New Concerns Ahead for Economy, CRE

A new Integra Realty Resources report suggests that commercial real estate could get caught up in the volatility of the stock and commodities markets.
Hugh Kelly
Hugh Kelly

The bottom line from Integra Realty Resources’ 2019 Commercial Real Estate Trends Report is basically: don’t expect 2019 to be like 2018. Or, in the report’s own words, “Things feel ebullient. The best advice: enjoy it while it lasts. The times, they are a-changing.” Hugh Kelly, PhD, authored the IRR report, which also advises the commercial real estate market that “it’s time to play defense.” 

Between the 2017 tax cut legislation and generous federal deficit spending, real GDP rose 4.2 percent and 3.5 percent in the second and third quarters, respectively. Job gains for the 12 months ending in November were about 2.4 million. And by some measures, both small business confidence and consumer confidence are at or near recent peaks.

That’s the good news

On the other side, with most of the corporate tax cut having gone to profits, that bump is short-lived, and several imponderables are clouding the forecast for this year: how tariff policy will affect trade, a shaky housing outlook and a stock market that went up, down and sideways, all to end more or less where it had started.

The report explores the likely near future of job growth and concludes, based on a 10-year projection from the Congressional Budget Office, that the economy’s recent multi-year history of job growth averaging 211,000 a month is likely coming to an end.

Generational demographic shifts, “the impact of technologies, the pervasive and still potent influence of globalization, and the consequences of a more restrictive approach to immigration” combine to present “a huge challenge to America’s job growth through 2028,” the report says, based on CBO numbers.

How huge? Through 2023, “average monthly job growth will be a mere 67,000. The following five years, moreover, are expected to be weaker still, with average monthly job change of 61,000.” All this even as projected unemployment remains below 5 percent.

Enough return for the risks?

Though capital for CRE investment remains plentiful, “volatility has been dominating market movements in equities and in commodities, and there is increasing concern that the conditions which have supported growth in past years may shift downward” if not this year, then next, says the report.

And volatility was not limited to Wall Street, where the S&P 500 moved more than 400 points in the 12 months ending Nov. 30, for little real progress. The report notes that “crude oil prices fluctuated between $49.32 and $76.69 per barrel, but by mid-December were near the bottom of the range at $51.32…”

Despite perceptions that CRE has been “priced to perfection,” cap rates for all property types—except hotels—have drifted downward for the past five years. “Against this backdrop,” says the report, “investors including international buyers and private equity funds, have increasingly scoured the market for higher yields, expanding up the risk curve in investment styles (value-add and opportunistic deals, versus core), in geography (secondary and tertiary markets versus primary cities), and niche products (data centers, medical office, senior housing, and self-storage versus ‘plain vanilla’ commercial/residential structures).” Given that this is a typical end-of-cycle picture, IRR asks: “Are investors being paid for the risks they are assuming?” 

Based on an analysis of risk premiums in cap rates and mortgages, the report asserts that “the pattern of a yield curve that is flattening as it rises is alarmingly parallel to the trend in the Treasury market that occurred between 2003 and 2006. History, they say, doesn’t repeat itself, but it rhymes…. Even with a lot of post-recession and recovery maneuvering, yields are still in risky territory.”

Closing its report on a high note, IRR takes a quick look at the budding marijuana industry. It notes that in 2018, Michigan legalized recreational pot use and Missouri and Utah legalized medical use. Meanwhile, New York and New Jersey reportedly are considering making recreational use legal.

Competition among cultivators has brought an ongoing decline in the price of wholesale marijuana. This is expected to continue as the relatively new recreational markets in California and Nevada ramp up. Some projections foresee as many as 340,000 full-time jobs in the pot industry by 2022.

Image courtesy of Integra Realty Resources