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Spring Market Update: Are the Bulls Still Running in CRE?

Are the Bulls Still Running in Commercial Real Estate?

Despite the recent roller coaster ride on Wall Street, the latest round of Commercial Real Estate industry surveys points to continued optimism ahead for commercial real estate over the next 12 months.

Both NAIOP and the Urban Land Institute have released new surveys that support a favorable outlook for property fundamentals, and despite signs of slowing growth, a relatively healthy investment climate. The research reports were released just prior to the May 1st Federal Open Market Committee (FOMC) meeting where the Fed confirmed that it would not make a move to raise – or cut – interest rates. The favorable interest rate climate bodes well for strong liquidity and access to capital that likely will continue to fuel acquisition and development activity.

The NAIOP CRE Sentiment Index for Spring 2019 dipped from a reading of 0.66 in Fall 2018 – the highest level for the Index since the survey first started three years ago – to its current level of 0.56.

What does that number mean for CRE? In short, a flat line of zero translates as no change ahead, while anything that falls into negative territory reflects a pessimistic view. So, the positive index level indicates a favorable view of commercial real estate market conditions in the coming 12 months. The current level also is in line with what has been a tight range for the Index over the past three years that has spanned from a low of 0.47 to the high of 0.66.

Other key findings from the NAIOP survey include:

  • Respondents agree that debt and capital will be plentiful over the next 12 months. Both debt and equity availability rated high index scores of 1.63 and 1.60 respectively.
  • Rising construction labor and material costs remain a significant concern for developers. However there was a slight improvement compared to the fall survey. For projects where they are seeking bids, respondent views were unfavorable at -2.15 for both rising material and labor costs.
  • Occupancy rates will continue to improve, although at a more tempered pace than in previous surveys with an index score of 0.63 as compared to 0.95 in the fall survey.
  • Face and effective rents are expected to continue to rise at a modest rate over the next year with an index level that declined slightly to 1.53 for face and 1.08 for effective rates.

Anecdotal responses garnered from the survey also show mixed views. People tend to be optimistic about the availability of capital, while still concerned about the possibility of a recession and slowing growth.

“We see a continuing disconnect between values determined by historically low cap rates, and the risks and realities of capital requirements to keep multi-tenant buildings well occupied and maintained”

NAIOP Survey Respondent

ULI’s Spring Real Estate Economic Forecast pushes the likelihood of a recession out beyond 2021. The report anticipates that growth will continue, albeit at a slower rate, through 2019, 2020 and 2021. Moderating growth in GDP and jobs growth over the next three years should lead to slower but still positive real estate demand and absorption. GDP is forecast to slow to 2.3% this year and hold at 1.8% in both 2020 and 2021.

Some of the ULI Forecast’s key findings for real estate include:

  • Transaction volume is projected to moderate from $562 billion in 2018, the second highest post-recession annual volume, to $535 billion in 2019 and $500 billion in 2020.
  • Commercial real estate prices will likely grow at slowing rates relative to recent years, at 5.0% in 2019, 3.7% in 2020, and 2.8% in 2021, with the latter two years falling below the long-term average growth rate of 4.4% for the first time since 2011.
  • Capital remains cheap. The 10-year Treasury rate is expected to increase slightly to 2.9% in 2020 and 2021.
  • Industrial continues to be the top performer among all the property types. Availability rates for the industrial and warehouse sector are expected to reach a new post-recession low of 6.9% in 2019 before moving up to 7.0% in 2020 and 7.1% in 2021. Forecasts are for healthy but moderating rental rate growth the next three years.
  • The apartment sector has continued to perform very well with vacancy rates decreasing from 7.0% in 2009 to 4.5% in 2018. Vacancies are expected to increase slightly each year of the forecast period to 4.6% in 2019, 4.8% in 2020 and 4.9% in 2021. Rental rate growth, which was 2.8% in 2018, will moderate to 2.2% by the end of 2021.
  • Office vacancy rates are projected to rise in the coming three years, while rental rate growth will drop. Vacancy rates are forecast to hit 12.5% in 2019; 12.8% in 2020; and 13% in 2021 – all of which remain below the 20-year average of 13.9%.
  • Retail vacancies are expected to inch higher from 9.0% in 2018 to 9.1% by year end, followed by nominal increases to 9.2% and 9.4% in the following years. Rental rate growth is expected to moderate from its 2018 level of 2.4% to 1% by the end of the forecast period.

Overall, the outlook for Commercial Real Estate remains bullish, especially considering the length of the current recovery cycle. Yet it also is important to put research in the context of some of the micro and macro risks lurking under the surface that could shift these projections. One wild card is whether recent fears over the trade war with China will push investors to the sidelines, or alternatively, drive more demand for real estate as investors look for a safe haven amid market volatility.

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