Wells Fargo Securities: CRE Remains in ‘Good Shape’

Commercial real estate remains in very good shape–particularly at this late stage of the business cycle–reported Wells Fargo Securities, Charlotte, N.C.

The Wells Fargo Securities Commercial Real Estate Chartbook noted eight and a half years of modest economic growth have brought the U.S. economy close to full employment. “Growth appears to have picked up a notch more recently, with real GDP growth increasing to better than a 3 percent pace in the second and third quarters,” Wells Fargo Securities Senior Economist Mark Vitner said.

Most importantly, the labor market continues to expand at a “healthy clip,” with employment gains reaching a broader swath of the economy, Vitner noted. “We expect the momentum to carry over into 2018 and expect real GDP to grow 2.5 percent.”

The slow recovery both in the U.S. and abroad has kept interest rates exceptionally low, Vitner said. “Persistently low rates set off a search for yield that pulled investment into real estate and created a wave of funding for startups and promising business models,” he said. “For real estate, the most rapid price gains have been in cities with close ties to the global capital markets. Now, with labor markets tightening and new leadership set to take over at the Federal Reserve, there is growing concern interest rates will rise more rapidly and to a higher level than previously thought.”

Development has remained tightly focused in a handful of rapidly growing cities and product types, the report said. “Apartments are the most notable standout, with the move back toward large center cities and emergence of millennials setting off a wave of high-end projects. Industrial development has been another growth area, with e-commerce driving demand for distribution and fulfillment centers.”

But retail development remains soft, with traditional retailers and regional shopping malls under “intense pressure” from online competitors and neighborhood center development held back by the slow recovery in single-family homebuilding. Office development also remains slow except in markets predominantly driven by technology, the report said.

One related concern: what might happen to the tech sector growth once interest rates start rising. “The strongest office, industrial, retail and apartment markets are often in areas of the economy where the technology sector is growing rapidly,” the report said. “With overall economic growth strengthening and broadening, the relative risk-adjusted rate of return on investments in startups and promising ventures will diminish and many of these businesses will need to throttle back their ambitions. The repercussions could potentially reverberate through all corners of the commercial real estate marke–but probably not in 2018.”