IRR Report: Cautious Optimism for Moderate, Steady Growth in 2018

The 25th edition of the firm’s annual CRE forecast provides a detailed look at the local and national commercial real estate market across five key property types, and examines economic trends and how they are affecting interest rates, capital markets and housing.
Anthony Graziano, MAI, CRE, chairman of Integra Realty Resources
Anthony Graziano, MAI, CRE, chairman of Integra Realty Resources

One month into the new year, Integra Realty Resources, the largest independent commercial real estate valuation services firm in North America, has issued its CRE forecast, Viewpoint 2018, with cautious optimism for moderate and steady growth as the main theme.

The firm’s 25th edition of the annual report provides a detailed look at the local and national commercial real estate market across five key property types—office, industrial, retail, hospitality and multifamily. It also examines economic trends and how they are affecting interest rates, capital markets and housing. An analysis of the emerging marijuana real estate sector, along with sections on senior housing, golf courses and Caribbean hospitality are also featured.

“Whether or not the economy can maintain forward motion is the definitive question in the year ahead. In this year’s report, we explore the major factors impacting continued economic expansion and a few of the key challenges and opportunities that face the commercial real estate market,” Anthony Graziano, MAI, CRE, chairman of Integra Realty Resources, said in a prepared statement.

Expansion phase continues

Veteran commercial real estate economist Hugh F. Kelly, PhD, CRE, who helped produce the report, noted that in the short term, commercial property markets are solidly in their ‘expansion phase.’

Hugh Kelly, PhD, CRE
Hugh Kelly, PhD, CRE

“But now is the time for real estate owners and investors to begin thinking about defense strategies. However, it should be a less severe downside for the commercial real estate industry than the downturn in 2008 thanks to more disciplined buyers,” Kelly said in a prepared statement.

The report describes capital markets as “cautionary,” noting a 23 percent drop in transaction activity year-over-year as of October 2017. But the report also notes an average 8.4 percent price increase for those transactions suggests “more careful selection rather than any withdrawal of capital.”

Individual asset purchases dropped 18 percent compared to a 38 percent decrease in entity and portfolio-level transactions, which may be a sign of “more careful buying activity among pension funds, insurance companies and publicly-traded REITs.” However, that may create more opportunities for high-risk/high-yield investors like hedge funds and private REITs, the report stated.

Performance by property type

It’s no surprise that the industrial sector, driven by e-commerce and global trade, “continues to be a capital magnet,” according to the report. Entering 2018, the industrial sector outperformed all other property types with double-digit total returns, high absorption rates, rising occupancy and rent growth. The report noted industrial transactions totaled $51.8 billion from the first through the third quarters of 2017, a 23 percent increase in price and an 18 percent increase in deal count. Markets expecting a 5 percent market rent growth include Cleveland, Seattle, Hartford, Conn., and Naples, Fla. Markets with top year-over-year transaction growth include Kansas City, Mo.; Westchester County, N.Y.; Sacramento, Calif.; Birmingham, Ala.; and the Washington, D.C. metro.

Cleveland and Westchester County also did well in the office sector ranking, with year-over-year transaction growth, along with Houston; Memphis, Tenn.; and Columbus, Ohio. In other highlights, the report notes that office sector posted another year of solid absorption and values are expected to increase more than 2 percent in 38 percent of the markets this year. Heading into 2018, nearly half of suburban markets were in expansion mode, the highest rate since the financial crisis and a reflection that CBDs are becoming fully priced so buyers are looking to the suburbs.

Momentum is slowing in the multifamily sector, where overall transaction volume was $150.6 billion from the fourth quarter of 2016 through the third quarter of 2017, a 9.8 decrease year-over-year. The report said that should not be an alarming figure, stating that it shows investors are being more careful in underwriting multifamily acquisitions and that a large supply means buyers are not inclined to “pay any price.” The vast majority of markets, 91.9 percent, are in expansion phase, and markets that have seen top transaction rates include Portland, Ore., Pittsburgh, Salt Lake City, Stamford, Conn., and San Antonio.

One sector that does seem to be losing momentum is hospitality and the report forecasts stable but slow growth through 2018. Last year, transaction volume was down 25 percent through the first three quarters compared to the same time period the previous year. Markets that did see transaction growth included Memphis, Tenn.; the New York City boroughs; Charlotte, N.C.; Broward County and Jacksonville, both in Florida.

The report noted that the retail sector continues to be “disrupted by e-commerce, plus shifting demographics and consumer spending habits.” The key to success for investors will be “aggressive asset management versus portfolio growth.” Retail transactions were down 19 percent in the first three quarters of 2017 compared to the same time in 2016.

Two sectors that should see increased demand in the coming years are senior housing, where aging trends will continue to push demand, and the marijuana real estate sector, which the report notes is seeing demand that has exceeded expectations. With California, the nation’s most populous state, now allowing legal sales of marijuana for recreational use, the report expects a “major and immediate impact on demand for marijuana-related real estate.”

Images courtesy of Integra Realty Resources