Expectations for Institutional Returns Slip

Institutional investors expect commercial real estate returns to slip over the next year, the Pension Real Estate Association’s Consensus Forecast survey said.

The survey asked about investment expectations as represented by the NCREIF Property Index, which measures unlevered institutional real estate returns. Respondents said they expect to earn a 6.4 percent total return including income this year but only 5.2 percent in 2018–an 80 basis point drop.

That return could drop to 4.8 percent in 2019, investors said.

Mortgage Bankers Association Vice President of Commercial Real Estate Research Jamie Woodwell said the survey of 20 firms indicated a “downshift” in their commercial real estate expectations. “Investors expect property income growth to hold up and property prices to moderate,” he said. “It’s not surprising that sales transaction activity has slowed during the first half of this year, as potential purchasers look at lower property value gains at the same time potential sellers see continued income growth.”

Multifamily should see the smallest drop in returns over the next two years, the survey said. Total multifamily returns could fall from their current 5.6 percent to 4.8 percent in 2019. Investors predicted industrial sector returns will likely fall the most, from 9.7 percent currently to 5.7 percent in 2019. 

Transwestern Investment Group President Charles Hazen called it appropriate to expect lower growth in commercial real estate values in the coming years “given the impact of new supply in the office, industrial and multifamily sectors and the effect of e-commerce in the retail sector.”

Barbara Byrne Denham, Senior Economist with Reis, New York, said because the diminished expectations are concentrated in appreciation returns rather than income returns, institutions see the same fundamentals going forward–steady rent growth and steady occupancy growth. “They’ve just re-set their expectations, as in become more conservative about the property market’s overall value as judged by the capital markets,” she said.

Byrne Denham noted this “re-set” can be driven by a number of factors including lower expected capital flows from China, higher interest rates driven by the Fed’s raising of the Fed Funds rate, an overall concern that changes in Washington, D.C. will be delayed further and a general sense that all participants feel more cautious about the future given how deep we are into the expansion.

“The market follows a certain law of self-fulfilling prophecies,” Byrne Denham said. “If enough feel that there will be less capital invested in commercial real estate and that values will not grow at the same rate as in the last few years, then these investors will allocate less capital and their expectations will be met.”