Mastering the Real Estate Cycle: Reading the Tea Leaves

How has the commercial real estate market fared thus far in 2018 and what is the outlook for the coming months and into 2019? In the kickoff to RMA's 2018-19 Credit Risk Management Audio Conference Series, Ryan Severino, Chief Economist at Jones Lang LaSalle discussed economic conditions and outlook, major property type performance, and a capital market overview.

The U.S. economy is experiencing its second longest expansion on record and may very likely surpass the record holder, the expansion of March 1991-March 2001. The economy is growing about 3% per year, quite a testament to its resiliency in light of the 2008 recession. However, a 3% growth rate will be difficult to sustain. As speculation swirls about the end of this expansion, a key indicator to watch is inflation. Temporary drags have ended and inflation rates are clearly rising, which is important for how the commercial real estate market performs.

Severino provided performance updates on the major property types. In the office market, tech, finance, and co-working remain dominant, capturing 55% of year-to-date leasing. Intense flight to quality and resulting “right-sizing” in the suburbs have led to year-to-date occupancy losses. Class A momentum has not slowed down and CBD A occupancy growth has now surpassed 11% since 2010.

The industrial market reigns as the new darling of CRE, a title formerly held by the apartment market. Its vacancy rate is the lowest its been in the last 20 years. Net absorption in major markets persistently exceeds new development, which likely won’t derail until the next recession.

In the retail market, vacancies are rising as hundreds of big box stores close, however, Severino pointed out that the market is not as dire as headlines have indicated. That said, construction is still well below pre-recession levels. Shopping centers are still seeing steady declines in vacancy.

The apartment market generally remains strong with most growth reported in urban areas. Although single family affordability remains an issue, multi-family demand continues to hold steady. Rent growth improved to 2.4 percent after a three-quarter tenure at 2.3 percent, while vacancy rate remains stable at 5.2 percent.

For the first half of 2018, larger deal activity and domestic capital are leading the markets to exceed expectations. Industrial portfolios, multi-family and hotel activity, and off-market transactions have boosted activity. Capital markets have been resilient, but with interest rates headed higher, the trend will be towards cap rates expanding over the next couple of years.

Join us for the next installment of the Credit Risk Management Audio Conference Series on October 9, Credit Portfolio Management.

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