Are Decreasing Oil Prices Friend or Foe to CRE?

Lower oil prices might be good for some, but not so good for others, according to industry experts.
MikeHowe - PENSCOBlog

Mike Howe, PENSCO Trust Co.

Oil prices have been decreasing since the end of 2014, and while some industry experts predict the price of oil will never reach $100 per barrel again, others prophesize it will go beyond that figure as early as summer.

Whichever one believes, one thing that is certain is that with oil prices dropping, energy companies are reining in their spending on drilling new shale wells and making further investments in long-term projects. Reports show that as much as $150 billion in oil projects are predicted to be deferred in 2015 as energy companies align their spending with current cash flow.

This will most likely have an effect on commercial real estate in energy markets, as well, although industry insiders are mixed about whether it will result in positive or negative outcomes for CRE.

“Oil-producing markets will be the focus of any negative impact from falling oil prices.  These would include places like Texas, Oklahoma, Louisiana, Mississippi and especially North Dakota (where shale was booming for the better part of the mid-late 2000s),” Mike Howe, PENSCO Trust Co.’s director of institutional products, told Commercial Property Executive. “These negative impacts could come in the form of decreased property values and lower rents (and thus lower income on investment properties), which is a product of the fact that energy companies would potentially be allocating fewer resources in those areas.”

Don’t expect an immediate impact, however, as Howe suggests real estate prices won’t come crashing down overnight, but rather the biggest impact might be in late 2015 or 2016.

“It is very possible that there would be a higher rate of vacancies in these areas as energy companies allocate fewer resources. This would affect rents and property values significantly as fewer workers means more vacancies, lower demand for units, and thus lower rents,” Howe said. “In that same vein, property values would, in theory, be lowered as well since there is less demand for those buildings as energy production would slow relative to the low energy prices.”

For example, Williston, North Dakota was forecast to need massive road, airport, and wastewater production improvements, along with thousands of new housing units to accommodate its growth. But those projects may not be completed—or even started—if production in the area continues to slow with the drop in oil prices and production.

Also, REITs that have a high concentration of commercial properties in these areas could possibly underperform based on a lack of demand.

Among self-directed IRA holders, real estate and infrastructure investments have been very popular in shale oil production boomtowns. That means, Howe opinions, we could see a slowdown in interest as investors wait to assess the fallout from plunging oil prices.

However, the past two weeks have seen a rally as oil hit its highest level for the year, with Brent crude rising slightly above $60 a barrel. Still, even if this is as high as it goes, many feel real estate won’t be affected too negatively.

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Kenneth McCarthy, Cushman & Wakefield

“I think you have to look at the double impact—the first is the general support to the economic recovery; for every $10 decline in the price of a barrel of oil adds roughly $30 billion to discretional income and spending over the next year. We’ve seen a $60 decline in the price of oil, which turns out to $180 billion,” Kenneth McCarthy, senior managing director for economic analysis and forecasting at Cushman & Wakefield, told CPE. “I think it helps every city. Offsetting that in some cities will be a softening in employment in some energy sectors and supporting sectors. The major ones being Houston, Dallas and Denver.”

According to McCarthy, it might mean slower growth, but the national improvement is large enough to help offset some of the decline in local markets and therefore, no major city should see any sort of contraction because of the declining oil prices. Houston has been booming and will continue to grow, and the same is probably true for Denver and Dallas.

Nationally, Cushman & Wakefield expects the rising economy to see vacancy rates decline, rents to increase and property prices to go up; and while it may translate into being a little worse than originally predicted in energy markets, it had foreseen pretty high growth, so it’s still pretty good.

“We need to be careful about overestimating the impact here of the energy industry as an employer,” McCarthy added. “When we’re talking about office space, the impact is far far offset and overcome by the positive impact lower oil prices will have on the economy.”

Peter Lewis, head of Wharton Equities, said the company is in discussions on a deal in Texas and evaluating the current risk, and thinks it’s better than what’s happening in Williston, N.D. Regardless, he thinks it would be foolish to not think there’s going to be a fallback.

Peter Lewis

Peter Lewis, Wharton Equities

“I think markets dependent on exploration and drilling will suffer significantly. We never liked Williston, it’s just too thin a market and too risky. It’s also a little scary because a lot of the activity is exploration in development rather than just taking oil out of the ground with established wells,” he told CPE. “When you move to Texas, there are more established markets in many ways, so their break-even cost is much lower as far as oil is concerned.”

What’s important, Lewis added, is not to pay prices based on two months ago as far as rents and outlook because that was the top of the trough and it will take a while for it to get back to those levels.

“Markets like Houston and Dallas to a lesser extant will see a drop, though it won’t be devastation. You just need to temper your expectations on growth,” he added.