 2020, RealNex presented its quarterly Commercial Real Estate Market Update, hosted by CEO Jeffrey Finn and featuring Head of Data and Research Dr. Jeffrey Fisher. The session focused on year-end 2019 data and findings based on Dr. Fisher’s work with the National Council of Real Estate Investment Fiduciaries (NCREIF) and supported by data from CBRE, Costar and Oxford Economics among others.

Investment real estate continued to perform well and is expected to continue far into if not through 2020. Cap Rates are at record lows and values at record highs. Capital remains abundant, new supply under control and a strong economy continues to fuel demand.

From a macro perspective, some warning signs are beginning to emerge with GDP expected to cool in 2020. The slow-down could be further exacerbated by Coronavirus which is already expected to shave 50bp off of growth before returning to the long term 2% trend level in 2021. This slow-down could put a damper on demand for space and goods but will also result in the continuation of accommodative money supply. Interest rates may even drop further in 2020, before beginning to slowly tick back up in 2021-2023.

Even with the low interest rates keeping mortgage interest rates low, a generation burdened by student loans and lack of sufficient capital for required down-payments continued to hold back home ownership. At 65% we are well off the 2016 low of 62% but still far from the 69% peak reached in 2006. Expectations are homeownership to normalize in the 67% range.

While industrial real estate markets continue to be the best performing, growth in demand for space is beginning to slow. After dropping precipitously from approximately 4% in 2019, growth in industrial demand is expected to be flat in 2020.

Largely driven by growth in NOI, the unlevered NCREIF Property Index was up 1.5% in the fourth quarter of 2019. Even at historically low levels Cap Rates ticked down further to add to the gains in the index. At 4.5% Cap Rates remain 50bp above the BAA bonds which indicates fair pricing and the potential to tick down slightly. However, going forward the majority of gains are expected to be driven by NOI growth and any future uptick in Cap Rates to be offset by strengthening property cash flow and performance.

The best performing sector by far in Q4 was Industrial at 3.15% with multi-family and office in the 1.5% range, while retail (.65%) and hotels (.17%) were weakest. Interestingly, from 2014 - 2018 the industrial market growth rate widened vis a vis other sectors, but has begun to tighten with industrial slowing slightly the others improving slightly.

Boding well for the markets is that new supply remains in check. Only new apartments have been built above historical trend lines. All other sectors have been delivering new space far slower than in prior decades. Coinciding with the limited new development, Cap Ex for existing space is spiking with landlords competing aggressively to fill inventory. Indeed, vacancy rates continued to trend down to just below 6%. The market strength is not only across product types but also across geographies, with only Houston below its 10-year average. Nonetheless a record amount of store closures in 2019 is expected to bring considerable “new” inventory to the market, more than likely for alternative use. In fact, by mid-year 2019, 6,555 stores were shuttered nearing the full year peak of 7,802 in 2015. Another potential impact is the curtailment of co-working space demand following the failed WeWork IPO.

With steady strong demand and limited new development NOI growth for Industrial properties lead all categories at 7.5% while retail dragged the index down with less than 1.0% growth. Office and Apartments clustered around the Index average of 4.0%.

All in all, the commercial real estate market is performing well and the outlook is strong for the near term.

Please click the link access a recording of the webinar and copy of the presentation deck.

Topics: RealNex Webinar Series