Annual growth in U.S. property prices slowed in March to the most modest rate since 2011, according to research firm Real Capital Analytics (RCA). But industry experts say commercial real estate pricing—and transaction volumes—could gain steam, or at least hold steady, as the year progresses.
Last year investors were spooked by some big worries, including the Federal Reserve’s interest rate tightening, China’s slowing growth, trade war escalations, Brexit in the headlines and a yield curve that was threatening to flip, says Peter Rothemund, managing director at Green Street Advisors, a Newport Beach, Calif.-based research firm.
“Looking at property pricing then, most people probably expected that the next move for property pricing was down,” he notes. “Now it feels like this year, oh, the rain is gone. The sun is out.”
Property pricing is unlikely to decline in 2019, Rothemund says. “Maybe it does in retail and that wouldn’t surprise me. Other than that, I don’t expect prices to decline. But, I don’t really expect them to go up that much either. Modest 2 percent price appreciation seems most likely, but there are probably a few sections that may do quite a bit better than that.”
U.S. economic growth, combined with a more supportive interest rate environment, bodes well for the country’s commercial property sector, which continues to be buoyed by robust transaction activity in the multifamily and industrial sectors.
“Stronger-than-expected first quarter economic activity has investors feeling a bit more confident today than perhaps they did three months ago,” notes Lauro Ferroni, director of research at commercial real estate services firm JLL.
In March, the U.S. National All-Property Index rose 5.8 percent from a year ago and 0.4 percent from February, according to RCA. The decrease in annual price growth comes as the pace of commercial real estate deal-making slows. Investment volume was down 11 percent in the first quarter of 2019 from a year earlier, according to RCA data.
The Green Street Commercial Property Price Index increased by 0.1 percent in March. The index has been stable recently, having increased by less than 1 percent over the past six months.
As the economy settles into a rhythm, an increase in transaction volume could be on the horizon, some commercial real estate experts say.
Broker Opinions of Value (BOV)—a leading indicator for transaction activity—have anecdotally picked up, according to brokers at real estate services firm Cushman & Wakefield. This suggests that transaction activity could rise in future quarters, says David Bitner, head of Americas capital markets research at Cushman & Wakefield.
“The economy continues to add jobs at a historically elevated rate, once again confounding expectations of a slowdown,” he notes. “We have a lot of observers thinking that we could have unemployment reach as low as 3.5 percent within the next year. Jobs are the most important fundamental for the property markets.”
Interest rate pressures on pricing, which rattled investors last year, also shouldn’t be an issue. The 10-year Treasury, which reached 3.26 percent last year before settling back down to about 2.5 percent, didn’t seem to have any negative impact on pricing, Bitner says. “Debt and equity spreads are much more favorable than they were three, four, five, six months ago and that is supportive to property pricing and should extend to transaction activity.”
When interest rates rose quickly in the fourth quarter and the stock market became volatile, real estate investors took a pause; they seemed to do the same when the interest rates fell in March. Now things are looking less volatile.
“As we get into an environment that seems a little less unsettled, then that’s when you are going to see people re-engaging with the market, particularly with pricing continuing to be supported,” Bitner says.
Capital still plentiful
JLL’s Ferroni says closed-end real estate funds, which hold record amounts of dry powder, will continue to acquire real estate as the year progresses.
“Those investors are actually struggling to deploy capital as quickly as they are raising capital,” he notes. “They may not be finding enough portfolios of scale to purchase or make the pricing work for some of the more expensive assets in the major markets.”
JLL expects less volume in the larger portfolio transactions this year compared to 2018, simply because there are fewer such opportunities in the market. Buyers of these portfolios last year are now managing their newly acquired assets and determining whether to sell a portion that may not be core to their strategies, Ferroni says.
Rothemund takes a more contrarian view on capital availability for real estate investment.
“I don’t think there is as much (capital) as people think there is,” he says. “The real estate private equity business has grown a lot over this time (since the 2005-2007 hey day for private equity deals), so if you just look in dollar terms, of course they have more dry powder. If you look at it as a percentage of their AUM (assets under management), it’s elevated but not record-breaking.”
“There clearly is a good amount of dry powder and that will support values, but there’s not a frenzied pace (for capital deployment into real estate). There’s a perception of this huge wall of capital looking to find a home in real estate and that’s not really what’s going on; most institutions are pretty close to their target real estate allocations.”