Real estate economists boosted their outlook for economic growth in March’s ULI semi-annual survey, compared with the survey of six months ago. The passage of the Tax Cuts and Jobs Act in December 2017 may have positively affected their forecast; this same group had shown a tempering of their expectations in the previous survey. The expectation for stronger economic growth is accompanied by the potential for higher inflation and interest rates. The higher rates, however, are not projected to be detrimental to real estate returns: Forecasts for industrial returns are higher than in the previous survey while office, retail and apartment returns are similar or revised just slightly downward. Still, returns over the three-year forecast period continue to show the same moderating trend projected six months ago.
These results are based on the ULI Real Estate Economic Forecast (formerly ULI Consensus Forecast), prepared by the ULI Center for Capital Markets and Real Estate. The survey was completed in March 2018 by 48 economists and analysts at 36 leading real estate organizations and includes forecasts for 2018, 2019, and 2020. (The survey of six months ago forecast 2017, 2018 and 2019).
Real estate economists expect a jump in economic growth in 2018. Real gross domestic product (GDP) growth is forecast to rise to 2.8 percent for 2018, up from the 2.4 percent projected in the October 2017 survey. Higher levels of economic growth may continue into 2019 with economists predicting a 2.5 percent growth rate, up from October’s projection of 2.0 percent for 2019. The economists surveyed do not see an end to the current economic expansion, with real GDP growth for 2020 of 2.0 percent.
Job growth is also expected to get a boost in 2018 and 2019. The current survey shows expectations for 2.2 million new jobs in 2018 and 1.89 million new jobs in 2019, with both years more than 400,000 jobs above the fall forecast. Job growth in 2020 is expected to be somewhat lower, at 1.38 million, but remains above the long-term average. With the higher levels of job growth in the first two forecast years, the outlook for the unemployment rate remains low. The current survey indicates that the unemployment rate will be at 3.9 percent at the end of 2018. The labor market could remain tight through the end of the forecast period, with expectations for the rate to be at 3.8 percent and 4.1 percent in 2019 and 2020, respectively.
Due to the stronger real GDP growth rate and tight labor market, survey respondents now forecast higher inflation rates during the forecast period. The Consumer Price Index (CPI) inflation rate is projected to rise to 2.3 percent in 2018, 2.5 percent in 2019 and remain at 2.5 percent in 2020. Interest rates are forecast to rise along with the increase in inflation. The Federal Reserve has made it clear they do not foresee March’s interest rate increase as an isolated incident, and the surveyed economists seem to agree. The survey outlook is for rates to be 0.4 percent higher in 2018 and 2019 than previously expected, with the Ten-Year U.S. Treasury rate rising to 3.1 percent in 2018 and 3.4 percent in 2019. The ten-year Treasury rate is forecast to remain steady in 2020 at 3.4 percent.
The belief that it isn’t the actual interest rate increase that matters to real estate investors, but rather the reason for the increase, seems to be reflected in the outlook for NCREIF capitalization rates. While the survey shows an expected increase in Treasury rates over the previous survey, the corresponding expectations for 2018 and 2019 capitalization rates are actually slightly lower than the previous survey and rise only modestly over the forecast period from 5.1 percent in 2018 to 5.3 percent in 2020. The survey respondents appear to feel that there is enough risk premium built into current capitalization rates to absorb the potential rise in interest rates.
Despite the outlook for stronger economic and job growth, and the expectations that capitalization rates will not rise in lockstep with higher interest rates, survey participants feel that core real estate returns will continue to be flat to trending lower over the forecast period. The 2018 projection for NCREIF total annual returns, while unchanged from the previous survey at 6.0 percent, is a decline from the actual 2017 returns of 7.0%. Expectations for 2019 are down to 5.1 percent from the 5.8 percent projected in October 2017, and the forecast for 2020 is 5.0 percent. The potential rise in interest rates could have a more significant impact on equity real estate investment trust (REIT) returns. Current survey respondents see equity REIT returns at 4.4 percent in 2018 and 5.5 percent in 2019. These rates are down from 6.0 percent and 6.5 percent projected in the previous survey.
It appears that the forecast for stronger economic growth may lead to higher levels of investment activity. Survey respondents increased their expectations for transaction volume for 2018 and 2019 (up $23 billion in 2018 and up $11 billion in 2019). Transaction volume in 2020 is expected to remain strong —although at a somewhat lower level. In addition, commercial mortgage–backed securities (CMBS) issuance is expected to be up $10 billion in both 2018 and 2019 compared with the previous survey results. The prices paid for real estate as measured by the RCA CPPI may also see some initial benefit from a higher level of transaction activity. Current survey respondents feel that prices could rise 5.0 percent in 2018, up from the 4.1 percent increase reported in the previous survey, although projected growth slows to 3.0 percent and 2.3 percent in 2019 and 2020, respectively.
