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The U.S. economy is weeks away from celebrating the start of its record-breaking 11th year of economic expansion, and the latest ULI Real Estate Economic Forecast is pointing to an even longer run that could extend through 2021, as discussed on a webinar hosted by ULI.

ULI officially released its latest three-year forecast on May 1 along with a webinar discussion that took a deeper dive into the outlook for the economy, capital markets, and commercial real estate. The overall theme of the outlook is one of moderation—but still positive—growth ahead. As a backdrop to the forecast, the latest economic data show that the economy picked up steam in first quarter with gross domestic product (GDP) growth that rose to 3.2 percent.

The recent economic data certainly “drives a stake into the heart of economic analyst vampires” who had a more dire outlook following the stock market storm late last year, said Stuart Hoffman, ULI webinar panelist and senior vice president and economic adviser at PNC Financial Services. Last year, the economy grew at a rate of about 3 percent with the addition of 2.7 million jobs. However, panelists agreed that it is no surprise that the forecast calls for a slower pace of growth.

Although the federal government is continuing to keep its foot on the gas on spending, the huge economic stimulus from tax cuts will start to dissipate. The underlying trend in the economy is more in line with 2 to 2.5 percent GDP and job growth close to 2 million, notes Hoffman. Yet even with slower growth ahead, everyone should be pleased that this economic cycle has legs, he adds.

Liquidity Boosts Sales Activity 

There continues to be an ample supply of both debt and equity available for commercial real estate from a multitude of sources. “Lenders are enjoying this run. Delinquencies are down, they like the spreads, and they don’t see any problems on the horizon, but they are holding the line on loan-to-value and taking risks,” said William Maher, a ULI webinar panelist and director, Americas Research & Strategy, at LaSalle Investment Management. Another positive on the borrower side is that the 10-year Treasury has dropped back to near 2.5 percent, with the forecast that the rate will remain below 3 percent through 2021.

That liquidity continues to fuel investment from both domestic and foreign buyers. Last year saw transaction volume surge to $562 billion, which was just short of the record-high levels achieved in 2015 and 2007. That robust activity was even more impressive given the pullback from Chinese buyers and high hedging costs for some foreign buyers, such as Germany and South Korea. It is entirely possible that commercial real estate could see that level of activity continue this year, noted Adam Ruggie, ULI webinar panelist and head of real estate research at MetLife Investment Management. “Looking at where to place your real estate dollars, the rest of the world doesn’t look as attractive as the U.S. does right now,” he adds.

That being said, total returns are decelerating due to lower appreciation levels. National Council of Real Estate Investment Fiduciaries (NCREIF) total annual returns at 6.7 percent in 2018 are expected to moderate to 6 percent this year and dip further to 5 percent in 2020 and 2021. The RCA Commercial Property Price Index also is forecast to decline from 6.2 percent in 2018 to 2.8 by the end of 2021. There could be flat, or positively negative appreciation returns in 2020 due to higher capital expenditures, noted Ruggie. “That doesn’t necessarily mean we are seeing a decline in prices, but when you make that deduct for cap-ex, it could take us to zero or below after 2019,” he says.

Industrial Continues to Outperform 

The outlook for industrial remains strong. In fact, industrial total returns on the NCREIF Index are double the level of other property types. “Industrial has been on a tear that has been so impressive, driven by the growth of e-commerce and consumer spending,” said Jeanette Rice, ULI webinar moderator and Americas head of multifamily research at CBRE

Vacancies are holding relatively firm despite new supply that is being added to the market. Beyond the e-commerce effect, demand is also being powered by the ability to delivery online orders much more quickly. Retailers need close-in industrial space that can accommodate the short delivery windows, and companies also have an appetite for newer, more modern facilities. “Controlling sites and controlling buildings in this supply-constrained market is about the best position you can be in right now in the industrial space,” Maher said.

Multifamily has proved skeptics wrong in weathering its building boom. The expectation was that new supply was going to result in a significant pullback in vacancy and rent growth. “We felt that people were underestimating the strength of the demand that millennials were generating and the financial constraints they were under that prevented them from buying homes and lack of home construction and lack of motivation,” said Ruggie.

Although rent growth is moderating more in line with the 20-year average, vacancies have held up under the weight of new supply at sub–5 percent. Looking forward, millennials are still going to be a big driver in demand for rental housing, but people once again are underestimating where that demand is going, Ruggie added. Aging millennials are going to be moving out of the urban core to the suburbs and satellite cities. They also may not be looking to buy a house, but rather rent larger two- and three-bedroom homes. “So, you will be able to get really strong multifamily returns, if you’re picking the right assets,” he said.

The residential side has been missing in action in this economic cycle and was down again in the most recent first-quarter GDP report. However, it does appear that housing will get a lift from lower mortgage rates. “The residential side is looking a lot brighter than it has in several years,” Hoffman said. “So, I think we are going to see some contribution to economic growth from both new and existing home sales, which does bode well for consumer spending.”

Clouds on the Horizon

The panelists did point to some potential downside risks in the market that could weigh on the ULI Forecast in the near term. Notably, those risks include a failure to reach a trade deal with China, impacts from weak growth in Europe, inflation risk, and a shortage of labor to support growth.

One risk that has been taken off the table—at least temporarily—is interest rate hikes. The Federal Open Market Committee (FOMC) announced in its most recent May 1 meeting that it would not raise rates. However, the Fed also indicated that it could resume rate hikes in the fourth quarter. In addition, while a number of inflationary pressures are evident in the market  a tight labor market, wage growth, and federal spending, inflation has remained modest.

Panelists agreed that even a converging of risks would likely result in a slowdown in economic growth and not necessarily lead to a recession. It also is important to look at the risks in context and view real estate compared with other assets. For example, real estate tends to perform well during periods of high inflation since it is an inherently inflation-protected asset class.

Specific to real estate investment trust (REIT) performance, the forecast calls for improvement after a very weak year in 2018 where returns dipped into negative territory. Projected returns that range between 5.3 and 6 percent over the next three years are still well below the 20-year average of 11.5 percent. One of the important points to note that does not show up in the forecast is that over half of the REIT market cap is concentrated in niche property types that include sectors such as cell towers and data centers that have really great fundamentals, says Maher. “You hear about the office and mall REITs that are trading at big discounts, but there are some really good growth and defensive characteristics in other parts of the sector, and I don’t think the forecast picked up on that,” he said.