2017 was a great year overall for the commercial real estate industry. Some of the trends will carry over into 2018. Here’s a short list of items to consider going into 2018.
Interest rates are rising. The problem is that only the short-term rates are rising. The longer-term rates are only marginally higher. If the Fed keeps raising the fed funds rate and the 10-year US Treasury doesn’t increase as well, the Fed could end up with an inverted yield curve. This could lead to a slowing economy. At the least, it could lead to some lenders not funding more loans because their net interest margins are shrinking– that alone could potentially slow down the economy. For commercial real estate, increasing rates will affect the spread between cap rates and borrowing rates– the smaller the margin between them the harder it is to find profitable investments.
GDP is growing at a better clip. GDP growth in recent quarters has been around 3%. Some are predicting 4% for 2018. Not everyone shares those forecasts, but one forecast from Goldman Sachs seems to think at 4% the economy will also be more productive– that’s a most welcome word (let’s read that again, productive) that hasn’t been spoken in a while and can replace the disruptive word we have heard so much for the past several years. The Wall Street Journal recently published a great article on how productivity might rebound. Do watch for technology to lead out increased productivity– no, surfing the net doesn’t count! Here’s one article discussing the forecasts of economists from several commercial real estate brokers.
The labor market is tight. Yes, unemployment is the lowest in years and could go lower below 4%. However, that also means wages should be going up and that could lead to inflation. So while everyone is looking at unemployment, it will be important to look at wage growth and inflation. The one thing that helps keep those in check is… here’s that word again, productivity. The more productive the labor market is the less pressure there will be on higher inflation. Of course, if you are developing anything, you are already keenly aware of the shortage of construction labor.
The CMBS market survived the wall of maturities. The CMBS market is looking strong. A great article on the CMBS market is out at Globestreet.com. Three items to watch here. One, improvements in servicing agreements. This should make CMBS more user-friendly. Two, B-piece buyers are being more selective, more credit sensitive. As a result, CMBS loan candidates really have to meet or exceed underwriting requirements. Third, the declining delinquency rate on CMBS to continue. The third one, with so much new volume coming into CMBS, delinquency would be expected to come down as new vintages of mortgages are funded and packaged into CMBS pools. This time around, delinquencies may remain lower as lenders and investors have been more conservative in their underwriting and deal selection.
International trade agreements. President Trump has pulled the USA out of some important trade agreements that could have an impact on our economy– its a bit early to tell. So this is a story to follow in 2018. Shipping and ports are the busiest they’ve been in years! So time will tell on this one.
Trends by property type
Multifamily will continue to be a hot market. However, watch out for rising vacancies as an early sign of the market softening. Another important development with the revised tax laws will be affordable housing credits. Keep looking for opportunities to serve the middle class, row houses, transit-oriented developments, and affordable rental units in most areas of the country would be a very welcome development. Finally, check out the chic micro units! These could be a very lucrative sector of multifamily– think luxury hotel rates with leases that last more than one night.
Retail continues to transform itself. As strong retail sales end the holiday season, it will be important to see how retail continues to transform itself with more attractions and creative tenants to draw traffic. Traffic is the key to retail’s success. Tenants are also finding ways to bridge the gap between physical stores and online sales through the omni-channel strategy. It has been said that consumers like to be able to return online purchases in physical stores because of the convenience. And retailers like it because the consumer ends up purchasing three times as much while returning the one item purchased online.
Industrial space has been in high demand with online retailers seeking locations closer to their customers. Expect that to continue, however, watch out for supply. With average construction times at less than 12 months, additional supply can be made available quickly and outstrip demand. So watch the available space in your market and the time it takes to fill up that new space. Look for rents to increase at a slower pace for signs that the market is becoming more balanced.
Office sector seems to be in a sweet spot. Tenants are using new office buildings in the suburbs to attract talent. There are new buildings being constructed in urban areas too. Construction cranes are in the air in most primary and secondary markets. Can demand absorb all the new space? Watch out for short-term oversupply. Watch the trend in the office flex product; it might become more than that as tenants and employees continue to redefine office work.
Rents have been increasing in 2017. Expect that to continue in 2018, unless the economy softens. Watch those vacancy rates in 2018 for any early signs of trouble in 2019!
Finally, look for emerging technologies to improve all aspects of the commercial real estate industry. Technology will provide easier access to data allowing more informed decisions and better service. At least that’s the hope. So embrace it before it embraces you.
We hope 2018 will be a great year for you. Happy Holidays and a prosperous New Year to you from us at Tower Commerical Mortgage!