2016 Continues to be a Year of Strong Performance in Commercial Real Estate
While macro-economic uncertainty and global instability may grab headlines, commercial real estate fundamentals and pricing continues to grow and expand according to second quarter results of major real estate data providers REIS, Inc. and CoStar Group. Overall with limited exceptions, all major sectors of commercial real estate experienced positive net absorption, declining vacancies, and positive rent growth in the second quarter of 2016, continuing a growth trend that has been in place for several years now according to REIS, Inc. The leading sector, in terms of rent growth, was multifamily with an approximate 1% growth in effective rents while office, industrial, and retail all experienced rates around 0.5%, which is just above estimated inflation. The improvements come as a result of sustained, stable new demand and limited new supply. In fact, REIS, Inc. reports that in the second quarter, completions of new apartment units, office space, and retail space fell in year over year measures as the overall pace of new construction slowed slightly. Census Bureau data also showed an overall rate of decline in volume for construction spending in all categories as well.
Slow and Steady Growth Through 2Q ’16
Thus, the markets are facing a continued dynamic of slow, but meaningful demand growth with relatively slower rates of new supply expansion; thus the result of higher rents and lower vacancies is entirely logical. Further, this condition of relative undersupply is only likely to get worse before getting better as capital markets remain constrained in financing new developments. So for now, tenants will be the losers and landlords the winners. Of course, the lack of quality, available vacant space in some markets is actually forcing firms to move markets to expand and thus causing some pain in some municipalities’ economic development initiates. Enterprising developers in certain markets may find great reward in speculative development at this stage of the cycle.
Pricing of commercial real estate assets also showed growth in the second quarter of 2016. CoStar Group reported a quarterly gain in pricing of 2% which represents a reversal from the first quarter which saw modest declines. CoStar’s value-weighted US Composite Index, which is more representative of large institutional grade assets, was up 3.3% quarter over quarter; while the equal-weighted US Composite Index, more inclusive of smaller properties, rose by only 2.1% in the second quarter. All property types were positive with apartments being the year over year leader at 8.5%. While all pricing results were positive, the rate of growth for 2016 is slower than 2015, but still pointing to the potential for 2016 to be a record-setting year.
Supply, Demand, and the Strengthening Job Market
The most recent quarterly results highlight the fact that supply and demand fundamentals are driving the commercial real estate markets despite turbulence in the capital markets, tightness in the lending environment, and even macro-economic slowdowns. Thus, it is logical to expect most markets to show resilience in the face of continued uncertainty. Of course, national job growth, which showed the initial signs of a slowdown, has rebounded back to strong positive growth in the past two months which is a positive indicator of real estate demand increasing in the near future. Overall, investors should be most concerned with monitoring localized oversupply or idiosyncratic demand pullbacks as the nation appears very stable and relatively healthy.
The next shoe to drop could be the Federal Reserve resuming their planned interest rate hikes given the positive hiring results of June and July. This could of course impact commercial real estate by raising cap rates and increasing the index rates of new loans. Since today’s cap rate spreads to treasury rates remain relatively wide, there need not be significant impact from such events but are nonetheless a source of risk, especially to pricing.