Translating the Market Outlook

Why is 2015 expected to be a strong year for commercial real estate?

As economic factors continue improving— employment, consumer confidence and spending, business investments — commercial real estate fundamentals strengthen. Net absorption is expected to increase across all property types in 2015, as demand for commercial space grows. Completions of new commercial spaces are also growing, but at a slower pace than absorption, leading to declines in availability and rising rents. The only exception to the rule comes in the apartment markets, where strong new supply is already exerting downward pressure on rents.

As fundamentals ensure growing positive cash flows, investors continue to find commercial assets attractive. Since the post-recession trough of 2009, investment sales have posted higher volume with each subsequent year and 2014 was no exception. Sales volume in 2014 totaled $433 billion, according to Real Capital Analytics. Prices rose across the board, with apartment and CBD office properties exceeding pre-recession peaks. Moreover, in 2014 commercial lending found new vigor, as sources broadened and capital availability increased. In light of these factors, 2015 should offer continued advances in property prices, sales volume and leasing activity.

What’s all the excitement about regarding secondary and tertiary markets as a target for institutional investors?

Secondary and tertiary markets were much slower to succumb to the economic recession, and they were also much slower to recover. Whereas for primary markets the commercial real estate rebound initiated in 2010, for most secondary/tertiary markets the rebound did not occur until 2013. Last year marked the first year of sustained strong growth for secondary and tertiary markets, indicating broad-based improvement in both economic and commercial real estate terms. Moreover, due to their position, secondary and tertiary markets offer investors higher yields on commercial investments. As primary markets became crowded over the past three years and available inventory shrank, investors found the higher returns in secondary and tertiary markets attractive, especially as fundamentals strengthened.

Are there any noteworthy segments in those markets that are performing particularly well or not well (e.g. warehousing in the southeast; land in the southwest; hospitality in the northeast)?

The coastal markets continue to provide strong performance for the retail sector, driven by rising employment, higher wages and tourism. In terms of industrial properties, ports, intermodal transportation hubs and distribution centers are expected to drive growth in major markets like Chicago, Atlanta, Los Angeles, Miami and also smaller key markets like Jacksonville, St. Louis and Charlotte. For the office sector, growing urban centers will continue as strong performers in 2015. Agricultural land in the Great Plains has seen strong price growth over the past few years, as institutional investors found it an attractive hedge instrument against inflation expectations, coupled with strong returns.

What local factors or economic indicators can members in small to mid-sized markets look for in order to help their clients capitalize on improving access to financing?

Tracking basic economic factors such as employment, wages and retail spending at the local level provides important insight into the overall health of markets. Based on NAR’s Commercial Lending Survey, the majority of our members consider local and regional banks as the main sources of capital. Maintaining relationships with local lending sources is likely to provide timely updates on changes in lending terms and cost of capital. As sources of capital are likely to continue broadening, members should remain aware of additional sources of liquidity which have become more active in smaller markets—institutional investors, insurance companies, cross-border capital. Based on my interaction with members, many of our members are keenly aware of local trends and well-positioned to see changing conditions in their markets.

What national or international economic indicators should members continue to watch?

In addition to the performance of the national economy, I would consider the changes in interest rates a fundamental indicator, as it directly relates to cost of capital. Also, while considering employment trends, personal and household income would be figures worth following, as they translate into both consumer confidence and consumer spending. Internationally, maintaining an awareness of global economic health provides insights into how the U.S. economy and markets perform relative to other major countries. Having an eye on currency exchange trends offers a view on the relative cost of U.S. commercial properties. With cross-border investors accounting for about 10 percent of U.S. commercial transactions, the value of the dollar relative to major currencies can impact this segment of the market.

How are hot button issues like low oil prices, a strong dollar and improving job numbers impacting the commercial real estate market?

Given the wide-ranging issues, it will mostly depend on the market and property type. Low oil prices are clearly a boon for consumers—as it provides additional money in their pockets—and consumer spending, leading to stronger retail sales, auto sales and recreation expenditures. At the same time, lower oil prices are having a negative impact on some aspects of the U.S. energy sector, leading to possible layoffs and negative impacts in energy-centered markets. Similarly, a strong dollar benefits importers and U.S. consumers of foreign products, while making U.S. products and U.S. real estate more expensive for foreign buyers. In terms of commercial real estate, I expect the impact to be mixed. In light of the global economic slowdown, the performance and returns offered by U.S. commercial properties will continue to make them attractive for cross-border institutional investors, pension funds, and sovereign wealth funds.

On balance, the health of U.S. commercial real estate is heavily dependent on the health of the U.S. economy and domestic markets. Continued improvement in employment, especially coupled with increases in income and wages, will have a much stronger and sustainable impact on commercial real estate in 2015 and beyond. Broader strengthening of macroeconomic fundamentals matched to a stronger post-recession financial sector will provide the capital to grow small businesses, nascent industries, and drive innovation, all of which will lead to increased demand for commercial properties.