Lower for Longer: Report predicts solid real estate market performance for several years to come.
In the latest presentation of the RealNex Webinar Series, Dr. Glenn Mueller presented the latest findings of his Real Estate Market Cycle Monitor. The Market Cycle Monitor tracks supply and demand across the top 54 US markets in the primary real estate investment asset classes providing insight as to where we are and what to expect in the months and years to come. The Monitor rates markets along a continuum from Phase 1 – Recovery, to Phase 2- Expansion, Phase 3 – Hypersupply and Phase 4 – Recession. The Demand Analysis is driven by GDP Growth and Employment, while Supply tracks actual new and pending delivers as well as obsolescence.
With Employment Growth continuing to run strong and steady and credit markets keeping supply under control, the vast majority of markets remain in Phase 2 - Expansion. And, the outlook remains bright for commercial real estate markets nationwide. The Theme of this Expansion was characterized as “Lower for Longer”. Employment growth is expected to continue apace, buoyed by steady GDP growth of 2% through at least 2021. While the current US expansion is now passing its 10th year, it is still far short of the record held by Australia at 26 years. Indeed, cycles can run long. A potential drag on employment growth is expected in 2020-2021 as a result of a wave of Baby Boom retirements, although this should be short-lived as an even larger wave of new employees quickly enter the market.
The Market Cycle Analysis focuses on real estate asset performance from three key metrics: Occupancy, Rents and Prices. Generally speaking, if the economy expands, real estate markets tend to improve and continue to do so until over-zealous developers and lenders over-build right into the face of the economic slow-down. Then we dig ourselves out and do it all over again.
The Four Phases of the cycle can be characterized as follows:
- Phase 1 – Recovery – Declining Vacancy, No new construction
- Phase 2 – Expansion – Declining Vacancy, New Construction
- Phase 3 – Hypersupply – Increased Vacancy, New Construction
- Phase 4 – Recession – Declining Vacancy, Construction Completion
Historically, this resulted in a boom/bust market cycle. However, this time given the slow and steady economic growth and the constrained development pipeline, we are in somewhat a “Goldilocks” era which looks to continue in balance for some time and even if the economy slows it won’t be in the face of massive overbuilding…at least yet.
Presently, even after 10 years of steady real estate market growth, the vast majority of markets remain in the Expansion Phase.
- In the Office Sector, 4 markets are in Recovery (Chicago, Stamford, N. New Jersey and DC) and 1 is in Hypersupply (Houston), with the 49 others all in Expansion.
- The picture is even better in Industrial where 52 markets are in Expansion, with only 2 (Denver and San Diego) in Hypersupply.
- The Apartment market cycle is most advanced, as easy government agency money has already led to an early stage of over-building and rental growth deceleration. 22 Markets remain in the late phase of Expansion with 32 now in Hypersupply.
- Retail is a bit of a surprise. 51 markets are in Expansion, while 3 have moved to Hypersupply. A dearth of development, the repurposing of assets and stealth growth of new concepts has resulted in the overall market health.
- Hotel has been hot, with occupancies rising into the mid-70% range resulting in an early stage of Hypersupply. 19 markets are now in Hypersupply with 33 still in Expansion and 2 in Recovery
Based on Dr. Mueller’s work, the future remains bright for market fundamentals and values. With expected flat to rising interest rates, capital seeking yield and appreciation remains very interested in real estate as an asset class. Rental and Occupancy growth, which tend to move hand-in-hand, are expected to run in the 2-3% range with cap rates holding steady. Indeed, when looked at it from global perspective, cap rates in the US are still quite low given the risk and liquidity profile.
The Real Estate Cycle Monitor Forecasts:
- Office Markets will remain strong, with 52 Markets in Expansion. Only the booming Austin market will join Houston in Hypersupply.
- With continued steady demand and just-in-time development, Industrial markets are expected to remain strong for several years to come although rental growth should moderate. 49 Markets are forecast to remain in Expansion, with Ft. Lauderdale, Portland and Riverside added to the Hypersupply list.
- From its peak of 6% rental growth, Apartments are now running below 2% with the vast majority moving into Hypersupply. 13 markets are expected to move into Recession Phase.
- Retail, with peak occupancy at over 95%, virtually no new development, continued conversion and slow but steady demand, 52 markets are expected to remain in Expansion.
- After the boom, Hotel markets are now expected to be equally split between Expansion and Hypersupply.
Given this back drop, income growth for all property types is expected to grow at least through 2020 and potentially through 2022. Capital will continue to chase quality yield. Any possible tick up in cap rates should be offset by even faster growth in rents supporting continued asset value appreciation even above current peak levels.
Please click the link below to access the recording and presentation deck.
