‘Change and Opportunity’ for CRE in 2018

Commercial real estate market dynamics are “in flux” as the current investment cycle enters its latter stage, said Avison Young, Toronto. 

“The industry continues to contend with differing property fundamentals across asset types, markets and regions, with occupier behavior, innovation and technology acting as key sources of change that are taxing the sector,” the firm’s 2018 North America Commercial Real Estate Forecast said. “The current interest-rate environment is another contributor to this change–albeit a somewhat limited factor.”

Avison Young Chair and CEO Mark Rose noted analysts have spent nearly three years debating where the real estate cycle stands. “[Last year,] we dragged out a baseball analogy…and concluded that the real estate industry was in the late stages of the game, but could be headed into extra innings.” Now, in early 2018, “the game is still going, but there is a clear and palpable difference,” he said. “Change is underway and the dynamics on the field are in flux. Our industry needs to decide what to do next.”

Rose noted interest rates remain very low, but are moving up incrementally, “as they really only have one way to go,” he said. “Capitalization rates are another story. Commercial real estate has printed trades at historically low cap rates, but the bid-ask spread is widening and acting as a brake on transaction volumes in major markets.”

The theory that short-term interest rates will rise but thinning spreads will keep cap rates in place “is not logical or supportable over the mid-to-long term,” Rose said. “Cap rates and corresponding return requirements will eventually move as financing acquisitions becomes more expensive.”

Technology’s effect on real estate could be the most exciting change agent in commercial real estate, the report said. “Technology adoption including artificial intelligence is gaining so much momentum that it is driving profitability and expanding capabilities exponentially.”

Rising interest rates and capitalization rates this year and beyond should allow more “traditional” asset pricing based on a risk-adjusted real rate of return, the report predicted. “Once the stalemate over prior cycle strategies and underwriting ends, growth should fuel more demand, reduce vacancies and cause rental rates to rise. When this change is combined with efficiencies captured by the latest technologies, we will welcome a new wave of demand, performance and innovation.”

Avison Young U.S. Operations President Earl Webb noted an “abundance” of capital remains available for trades and pricing is strong. “Property markets are registering meaningful development in response to demand for modern properties,” he said. “These factors will keep the U.S. commercial property market on its current upward trajectory through 2018.”