Economy, CRE Moving Beyond Headwinds

Posted on August 25, 2015

WASHINGTON, DC—As if to corroborate a point made in FTI Consulting’s second-quarter Economic & Real Estate report—that “risk to the US economy related to global uncertainty is a potential headwind”—the Dow Jones Industrial Average closed down nearly 600 points Monday afternoon. Earlier in the day, Bloomberg Business reported that share prices slid on stocks in publicly traded commercial real estate services firms.

Some sort of domestic upheaval—perhaps the Federal Reserve unexpectedly announcing a sharp increase in the federal funds rate? Nothing of the kind: the source ultimately was heavy losses on shares of Chinese stocks, with even the Beijing-controlled People’s Daily referring to the day’s trading debacle as “Black Monday.”

Episodes of turbulence aside, though, the FTI report notes that as of August, “it appears that the US economy has moved beyond headwinds experienced earlier in the year such as inclement weather and port delays.” With consumer confidence continuing to rise, so has household formation.

During Q2, according to the report from FTI’s Michael Hedden, Marc Shapiro and Mark Field, annualized household formations averaged 2.2 million, “up considerably from the 449,000 annualized pace set at this time last year. This occurrence has helped housing market fundamentals, which improved during the spring months, characterized by rising home sales, prices and starts.”

The report notes that commercial property fundamentals have continued to improve since 2014. “The latest market data and commentary from leading real estate brokerage firms and data providers report falling vacancy rates, growing absorption, steady rental rate appreciation and more investment activity,” according to FTI’s report.

The simple average overall capitalization rate—comprising the office, retail, apartment and industrial sectors—declined in Q2 for the 13th consecutive quarter, FTI says, citing the Q2 PricewaterhouseCoopers Real Estate Investor Survey. Furthermore, according to FTI’s report, commercial real estate indices produced by NCREIF, Moody’s/RCA and Green Street Advisors “continue to show healthy price appreciation for commercial real estate assets. Driven by high yields, availability of capital and willingness for risk, investor sales volume bettered totals recorded at this time last year by 38.0%.”

This momentum, FTI says, is expected to persist, “characterized by sustained demand for space, gains in occupancy, growing absorption and continued rental rate growth.” Strong investment demand, especially from cross-border investors, is predicted to continue to “drive volume, intensify competition for trophy assets and keep pricing elevated as investors seek stability/value amid global uncertainty.”

As it has throughout 2015, the pursuit of higher yields relative to other investments will continue to drive activity and interest in secondary markets as well as for second-tier quality properties in primary markets, according to FTI’s report. Looking ahead, FTI says, “Real estate allocations and the level of investment among institutional investors are expected to shift more to debt-side investment and away from equity-side investment until equity yields normalize to compensate for risk.”

Having fallen now each quarter since the start of 2012, cap rates are expected to remain generally stable over the next several quarters, yielding positive value appreciation across all property sectors. “Spreads between real estate cap rates and interest rates are expected to fall with the anticipated increase in interest rates,” according to FTI.