RCLCO’s Latest Chartbook Sees Few Clouds

The downturn looks to have been postponed yet again. Even though conditions are at—or near—peak, the report foresees no downturn this year.

The “base case” scenario for the U.S. commercial real estate sector assumes that “late stable” conditions continue through this year, and perhaps even into 2019 or 2020. Meanwhile, “moderating, though still generally positive operating and investment performance” driven by a strong economy and healthy CRE fundamentals is how things stand now, according to the Q4 2017 Chartbook just released by RCLCO.

Despite concerns over inflation and recent stock market gyrations, RCLCO reminds CRE investors to “be grateful that our assets are valued much less frequently than public equities,” freeing the CRE sector to focus on “underlying fundamentals rather than investor sentiment”

Breaking it down

The report makes the case for inflation and interest rates not being likely to strongly shake CRE, pointing out that CPI inflation was only 2.1 percent last year and that CRE, especially product types (such as multifamily and hotels) with shorter-term leases, tends to absorb inflation reasonably well. Besides, RCLCO notes, real estate investors have long taken rising interest rates into account in their underwriting. 

Multifamily, CBD office space and hospitality assets still hover around peak conditions, as industrial and suburban office slowly climb toward maturity. Only retail, for well-understood reasons, seems to be on its own path, though a very limited amount of new construction has helped improve market fundamentals, including rising occupancy in most markets, even in that beleaguered product type.

Though 2017 was the second straight year in which transaction volume dropped (by 6.7 percent), as did fund-raising, deal flow still well exceeds the long-term average, and the quantity of capital looking for investments continues to outmatch the available opportunities. Offshore capital in the United States has fallen off substantially, and CMBS issuances in 2017 were barely more than those the previous year.

Debt is still available from a variety of sources, even as interest rates gradually rise. Cap rates remain well under long-term averages.

In the office sector, one phenomenon of note is that as nationwide office vacancy is flat, Class B vacancy declines while Class A vacancy increases. The vacancy spread between them is about two percentage points nationally. Industrial vacancy rates remain below historical averages in most U.S. markets; transaction volume is up year-over-year, prices continue to increase and cap rates remain at all-time lows. 

The report’s broad outlines are consistent with those of RCLCO’s year-end 2017 Sentiment Survey, one key similarity being that while neither one denies where market conditions are trending currently, neither one expects an imminent downturn (absent anything major and unforeseeable).

The Q4 report is available here.