Ten-X: CRE Activity Increases, But ‘Stormier Waters’ Loom

Commercial real estate investment activity remains strong, but cyclical and political shifts could threaten continued growth, said Ten-X, Irvine, Calif.

Ten-X said investment activity increased during the fourth quarter, the second straight quarter to record growth. Transaction volume jumped 7.3 percent from the third quarter to $129.7 billion driven by growth in the apartment, office and industrial sectors. Though deal volume has fallen nearly 20 percent from its cyclical peak, it has now topped $100 billion during each of the past 10 quarters.

“For years, a slowly expanding economy has been a boon to commercial real estate, driving unprecedented periods of growth in many areas of the market,” said Ten-X Chief Economist Peter Muoio. “After years of smooth sailing, however, the industry could be headed for stormier waters.”

Muoio noted the Federal Reserve’s stated plans to raise interest rates this year and possibly significant changes to trade, immigration and tax policies, which he said contribute to uncertainty the market has not seen for years. “While commercial real estate remains in a period of steady growth at the moment, investors should be aware that this enduring stretch of stability may be nearing its end,” he said.

For now, commercial real estate continues to benefit from a healthy labor market, Muoio said. Labor force participation is increasing and the national unemployment rate remains below 5 percent. But the economic stability seen for the last several years is now in question due to uncertainty created by several paradigm shifts including rising interest rates and a new president that has promised radical policy changes, he said.

Ten-X said risk premiums fell “sharply” across all five CRE sectors during the fourth quarter, thanks in part to the 10-year Treasury rate’s swift rise. That rate is now 2.49 percent–the highest since 2014–reflecting the Fed’s December interest rate hike and increased inflation expectations. “Despite the recent deceleration in wage growth, the Fed has promised to increase rates three more times during 2017,” Ten-X said.

The apartment sector saw the largest risk-premium dip, declining 90 basis points during the quarter to their lowest level in more than five years, Ten-X said. Hotel and retail risk premiums each slipped 70 basis points and the office and industrial sectors recorded 60 basis point drops. “With its various challenges, the hotel sector easily retains the highest premiums, and is the lone segment that measured above its 10-year average,” Ten-X said.

Boosted by rising treasury yields, cap rates increased in four of the five sectors during the fourth quarter, Ten-X reported. Only the only apartment saw a slight 10 basis point downtick. Real Capital Analytics, New York, said other sectors saw fairly uniform cap rate increases: office and industrial sector cap rates rose just over 20 basis points and retail and hotel rates rose just under 20 basis points. Hotels remain the sole CRE sector with a rate above its 10-year average.