Urban Land Institute forecast sees three years of continued strength for commercial real estate
Three more years of favorable real estate conditions in the U.S. That's the main message in a new three-year forecast by the Urban Land Institute (ULI) Center for Capital Markets and Real Estate in Washington D.C.
According to the outlook — the latest installment of the semi-annual ULI Real Estate Consensus Forecast — the commercial real estate industry is expected to remain on a course of solid growth for 2015 through 2017. The outlook is based on a survey of 43 of the industry’s economists and analysts representing 32 of the country’s real estate investment, advisory and research firms.
It was released Wednesday in conjunction with a ULI-sponsored Webinair of real estate panelists. Some of them said the “Goldilocks” outlook was deserved considering that some real estate sectors are seeing returns of as much as 10 percent on investment and that new construction has been held in check since the Great Recession of 2008-09.
“This cycle has seen much less new development than what we’ve seen in other recoveries,” said Lisa Pendergast, managing director and co-head of CMBS strategy and risk. “In some ways, that’s likely to continue given the souring outlook globally … I am in the Goldilocks campus … We’re in a better position, because we haven’t seen an excessive amount of new supply although we are starting to see some overbuilding in multifamily.”
Asked what might derail the positive environment through 2017, the panelists expressed concern over action the Federal Reserve Bank might take in raising interest rates.
“The biggest risk in my mind is the Fed,” said Tim Wang, director and head of research for Clarion Partners. “If you look at past recessions, the Fed tightens. If they tighten too fast and too steep, we have a contraction. We are watching that closely … This recovery has been shallow, about 2.5 percent… compared to the past of 4 percent, or about half of the strength. We are in the camp that the next recession won’t happen until 2019-2020, so there’s a few more good years before we expect a downturn, and there are opportunities ahead.”
An analysis of the survey findings by ULI leader William Maher, director of North American strategy for LaSalle Investment Management in Baltimore, highlights areas of the industry and overall economy that are generating the most optimism for 2015 through 2017:
• Net job growth is expected to be 2.9 million per year, compared to a long-term average of 1.2 million. Demand for real estate, particularly office and apartments, will remain strong. Low unemployment rates should lead to healthy wage growth, although shortages of skilled workers may surface.
• The rate for 10-year U.S. Treasury notes will average 3 percent over the three-year period, lower than the long-term average of 4.1 percent, but rising significantly over the forecast period.
• Issuance of commercial mortgage-backed securities is expected to rise to $150 billion in 2017 (rising from $115 billion in 2015 and $133 billion in 2016). 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,” Maher notes.
• Commercial real estate prices as measured by the Moody’s/RCA Index are projected to rise by an average of 7.6 percent per year, compared to a long-term average increase of 5.3 percent, implying three very strong years of net appreciation for U.S. real estate.
• Warehouse rents and hotel revenue per available room (RevPAR) are expected to be leaders among the major property types, growing by an average of 3.6 percent and 5.3 percent over the three-year period — well ahead of their historical growth rates.
• The total return rate for core unleveraged properties as measured by the National Council of Real Estate Investment Fiduciaries (NCREIF) is projected to average 9.9 percent during 2015-2017, which is significantly higher than the expected average yield for U.S. Treasuries.
Mayer did point to some areas of concern, including the likelihood of higher short-term rates squeezing investment returns and causing an increase in capitalization rates.
Still, the findings suggest more reasons for hope than worry, he says. “In summary, almost all U.S. real estate participants would be very pleased if the future unfolded as predicted by the ULI consensus forecast,” Mayer said in a statement. “The forecast represents almost the perfect combination of strong economic and property market fundamentals, combined with an orderly wind-down of monetary stimulus.”
Although the potential exists for progress to be hampered by obstacles such as economic downturns, foreign crises, interest rate spikes, or oversupplies, “real estate pros predict three more years of smooth sailing for U.S. real estate,” Maher said.
In general, the performance of most commercial property sectors, as measured by vacancy rates, rental rates, total returns, and product availability is expected to exceed or hold close to the 20-year (1995-2014) averages for each category. Key predictions by commercial property type:
• Office — The forecast predicts a continuing decline in office vacancy rates, dropping from 13.9 percent in 2014 to 13.0 percent in 2015, 12.5 percent in 2016, and 12.0 percent by the end of 2017. Survey respondents expect rental rates to rise by 4.0 percent in 2015, 4.1 percent in 2016 and 3.5 percent in 2017.
NCREIF total annual returns for the office sector are projected to be 11.8 percent in 2015, 10.0 percent in 2016 and 9.0 percent in 2017.
• Apartments – Apartment vacancy rates are forecast to rise marginally from 4.6 percent in 2014 to 4.7 percent in 2015, 5.0 percent in 2016 and 5.3 percent in 2017. Survey respondents expect rental rates to rise by 3.5 percent in 2015, 3.0 percent in 2016 and 2.7 percent in 2017.
NCREIF total annual returns for the apartment sector are projected to be 9.0 percent in 2015, 8.3 percent in 2016 and 8.0 percent in 2017.
• Retail – Retail availability rates are forecast to drop from 11.4 percent in 2014 to 10.9 percent in 2015, 10.5 percent in 2016 and 10.2 percent in 2017. Survey respondents expect rental rates to rise by 2.0 percent in 2015, 3.0 percent in 2016 and 2.9 percent in 2017.
NCREIF total annual returns for the retail sector are projected to be 10.9 percent in 2015, 10.0 percent in 2016 and 8.4 percent in 2017.
• Industrial/warehouse – Industrial/warehouse availability rates are forecast to drop from 10.3 percent in 2014 to 9.8 percent in 2015, and to 9.6 percent for 2016 and 2017. Survey respondents expect rental rates to rise by 4.0 percent in 2015, 3.8 percent in 2016 and 3.1 percent in 2017.
NCREIF total annual returns for the industrial sector are projected to be 12.0 percent in 2015, 10.5 percent in 2016 and 9.5 percent in 2017.
• Hotel – Hotel occupancy rates are forecast to rise from 64.4 percent in 2014 to 65.2 percent in 2015, and to 65.6 percent in 2016 and 2017. RevPAR rates are expected to rise 7.0 percent in 2015, 5.0 percent in 2016 and 4.0 percent in 2017.
• Single family – Predictions for single-family housing suggest that the residential sector remains in recovery mode. Survey respondents expect housing starts to rise from 647,400 in 2014 to 700,000 in 2015, 815,000 in 2016 and 900,000 by the end of 2017. The average price for existing homes in the U.S. is expected to rise by 5.0 percent in 2015, 4.0 percent in 2016 and 4.0 percent in 2017.
The market survey, conducted last month, is the seventh in a series of polls conducted by ULI to gauge sentiment among economists and analysts about the direction of the real estate industry. The next forecast is scheduled for release during October 2015.