Q3 2018 CRE Market Update (+ SlideShare)

Posted by Ted Van Brunt on Jul 17, 2018 10:19:40 AM
Ted Van Brunt

Q3 2018 CRE Market Update_RRA-01Periodically, RRA will provide a brief snapshot of what we are seeing in the commercial real estate market in order to educate our clients and investors. Q3 2018 represents a poignant time in which to kick this initiative off, as interest rates and uncertainty are increasing and interest in alternative investments such as CRE are continually on the rise.

Summary

CRE values appear to be peaking but it’s not looking like a bubble as leverage remains conservative and the economy is healthy. The fundamentals are good but few are expecting large further increases in rent and values. Transaction volume is down and it will be interesting to see if there are enough compelling investments out there in order to put the sizable dry powered raised to work. The rising interest rate environment can have both positive and negative effects on CRE and we are watching this closely. Investors looking for additional security along with current income are finding a fit with CRE debt.

Details

Commercial property values have had a good run but we are starting to see cooling as RCA shows prices plateauing and transaction volume sliding. CoStar is predicting that volume will drop 5% in 2018 on top of 2017’s decline; however, Preqin shows a record amount of dry powder still looking to CRE investments, which could keep volume steady.

On the value side, we’ve seen some discipline in lending and don’t have the overleverage of last cycle. Debt levels have increased markedly slower than property values. But keep an eye on loan underwriting as interest-only loans continue to increase in the CMBS space possibly signaling slipping standards. Also encouraging for values is a low new supply for most product types. Investment in construction is still below its average long-run share of the GDP. Cap rates have returned to pre-recession lows and the looming possibility of rates increasing is a real concern for investors. However, there is a historically low correlation between Treasury and cap rates so we might not see movement for a bit. Further, rising cap rates in a good economy are usually accompanied by rising NOI which helps offset hits to value.

Looking at the main sectors, this year apartment volume is flat, industrial is up, and retail/hotel volume has declined. This jives with CBRE’s most recent investor survey which shows that industrial and multifamily continue to be preferred to retail and hospitality (office is somewhere in the middle). Retail’s pain tends to be industrial’s gain. In these later innings, investors are getting more interested in alternatives to the main real estate food groups. They are primarily concerned with valuation and hunting for yield. One place they are looking to find both of these is CRE debt.

The CMBS wall of maturities has passed and banks are now taking some of CMBS’s market share. Banks hold over half of the market’s debt (52.8% at the end of 2017) and are on track to increase that even as they are more regulated than ever.

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Topics: Market Update

Ted Van Brunt
Written by Ted Van Brunt

As Chief Investment Officer, Ted draws from his experience in over $15B in retail, office and industrial transactions and asset management experience in over 6 million square feet of office, multifamily and retail portfolios. Ted was formerly with Cole REIT (now Vereit) and Unico Properties.