Enhanced CRE Fundamentals in Year Ahead

A new report by Transwestern predicts the current economic growth will enhance commercial real estate fundamentals, improving cash flow and returns.
TOM

Tom McNearney, Transwestern

A new report by Transwestern predicts the current economic growth will enhance commercial real estate fundamentals, improving cash flow and returns.

“The main thing people should understand is while the economy has not performed at a level people may have expected given some of our other recoveries, we have been making slow steady progress for five years,” Tom McNearney, Transwestern’s chief investment officer, told Commercial Property Executive. “At the end of the day, that is more growth and attraction than many other areas of the globe.”

The Transwestern “Briefing” report did show that while the economy appears to be entering the New Year on a roll, uncertainty in China and emerging markets are creating uncertainty and threatening to derail growth in both the U.S. and abroad. Still, according to McNearney, on a relative basis, commercial real estate should remain very attractive to both debt and equity investors.

“In some respects, it’s certainly driving positive fundamentals for commercial real estate business,” he said. “We are seeing occupancies going up and rental rates going up across the board in all property types. It may be at a little anemic pace because of construction and overreaction, but it’s still very attractive to investors.”

McNearney said he believes that stocks and bonds are not the way to go. He sites the little reaction to the Federal Reserve’s decision to cut its monthly bond-buying program from $85 billion to $75 billion.

“This ‘tapering-lite’ program combined with the projected economic growth is expected to create upward pressure on interest rates,” he said. “Therefore, 2014 is going to be a bumpy road for stocks and bonds, particularly Treasuries and high-grade corporate bonds.”

Despite nearly 100 bps rise in 10-year Treasuries, commercial real estate sales ended the year with increased volumes and flat or lower cap rates.

“Since 2009, the biggest impediment to more sales of troubled assets has been the expected loss banks were taking on the disposal of assets,” he said. “Today, pricing on performing, sub-performing and non-performing assets has improved dramatically, and the vast majority of banks have the capital and reserves to move assets.”

Furthermore, the report shows that in some cases, banks are finding sales of undesired assets to be capital accretive and there have even been whispers from buyers that appraisals on assets are too low. Therefore, banks that dismissed loan sales two to three years ago should consider taking a second look.

According to the report, much of the recovery over the last few years has been based on cap rate compression, due to lower interest rates and better financing.

“On a relative basis, commercial real estate should remain very attractive to both debt and equity investors,” McNearney concluded. “Despite a rise in interest rates on 10-year Treasuries by nearly 100 basis points, commercial real estate sales ended the year with increased volumes and flat or lower capitalization rates.”