Will Commercial Real Estate Values Fall in 2018?

I recently ran across an article in Forbes magazine (see article here) on real estate market and they asked whether or not the market will continue to go up. They noted that investors have been spoiled by two decades of double digit returns. According to the article, in 2016, the market saw a change of pace as returns on institutional-grade properties fell below a 20 year 10.1% average for the first time since the Great Recession. While it’s logical to expect a downturn sometime soon, the article said that the commercial industry is expected to see continued growth albeit at a more moderate pace.

I would agree with the Forbes article, in fact, Cushman & Wakefield just came out with the U.S. Macro Forecast dated February 2018. Per the C&W report, we are eight and a half years into the current real estate cycle and the U.S. economy is showing no signs of fatigue; in fact, it’s getting stronger.  The real estate industry has been asking when the market might cycle down and year after year, the answer keeps coming back, “not yet.”

A few highlights from our report were:

• For the last six years, the US has created more than 2 Million net new nonfarm jobs each year and we forecast that to continue in 2018.
• Office segment – Since 2016, the demand for office space has been decreasing every year. Look for this trend to continue.
• Industrial segment – We expect the industrial market to continue its record setting run of demand to continue.
• Retail segment – Bankruptcies continue to hit the headlines in the retail segment. In fact, we expect upwards of 25 retailers to file for bankruptcy and potentially that could equate to 11,000 stores shutting their doors in 2018.
• Capital Markets – Record levels of capital are aimed at the U.S. commercial property market.

The economy is strong and there is a lot of momentum from the strong economic fundamentals. The result is we are poised for greater growth. Consumers and businesses are both feeling positive about the economy and confidence is critical to the CRE industry. When consumers are confident, they spend more which boosts business profits, creates jobs, and ultimately translates into demand for CRE space. What do we need to watch out for? The labor market seems to be the largest risk factor to the CRE outlook.  We’ve seen a deceleration in job gains since 2015. Job gains in 2015 were 2.9M, in 2016, they were 2.5M, and in 2017 they were 2.1M. We will continue to watch this trend despite the demand for labor being very robust to see how things play out.

Our report goes into depth in the Office, Industrial, and Retail segments but I want to wrap up highlighting the Capital Markets. We expect the Capital Markets to have a stable year in 2018. Due to the large amount of capital chasing deals, we anticipate seeing an increase in the number of deals in 2018 but with dollar volumes expected to be lower per deal the overall deal volume is expected to be flat. Cap rates either remained flat in 2017 or compressed between 10-20 bps depending on the sector. “Nevertheless, with spreads at current levels, rising interest rates and the stage set for greater inflationary pressure, price appreciation will occur at a lower rate.”

For more on our recent U.S. Macro Forecast, please click here.