When it comes to commercial real estate, it pays to ignore the media. Capital flows into commercial real estate are expected to stay strong through the fourth quarter of 2016, according to some experts. However, high prices and valuations could affect the amount of money flowing into this subdivision of the marketplace, according to the October edition of “The Briefing.”
The National Economic Factors Driving Growth In Commercial Real Estate
The economy grew nearly 4 percent in the second quarter of 2015. At the same time, the ISM manufacturing index dropped to 51.1 in August. And, while the capital markets seem to be concerned about interest rates going forward, this has actually been a good thing for investors.
The bond markets signal “risk off” as the U.S. sells its Treasuries at an unheard of zero percent for the first time ever.
Pension funds are gearing up for lower returns, and those 7.5 to 8 percent return projections are falling short for pension fund managers. Yield is hard to find these days, and the money seems to be keen to flow into real estate. Specifically, commercial real estate.
With that said, the markets seem to be shifting to secondary and tertiary markets in cities and suburbia so the amount of capital flowing into the commercial space might not be as much as we’ve seen in the past.
Real Capital Analytics does show a 26 percent total increase in sales volume in the first 8 months of 2015.
Over the long-term, commercial real estate is an income-driven play with performance driven by high and stable rents. In the UK, this most apparent between 2000 and 2014 when the average annual rental income returned to landlords was 6 percent.
Landlords today are being asked to accept more risk, however, as volatility increases. In some markets, there’s a significant imbalance between supply and demand. Finally, government regulation plays a huge role in total and average returns. For example, the Indian REIT sector may grow substantially over the next few years due to relaxed rules on foreign investment.
Other changes included decisions in 2012, and 2013, that allowed Chinese and Tiawanese insurance companies to invest in foreign real estate. We’re still seeing the effects of these regulatory changes.
And, in Asia Pacific, the most significant change is the free trade agreement between China and Australia. Obviously, if investors can flood the market with capital in under-invested areas, those areas are ripe for at least short-term, if not long-term, growth.
Commercial Real Estate Development
According to “The Briefing,” a study done by Prequin showed that 78 percent of investors planned on investing at least the same amount in commercial real estate over the next 12 months. This takes steady growth deep into 2016.
To add to this, Moody’s composite index showed record high pricing in the sector in July 2015, doubling the valuations in 2013.
And, while core allocations declined in 2013, North American allocations have skyrocketed from 37 percent to 73 percent.
According to JLL, the capital markets tied to commercial real estate are volatile. And, while that means risk, it also means potential reward. A flat market is a dead one.
The U.S. market drives over 50 percent of the global transaction volume. This, despite increased caution from institutional investors. What’s holding commercial real estate above water seems to be the same thing that has always made it more stable than residential real estate – commercial leasing contracts.
Across the industry, the biggest increases seem to come from office space and multifamily dwellings (rental properties). A stunning 77 increase in quarterly REIT acquisitions that are tied to entity-level transactions drives this growth.
Office lease agreements come in at an impressive 53 percent year-over-year growth. The lowest performing commercial real estate investment is retail, with just 200 basis points added.
In general, growth is averaging 30.1 percent year-over-year – an impressive figure considering the stock market is returning only a fraction of that amount to stockholders.
One of the uncertainties going forward will be interest rates. As capital flows into the commercial side of real estate, it’s looking for a place to settle down. At the same time, investors need yield. So far, landlords are able to hold the upper hand by decreasing concessions made on lease agreements and increasing rents. This trend is expected to continue through the next 18 to 24 months.
Beyond that, investors need to keep their finger on the pulse of central bank monetary policy. As rates rise, it could squeeze investors – particularly those using variable rate loans.