The outlook for property sector fundamentals generally continues to reflect the characteristics of the current real estate cycle. Fundamentals either are steadily improving or appear to have stabilized at sustainable levels. There is no indication that we are about to see any imbalance in 2018 that will send the property sectors into a significant downturn. That said, there remain differences within the different sectors.
Industrial. Survey respondents continue to feel that the industrial sector will outperform the market over the forecast period. The 2018 outlook for availability rates is 7.4 percent, well below the 20-year average of 10.1 percent, and is expected to stay below the long-term average in 2019 and 2020 at 7.5 percent and 7.7 percent, respectively. The low availability rate is helping to support the 2018 outlook for rental rate growth of 4.6 percent, though growth rate is expected to slow to 3.8 percent in 2019 and 3.0 percent in 2020. Finally, the strong fundamentals have survey respondents raising their outlook for industrial total returns to 10.0 percent in 2018, up from the 8.4 percent projected in the October 2017 survey, although respondents forecast moderating returns in subsequent years, reaching 8.0 percent in 2020.
Apartment. Expectations for the apartment sector continue to moderate. Survey respondents expect the vacancy rate to increase slightly to 5.0 percent in 2018 and to 5.2 percent in 2019, where it is expected to remain in 2020, still all three years are below the 20-year average. While vacancy rate projections for 2018 were unchanged from the October survey, 2018 rent growth projections decreased to 1.5 percent from 2.1 percent in the Fall survey. Rent growth rates for both 2019 and 2020 are just 2.0 percent. Total returns are projected to moderate from 5.4 percent in 2018 to 4.5 percent in 2020.
Office. The 2018 office vacancy rate is projected to remain unchanged from the actual 2017 rate of 13.0 percent but is expected to increase to 13.2 percent in 2019 and 13.4 percent in 2020. Rent is projected to grow at 2.5 percent for 2018 and 2.0 percent in 2019, both higher than the previous outlook, while rent growth slows to 1.5% in 2020. The outlook for returns is similar to the apartment sector, with 2018 total returns at 5.4 percent, decreasing to 5.0 percent in 2019 and 4.5 percent in 2020.
Retail. The struggles in the retail sector have been well documented, and the survey respondents see this holding back retail fundamentals. The outlook for 2018 and 2019, however, may reflect an expected increase in consumer spending due to the projected stronger economy. Retail availability rates for 2018 and 2019, at 9.8 percent and 9.9 percent, respectively, are slightly better than the 10.2 percent and 10.3 percent projected in the October 2017 survey. The expected rental rate growth for 2018 of 2.0 percent is stronger than the previous survey’s 1.8 percent, as is the 2019 projection of 1.8 percent relative to the previous outlook of 1.5 percent. Similar to other sectors, retail fundamentals are expected to moderate by 2020, to an availability rate of 10.0 percent and rental growth at 1.1 percent. Retail sector total returns are forecast to be 5.0 percent in 2018, moderating to 4.6 percent in 2019 and 4.3 percent in 2020.
Hotel. A stronger economic outlook appears to have raised the occupancy outlook for the hotel sector. Survey respondents expect occupancy rates to be at a post-recession high of 66.0 percent in both 2018 and 2019, up from the 65.4 percent and 65.1 percent, respectively, forecast in the October 2017 survey; the occupancy rate is expected to moderate just slightly to 65.8 percent in 2020. The current survey expects growth in revenue per available room (RevPAR) to moderate from 2.7 percent in 2018, to 2.4 percent in 2019, and 1.7 percent in 2020.
Single-family. The results of the survey do not indicate much optimism that the shortage of homes for sale will be fully corrected during the forecast period. The outlook for 2018 single-family housing starts, at 923,000 homes, is actually down from the 937,500 that respondents expected in the previous survey. However, participants do expect a bump in 2019 to 987,500 starts, before moderating back to 925,000 in 2020. Survey respondents expect home prices to rise 5.3 percent in 2018 and 4.3 percent in 2019, both above the 20-year average annual growth rate of 4.0 percent.
In summary, survey respondents do expect a stronger economy over the next two years, but along with the increase in growth will come higher inflation and interest rates. The real estate market appears well positioned to absorb the projected changes. Property sector fundamentals have stabilized near equilibrium levels and core properties are expected to continue to produce stable returns.