Are CRE Transactions Finally Slowing Down?

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Includes: DRA, DRN, DRV, FREL, FRI, FTY, IARAX, ICF, IYR, JRS, KBWY, LRET, NRO, PSR, REK, RFI, RIF, RIT, RNP, RQI, RWR, SCHH, SRS, URE, VNQ, WREI, XLRE
by: Hightower

The commercial real estate industry has been cruising along at a healthy clip with robust investment sales, improving fundamentals and a return of new construction. However, the sector may be getting ready to tap the brakes. According to the latest Urban Land Institute (ULI) Real Estate Consensus Forecast, the real estate market will see a dip in transaction volume and more subdued growth in occupancies and rental rates over the next three years.

Following six years of rising investment sales, the forecast expects commercial property transaction volume to trend downward over the next three years. Transaction volume likely peaked in 2015 at $534 billion and is expected to decline steadily to reach $475 billion by 2018, according to the ULI forecast. In fact, many metros are already seeing signs of that slowdown. Part of that pullback can be attributed to the cap rate compression that has already occurred, with some investors wary of over-paying for properties.

The glass is half full side of that story is that the sales volume is still healthy and the economy is expected to continue to expand over the next three years. In fact, the U.S. will likely stay on the same steady course it has been on, with economists predicting that annual GDP growth will range between 2.0 and 2.6% in the near term. The ULI forecast calls for further commercial price appreciation and positive returns, but at lower levels. Rent growth will remain above-average but will decelerate as compared to performance in recent years. Commercial property rents are expected to increase for the four major property types in 2016, ranging from 2.0% for retail up to 4.5% for industrial.

Vacancy rates are expected to continue to decline modestly for office and retail over all three forecast years. Industrial availability rates and hotel occupancy rates also are forecast to decline modestly in 2016 and then very slightly reverse direction in 2017 and 2018. However, apartment vacancy rates will rise over the next 3 years, likely due to the development that has been occurring in that sector.

For example, the office vacancy rate forecast for 2016 and 2017 is for continued declines to 12.6% and 12.3%, respectively, where it will remain flat in 2018. Office rental rates increased 4.0% in 2015. Rental rate growth is expected to continue at 4.0% in 2016 and then moderate to 3.5% in 2017 and 3.0% in 2018.

The ULI forecast includes survey responses from nearly 50 real estate economists and analysts, and respondents are clearly registering more concern over the near-term growth potential. The gradual slowdown will impact the bottom line for building owners and investors. For example, institutional real estate assets are expected to provide total returns of 8.1% in 2016, moderating to 7.2% in 2017 and 7.1% in 2018, according to ULI.

Although the slower forecast is not great news, it is by no means setting off alarm bells. Rather, the slowdown is a natural evolution of a market that is transitioning from recovery to a more mature stage of the cycle, noted Anita Kramer, senior vice president for ULI's Capital Markets Center, in a recent NAREIT Podcast. It also is important to note that the U.S. still looks attractive to global investors, and the occupancy and rental rate growth is exceeding performance in many key cities across Europe, Asia and South America.