Surprise, Surprise: 2017 Ushers in a New Era

By Ken Riggs, President, Situs RERC: With a new administration set to take over next month, what is ahead for commercial real estate investment in 2017?

Ken-Riggs_webAs the nation embarks on 2017,  shouldered with a surprise election result, we enter into a new era of politics under President-elect Trump. While the results of the election were initially greeted with concern and uncertainty, many are now expecting the economy to do better than it would have under Hillary Clinton. As seen by Mr. Trump’s recently appointed cabinet members, the new administration is likely to be pro-business and pro-growth, which is expected to stimulate the U.S. economy. This is coupled with Gallup data showing that U.S. economic confidence is at a nine-year high and consumer spending has been trending upward over the past year. The economy was already gaining traction prior to the election, but it is now expected to ramp up over the coming year.

What does this mean for commercial real estate? President-elect Trump is likely to support endeavors that boost and encourage investment, promising during his campaign to make significant personal and corporate tax cuts and scale back financial crisis-era regulations.

Typically, what is good for the economy is good for CRE. Employment growth spurs demand for office space and housing. Increasing wages mean consumers have more disposable income to spend in shops, restaurants and hotels.  A boost in online shopping means more demand for industrial space to meet the needs of efficient supply changes and tight delivery schedules. All in all, the outlook for CRE is positive in the near future.

The potential downside to Trump’s pro-growth policies is that they may lead to increased inflation and interest rate hikes over the next four years. Since the U.S. economy is at near-target inflation, the Federal Reserve raised the interest rate by .25 percent in December and signaled that several more increases are likely in 2017. In response to the Fed’s decision, the 10-year Treasury rate climbed above 2.5 percent, up more than 130 basis points since July, which is further evidence of the strengthening economy. It is possible that the 10-year Treasury may reach 4.0 percent over the course of the next year.

Higher inflation is a mixed-bag for CRE. Inflation will lead to rising long-term interest rates, which may temper CRE investment. In this scenario, the cap rate compression seen in the past few years would reverse course. On the other hand, CRE investment is typically considered a buffer against high inflation since greater inflation can lead to higher rents.

Despite lower transaction volumes in 2016, CRE fundamentals continued to grow for most property types, with increasing rents and decreasing vacancies. In 2017, CRE fundamentals are predicted to grow, albeit at a measured pace. The CRE market is fully priced, yet because of its relative security compared to other investment alternatives, CRE will continue to be a top choice with investors in these increasingly turbulent times. However, investors should also expect surprises, be cautious and weigh the benefits of CRE investment with knowledge that we are late in the CRE cycle and a market correction is looming on the horizon, though likely a couple years out.

For the major property types, the predictions for 2017 are:

  • Hotels and apartments will fare better than other property types due to their short-term leases and ability of rents to react quickly to changes in inflation.
  • Since the U.S. is at near-full employment, wages are expected to increase slightly, leading to increased consumer spending. This will be a much-needed boost for the retail sector.
  • The bidding war in the industrial sector will likely result in increased prices as demand for warehouse space continues to outpace supply.
  • The continued increase in employment for professional and business services will lead to steady demand in the office sector; however, new supply is expected to come to market in 2017, resulting in flattening rents.