Wells Fargo Securities: Fundamentals Remain Favorable

Commercial real estate operating fundamentals continue to look favorable, reported Wells Fargo Securities, Charlotte, N.C.

“U.S. commercial real estate has become the asset class of choice, as investors reach for yield in a global, low-interest rate environment,” said Anika Khan, senior economist with Wells Fargo Securities.

Khan said apartment, hotel and industrial operating fundamentals continue to outperform, “especially given the interest from overseas buyers. A combination of firming fundamentals and an uptick in cross-border transaction volume have helped lift pricing to the highest level on record. The low level of cap rates is also behind the increase in valuations.”

Khan noted that the apartment sector benefits from improving labor market conditions and rising household formation. “With young adults steadily securing full-time jobs and gradually leaving the comfort of their parents’ home, the apartment sector has more room to grow,” she said. “Moreover, population projections for this age cohort by the U.S. Census Bureau also suggest demand will remain robust in the coming years. However, the ramp up in supply will put upward pressure on the vacancy rate.”

Lodging sector performance metrics also remain solid, Khan said. She cited Smith Travel Research figures of 71.3 percent hotel occupancy in the third quarter and an increasing average daily room rate.

The national retail sector continues to lag, but high-end malls and gateway markets perform well, Khan said. “Suburban and Class B and C retail properties have recovered much more slowly.” Khan said specialty apparel and home furnishing stores face increasing pressure as consumers shift from shopping at brick-and-mortar stores to online. She noted that more than 80 percent of announced store closings in the second quarter were in apparel and furnishings.

“However, the shift to online shopping is helping boost industrial demand, with effective revenue growth projected to reach its highest level in almost 15 years,” Khan said. “As a result, completions as a percentage of stock are growing, but the level remains below the long-run average.”