Double-Digit Increase in Capital Markets Expected in 2014
- Mar 19, 2014
The capital markets are projected to be very active in 2014, with volume expected to increase 10 to 20 percent over last year. Several factors will combine to drive the increase as real estate fundamentals continue to improve throughout the country, with most major U.S. markets showing signs of growth.
If 2014 performs as expected, it will be the second year of significant increases for commercial real estate transactions. The investment volume was $355 billion in 2013 − 19 percent higher than the 2012 volume. This increase is a compelling sign of growth because a higher number of deals than usual were completed by year-end 2012 to avoid an increase in the capital gains tax that went into effect Jan. 1, 2013. Activity last year was also boosted by historically low interest rates, despite the interest rate bump in late spring.
The capital markets volume for this year is expected to reach a total of $400 to $430 billion. The capital markets and stock market are expected to work in tandem to drive the increase. There was a major run-up in the stock market last year, producing unusually high returns on investment in excess of 30 percent. Stock market earnings this year are expected to return to their normal level of 8 to 10 percent, which historically is a good return. The return of normal stock market earnings is expected to encourage more individual and institutional investors to increase their allocations to commercial real estate. Real estate as an investment will become more attractive due to the ability to increase leverage with fairly low interest rates and a continued recovery of real estate fundamentals. These combined dynamics will allow real estate investors to achieve a 10 to 12 percent return, or even higher for more aggressive asset strategies. Commercial real estate investment should outperform the stock market by 200 to 400 basis points, which is significant when considering institutional-quality investment deals. Expect to see more equity investment pursuing core-plus and value-add assets in order to achieve investment objectives.
Improving real estate fundamentals in the U.S. are attracting more investment. Rental and occupancy rates are increasing as the economy continues its slow but steady recovery. The best performing markets are in Texas and on the coasts. Leading markets include Dallas; Houston; Austin; Manhattan; Los Angeles; Chicago; Boston; Denver; Seattle; and San Francisco. Investors with a higher appetite for risk are also driving activity in the Sunbelt, in markets such as Atlanta, Phoenix and Florida. Multi-family remains a preferred asset class for investment, however there is an increasing demand for industrial development for distribution centers in major transportation hubs. Select office construction is occurring in recovering markets, and the development of grocery-anchored projects is taking place in high job growth areas. New development appears to be well in check, with demand outpacing supply.
Transactional volume will increase in 2014 as there continues to be well-funded debt programs from life insurance companies, banks and commercial mortgage-backed securities (CMBS). The volume of CMBS lending was just under $100 billion last year and is projected to reach $120 to $130 billion in 2014. This amount of activity provides a viable financing alternative for assets in secondary and tertiary markets that are making recoveries. An increase in CMBS volume is also expected to benefit the retail sector, in which CMBS has typically been a very active lender.
To summarize, 2014 should continue the upward trend in transactional volume for commercial real estate. Active investors will drive volume in core, core-plus, value-add and opportunistic asset strategies. The one concern that may dampen investors’ sentiment would be an unexpected jump in interest rates. Most investors are expecting an increase of 50 to 75 basis points in interest rates and will continue to be active if that takes place. So if capital markets perform as expected, commercial real estate investment is poised for a productive and favorable year.