The U.S. real estate industry is on a steady course to sustain growth through 2017, according to ULI’s latest three-year forecast. At the ULI Spring Meeting in Houston, the consensus forecast was discussed in a session moderated by William J. Maher, director of North American strategy for LaSalle investment Management. “This forecast represents almost the perfect combination of strong economic and property market fundamentals and an orderly wind-down of monetary stimulus,” he said.
“For this semiannual forecast, we surveyed 46 of the industry’s top economists and analysts,” explained Anita Kramer, senior vice president, ULI Center for Capital Markets and Real Estate. “This was the seventh in a series of polls we have conducted to gauge sentiment about the direction of the real estate industry.”
The consensus forecast predicted the National Council of Real Estate investment Fiduciaries capitalization rate for core unleveraged properties to rise steadily from 5.3 percent in 2015 to 5.9 percent in 2017 as a result of higher interest rates and borrowing costs. But while this study represents consensus, its broad-based nature “masks a lot of nuances,” said panelist David J. Lynn of Everest High Income Property. “It’s a tale of two cities: in gateway markets, cap rates are below 5, even as low as 3 or 4––but in other markets, cap rates range from 6 to 9.5.”
But this situation is likely to change. “Capital is flowing rapidly into those secondary and tertiary markets, so we can expect to see cap rate compression in those markets,” Lynn continued. “I don’t see any end in sight to the inflow of global capital. U.S. real estate is the most popular girl at the dance right now, attracting a huge amount of international capital that is driving down cap rates. The massive wall of capital that’s coming will keep real estate prices high.”
How high? Total returns for institutional quality direct real estate investments, as measured by the NCREIF Property Index, have remained fairly steady the last three years, between 10.5 percent and 11.8 percent. Returns are forecast to stay in this range in 2015, at 11 percent, before trending somewhat lower to 9.7 percent in 2016 and 9 percent in 2017.
Of course, not everyone agrees on this prediction. Lee Menifee, managing director, Prudential Real Estate Investors, questioned how real estate can bring in double-digit returns when most other asset classes are delivering returns in the single digits. In fact, all of the panelists agreed that the good times could end quickly as a result of unpredictable geopolitical or global economic upheaval. “The global economy continues to impact the U.S. economy and the capital markets,” said Paige Mueller, managing director, RCLCO Real Estate Advisers,
Another concern is projected job growth. “The economy is bifurcated, with many jobs being created at or near minimum wage,” said Lynn. ”How can this support real estate investment? This situation has ramifications in all sectors, including housing, retail, medical, and office.”
Menifee agreed. “We do need to talk about job quality. Several things may happen: Wages have to increase due to scarcity in some professions; more people could come into the labor force; and employers could invest in training. All three are positive for real estate.”
Key findings of the consensus forecast, which can be found on ULI’s website, include the following:
- Net job growth is expected to be 2.9 million per year, compared to a long- term average of 1.2 million. Demand for real estate, particularly offices and apartments, will remain strong.
- The rate for ten-year US Treasury notes will average 3 percent over the three-year period, lower than the long-term average of 4.1 percent, but rising significantly over the forecast period.
- Issuance of commercial mortgage-backed securities is expected to rise to $150 billion in 2017, from $115 billion in 2015. With banks and insurance companies also active, real estate lending will remain competitive and favorable for borrowers, including those with loans coming due over the next three years.
- Commercial real estate prices, as measured by the Moody’s/RCA Index, are projected to rise by an average of 7.6 percent per year, compared to a long-term average increase of 5.3 percent, suggesting three very strong years of net appreciation.
- Warehouse rents and hotel revenue per available room (RevPAR) are expected to be leaders among the major property types, growing by an average of 3.6 percent and 5.3 percent over the three-year period—well ahead of their historical growth rates.
The latter figure was one of the surprises in the new report. “Industrial is the new retail, with e-commerce growth driving demand for warehouse space,” commented Mueller. And the growing hotel metric follows GDP growth, said Maher. The retail sector has the lowest supply, but rent growth has been suppressed by the sector’s recovery from the recession.
The recession’s lingering effects have hit the single-family housing market hardest. Housing starts are expected to increase slowly, from 647,000 in 2014 to 900,000 by the end of 2017. The average price for existing homes is forecast to rise by 5 percent this year, but only 4 percent in the next two years.