The latest ULI Real Estate Economic Forecast (formerly the ULI Consensus Forecast) is predicting more positive momentum ahead for both the economy and the commercial real estate industry through 2019. That being said, the pace of growth is slowing and the survey of 48 economists and analysts clearly reveals some lowering of expectations.

Some notable findings include an anticipated decline in transaction volume and lower annual returns ahead for the NCREIF Property Index. Industrial will continue to lead the four core property types over the next three years. By 2019, total annual NCREIF returns for the industrial sector are forecast to reach 7 percent, followed by apartment, retail, and office returns at 5.5 percent, 5.1 percent, and 5 percent, respectively.

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However, economic growth and job growth are still positive, and many key indicators related to property fundamentals are still better than their 20-year averages. Gross domestic product (GDP) is expected to rise from 2.2 percent in 2017 to 2.4 percent in 2018 before dropping back to 2 percent in 2019. “I think the forecast of 2 to 2.5% growth over the next three years is pretty reasonable. The labor market is very strong. It is slowing down, but it is slowing to a still-healthy pace,” says Adam Ruggiero, director and head of real estate research at MetLife Real Estate. Ruggiero was one of four panelists who discussed survey findings on a webinar.

The expectation is that the United States will add 2 million jobs this year, followed by 1.79 million in 2018 and 1.5 million in 2019. “What we have really been missing, and what we are looking for is increases in wages,” Ruggiero says. However, with unemployment expected to dip to 4.2 percent next year, the tight labor market could put some added pressure on wage growth in 2018, he adds. Strong job and wage growth typically correlates with more demand for space across all property types.

Market Is “Awash” with Liquidity 

Capital costs are expected to remain favorable by historical standards. The ten-year Treasury yield has been hovering at about 2.35 percent in October. The ULI Forecast predicts that the ten-year rate will rise 75 basis points to reach 3 percent by the end of 2019, while the average NCREIF cap rate will rise only 30 basis points to 5.3 percent in 2019. “The world still seems to be awash with liquidity, which has great impact on capital flows here,” says David Gilbert, CEO and CIO at Clarion Partners. The fact that much of that capital is targeting investments in U.S. real estate is part of the reason why there is that divergence between cap rates and U.S. interest rates, he adds.

Despite the availability of capital, transaction volume is continuing on a downward trajectory. After reaching what may be the high for this cycle at $547 billion in 2015, transaction volume is expected to decline to $414 billion in 2019. That slowdown is likely due to a combination of factors, notably more caution at this stage of the cycle and higher property prices.

“Fundamentals are good, but values are plateauing. So, this is probably what a late cycle should feel like when we don’t have irrational exuberance in the debt markets or we don’t have a glut of new supply hitting the market. You really have a slowdown in transaction activity and a slowdown in value growth, but you still have good fundamentals and good property income,” says Mark Wilsmann, managing director and head of equity investments for MetLife Real Estate.

Industrial Takes the Lead in Performance

Economists remain bullish on their outlook for industrial. The fundamentals in the sector are strong, and e-commerce is a powerful force driving more demand for space. Even with increased development activity, vacancy rates are expected to hold steady at 7.7 to 7.9 percent through 2019, which is well below the 20-year average of 10.2 percent.

“Even though there is a significant amount of new construction, it is the only sector where our outlook is that we will be developing more than the historical average over the next several years,” says Wilsmann. That new supply is matching the demand, and because it has a shorter construction cycle as compared with other property types, it is less likely to be significantly overbuilt, he adds.

In the 2016 ULI Forecast, there was more negative sentiment directed at apartments due to concerns that new supply growth would overwhelm demand. New supply has created some slight softening in fundamentals, but the overall outlook is still very positive. Vacancy rates are expected to remain at 4.8 percent in both 2017 and 2018 before ticking higher to 5.1 percent in 2019. After slowing in 2016, rent growth is expected to rebound to 2.5 percent this year, followed by moderate growth of 2.1 percent and 2.2 percent in 2018 and 2019.

Demand is being fueled by the approximately 85 million millennials who are delaying homebuying due to factors such as a heavy student loan burden, as well as decisions to marry and have children later in life, notes Ruggiero. “There is this really tremendous demographic tailwind that has been floating the multifamily sector for a number of years, and we think it is going to continue to well into 2020,” he says.

Office and Retail Continue to Face Challenges

Office vacancies did improve for the seventh straight year to 12.9 percent in 2016. However, available space will tick higher to reach 13.4 percent in 2019. Office rental rates will remain subdued, growing at between 1.9 percent and 2.1 percent for the next three years.

One challenge in the office sector is the slow recovery in many suburban markets. Pockets of premier suburban office markets remain attractive, but in general, there has not been strong demand for traditional suburban office space, says Tim Wang, managing director and head of investment research at Clarion Partners. “It is a big question mark when the millennials are going to move to the suburbs and whether employers are going to chase them to the suburbs in the future,” he says. “We believe that is at least five years away.”

Retail continues to face significant volatility. Power centers have been battling rising vacancies in recent years due to the closure of big-box stores. Class B and C malls will continue to struggle, while the Class A malls with good demographics and access to capital are better equipped to adapt to the changing marketplace. It also is important to point out that some segments of the market, such as grocery-anchored centers and urban lifestyle centers, are doing very well, notes Ruggiero.

The forecast for retail certainly reflects some of the current market challenges, but it is not entirely bleak. Retail availability rates have been on a steady decline from a high of 13.0 percent in 2011 to 10.1 percent in 2016. The forecast anticipates a plateau in 2017 at 10.1 percent, before ticking up 10 basis points in 2018 and another 10 basis points in 2019. The forecast also expects positive rent growth at 1.9 percent this year, following by further growth of 1.8 percent in 2018 and 1.5 percent in 2019.

Some markets’ risks could surface to shift near-term sentiment. One concern is that the economic stimulus that many were expecting under a Trump administration has not materialized. “I think expectations have moderated,” says Ruggiero. “But, if we don’t get a tax cut, if we don’t get infrastructure spending—or it is substantially weaker—then we could end up seeing a retrenchment in stock market prices that causes a portfolio balancing problem for equity capital flows and we end up seeing real estate prices get hurt as a result of that.”