‘Neither Too Hot Nor Too Cold’ CRE Environment
Several metrics and indicators suggest commercial real estate is in a ‘late stable’ stage of the market cycle for most property types in most geographies, said RCLCO, Bethesda, Md.
“Real estate has continued to benefit from strong growth of the U.S. economy,” RCLCO Managing Director Taylor Mammen said in the firm’s State of the Real Estate Market Chartbook. “In general, this has led to ‘goldilocks’ conditions–neither too hot nor too cold–for the asset class, with fundamentals either continuing to improve or holding steadily positive.”
RCLCO predicted the current late stable stage of the market cycle will endure through the end of 2018 and into 2019 for underwriting and business purposes. The late stable market stage is generally followed by the early downturn stage.
The current conditions of growing rents and increasing occupancies, will likely continue until the broader economy slows, the report said. But the relatively flat yield curve hints at some risk of a recession within the near- to medium-term.
“Whenever [a recession] occurs, real estate will experience some pain, even if not to the same degree as during the last downturn,” the report said. “Absorption may no longer keep up with deliveries of new multifamily and industrial buildings and office and retail assets may struggle to maintain occupancy as they likely continue to struggle with changing demand characteristics.”
One reason the Fed is raising rates is to stockpile “dry powder” for the next recession, RCLCO noted. “Real estate investor might consider doing likewise, taking advantage of current favorable capital and property market conditions to build up their own stores of dry powder by reducing exposure to enhanced risks and lining up capital to take advantage of future opportunities.”
The report cited two stories that have emerged in recent years. The first, seen in the multifamily, industrial and hospitality sectors, is one of significant and sustained demand leading to rent growth and new construction. “Demand continues to sustain new deliveries, but construction pipelines are sizeable nearly everywhere and could create distress when an economic slowdown occurs.”
The second story applies to the office and retail sectors, property types threatened with structural obsolescence due to changing demand. “Performance of these property types varies significantly across markets, though generally positive fundamentals for both office and retail have resulted largely from very little construction outside of rapidly growing tech and other “boom” markets,” RCLCO said. “This would likewise reverse when employment and consumer spending slow down.”
Real estate capital market conditions continue to favor sellers of both property and debt investments, RCLCO said. On the equity side, fundraising and transactions are on par with first-half 2017. “Record levels of ‘dry powder’ suggest these conditions may continue for the medium term,” the report said. On the debt side, lenders are “eager” to place capital in real estate and lenders appear to be easing off of the recent trend of tightening standards and taking advantage of higher interest rates.
