CRE Fundamentals Positive, but Activity Moderates
Recent reports suggest commercial real estate, which has enjoyed a period of relative stability, could be cooling.
Hotel revenue growth has slowed “considerably” in the past year, said Joseph Rael, Director of Financial Performance with STR, Hendersonville, Tenn. And multifamily rents grew just 2 percent year-over-in April, the slowest rent growth seen since April 2011, reported Yardi Matrix, Santa Barbara, Calif.
“With the U.S. economic expansion entering its eighth year in July, it is not surprising to see underlying CRE fundamentals cooling,” said Wells Fargo Securities Senior Economist Anika Khan in the comapny’s quarterly Commercial Real Estate Chartbook.
Khan noted that as rent increase slowing and lending standards tighten, five-plus unit multifamily starts are down 25 percent from the mid-2015 cyclical peak. “The deceleration in multifamily activity is consistent with the slower pace of renter-occupied household growth,” she said. “Recent quarterly data for household growth show the share of renter- and owner-occupied units were evenly split in the fourth quarter, suggesting that some households are beginning to choose ownership rather than renting.”
In addition, the office sector faces well-documented challenges including increased tele-working, the report noted. “In particular, the decline in average square feet per office worker and increase in remote office work is taking a toll on office demand,” Khan said. “The surge in office supply delivered in early 2015 continues to put downward pressure on asking rent growth, with activity slowing to just 1.8 percent in the first quarter relative to a year earlier.”
Industrial is the lone bright spot, especially as e-commerce demand remains solid, Khan said. Asking rent grew 6.5 percent in the first quarter year-over-year, registering the strongest pace of growth across sectors.
Khan noted that e-commerce growth showed the strongest gains in Houston, Atlanta and Kansas City. “These markets are near population centers and intermodal hubs,” she said. “In the same space, year-over-year asking rent growth remains in the double digits for Long Island [N.Y.], Inland Empire [Calif.], Seattle, Las Vegas, Fort Lauderdale and Pittsburgh.”
But even in the still-healthy industrial sector, “late-cycle activity is showing up,” the Chartbook said. “Net absorption for large distribution reached its lowest level since early 2015.”
Khan said capital is still available for most property types but noted that “lenders have taken notice of pockets of risk,” and tightened standards for construction and land development lending.
“The outlook for cap rates and valuations are not only top of mind for loan officers, but investors are also expressing angst as worries about higher exit cap rates and lower valuations take shape,” Khan said. “It is commonly thought that cap rates move in tandem with rates and in turn, could put downward pressure on prices. Indeed, there is a positive statistically significant relationship between the 10-year U.S. Treasury yield and the all-property cap rate, but other factors play an even larger role in explaining the variance between the two variables, namely the term premium, prospects for economic growth and net operating income.”
