Woodwell: Is CRE ‘Winter’ Coming?

LOS ANGELES–Commercial real estate is enjoying good times, but to paraphrase Game of Thrones, is Winter coming? MBA Vice President of Commercial Real Estate Research Jamie Woodwell shared his outlook for the sector here at the MBA Commercial/Multifamily Servicing & Technology Conference.

“We’re currently in the longest economic expansion ever,” Woodwell said. “There have been a couple negative quarters here and there, but not two in a row, which is the definition of a recession. So there’s been an incredibly long run of economic expansion.”

Woodwell cited several record-setting metrics: Commercial property cap rates are at record lows; MBA reported a record $574 billion in commercial and multifamily mortgage bankers originations last year; and loan delinquency rates are at or near record lows.

“So, there are a lot of phenomena going on, putting us in a place we’ve never seen before,” Woodwell said. “Thus, the question becomes what’s next?”

The answer depends on what kind of person you are, Woodwell said. “It’s almost a psychological question: If someone is in Los Angeles and it’s sunny today, they sort of expect that it will be sunny tomorrow, too. But if you’re in Pittsburgh and it’s a sunny day, you might keep your raincoat ready.”

People with a more optimistic disposition might say they don’t see anything likely to change the current situation. Others might say, “it’s been a great run, so I’m going to get ready for what comes next,” Woodwell said.

Right now, the U.S. economy remains quite strong, Woodwell said, citing the first quarter’s 3.2 percent real GDP growth rate. Job growth has averaged more than 200,000 per month so far this year and the unemployment rate fell to its lowest point in 50 years. “That’s boosted wages, which economists had expected would happen well before now,” Woodwell said.

One conundrum for the economy is that its strong performance could bring some inflation pressure. “But that has not yet materialized,” Woodwell said. “Some think trade tariffs could start to bring more inflation on.”

Given this economic backdrop, each commercial property type has an interesting story to tell, Woodwell said. “In the multifamily sector, we’re running fast in terms of both demand and supply for apartments. The younger generation is filling the shoes of their parents, supporting good demand for multifamily properties. The real surge is in Millennials; they are starting to form households and demand apartments, especially high-quality urban recently developed apartments.”

But if either the apartment supply or the demand pipeline stumbles, that could quickly lead to either affordability or excess supply problems, Woodwell said.

The office sector has seen a long run of positive job growth, but on the other side of the coin, companies are using less space per employee, which has lead to the current fairly stable market, Woodwell said. But he added wage pressure is increasing as employers fight to retain their best employees during an extended strong job market. “One tool employers could use would be to reverse the recent trend of shrinking office space and increase the room given to employees in an effort to compete for talent,” he said.

The retail sector has seen the biggest changes, largely due to e-commerce, which has taken over nearly 10 percent of all retail sales and continues to grow three basis points every quarter, Woodwell said.

But consumer consumption is strong enough that both e-commerce and brick-and-mortar stores can grow–as long as consumer spending continues, Woodwell said. “But if consumer spending should slip, which will lose more?,” he asked.

With e-commerce growing and manufacturing shipments at record highs, the industrial sector continues to thrive–and evolve, Woodwell said. He noted new warehouse properties are changing rapidly and some now include a second or a third story, something rarely seen in the past.

“When I think about what’s likely to happen, I come back to the idea of a plateau,” Woodwell said. “Coming off a record year of originations, I don’t see much pulling those numbers down, and I also don’t see much pushing those numbers much higher, so we generally see a plateau for originations for the next few years. If we continue to run at this level, that still means growth in mortgage debt outstanding because of maturities, and that means there will likely be more need for servicers like you to service these loans.”