Results from the fall ULI Real Estate Economic Forecast show a rise in economic expansion in 2018, with growth tapering in 2019 and 2020.

Tax reform is largely credited with the economic bounce that has occurred this year, with gross domestic product (GDP) growth that jumped from 2.2 percent in 2017 to an expected 3 percent this year, according to the survey conducted by the ULI Center for Capital Markets and Real Estate. Economic growth is expected to slow to 2.5 percent for 2019, which is still ahead of the more conservative prediction of 2.2 percent that was made in the fall 2017 survey. Although the semiannual forecast for economic growth is consistent with the spring forecast, the outlook for 2020 is slightly more pessimistic at 1.7 percent as compared with a prediction of 2 percent that was made in April.

The recent tax reform and increasing government spending have provided a “shot in the arm” for the U.S. economy, says Tim Wang, director, head of investment research at Clarion Partners. “So, 2018 and 2019 should be great. The question is what’s going to happen beyond that,” he says. If the current forecast for GDP growth holds true through 2020, then summer 2019 would mark the longest economic recovery cycle since the post–World War II boom.

Yet it remains to be seen whether the economy can continue to grow without overheating, and whether or not the Fed will be successful in engineering a soft landing, notes Wang.

Wang was one of three panelists who discussed the forecast results in a webinar hosted by ULI.

CRE Outperforming Long-Term Averages

The ULI forecast, which surveys 45 leading economists and real estate analysts, shows positive growth in the near term—in many cases, with forecast numbers for both economic and commercial real estate performance that are above long-term averages. At the same time, there is a clear trend of decelerating improvement. The economy and commercial real estate markets still look good in the near term,  just not as good as recent performance.

Overall, the outlook for commercial real estate investment remains favorable. NCREIF total returns are expected to moderate over the next three years, with a forecast of 6.5 percent in 2018 that will decline to 5 percent by 2020. By property type, industrial is leading the sector in performance with a forecast return for 2018 of 11.4 percent, followed by office and apartment returns each at 6 percent, and retail returns at 4.5 percent.

One of the “shocking” aspects of the forecast is that there is very little difference between the forecast total returns for apartments, office, and retail, said Melissa Reagen, another webinar panelist and managing director, head of Americas real estate research at TH Real Estate. The drivers, characteristics, and what people like—and don’t like—in each of those sectors are very different, and it doesn’t appear that those differences are showing up in the results, she says.

On a positive note, the forecast is predicting that long-term interest rates will remain relatively low even as the U.S. Federal Reserve has continued to raise short-term rates. There is still a bit of a disconnect with long-term interest rates, especially with how bullish people are on the economy, adds Reagen. The forecast calls for the ten-year Treasury note to rise about 50 basis points to 3.5 percent in 2020. In addition, there is still quite a lot of capital in the market that will keep pressure on capitalization rates and continue to fuel investment sales activity. Cap rates are expected to hold relatively firm, increasing only 30 basis points from the current 5 percent to 5.3 percent in 2020.

Industrial Still “On Fire” 

After seven years of steady improvement, industrial vacancies appear to be leveling off at a very healthy 7.3 percent for 2018 and 2019, followed by a slight uptick to 7.5 percent in 2020. Both vacancies and rent growth have been significantly outperforming the long-term (20-year) average. However, warehouse rent growth is projected to decline from 3.9 percent this year to 2.4 percent in 2020.

Industrial has been performing well across the board and hot spots in that sector will continue to be urban infill locations, as well as coastal markets near the ports on the West Coast, as well as the Southeast and New Jersey. “The industrial sector is really supporting the U.S. consumer. So, if you’re betting that the U.S. consumer will continue to spend money, industrial warehouse will continue to do well. The question is where,” says Wang. There could be adjustments from port markets to more inland hubs, due in part to the impact on imports from the trade war, but that remains to be seen, he adds.

“Industrial has been the outperformer by far for the last three to four years and making everyone else look pretty weak,” said webinar panelist William Maher, director, Americas research and strategy at LaSalle Investment Management. One potential risk is the strong construction pipeline with developers that can build and sell properties at a big premium over replacement costs. If demand dips, that could result in oversupply, he adds.

Low unemployment and job growth have not moved the needle significantly in the office sector. After reaching a low of 12.9 percent in 2016, office vacancies are beginning to edge higher. The forecast anticipates that vacancies will climb to 13.6 percent in 2020. The forecast also calls for rental rate growth to tick up 10 basis points this year to 2.2 percent before edging back down to 2 percent in 2019 and 1 percent in 2020.

Renters Slow to Return to Homeownership

The single-family housing market shows some signs of recovery, but construction remains subdued compared with pre–Great Recession levels. Although new home starts have been rising over the past several years, they remain below the 20-year average that sits just shy of the 1 million mark. Housing starts are expected to rise to 900,000 this year, followed by a forecast of 930,000 in 2019 and 900,000 in 2020.

A number of changes have negatively affected homeownership, notes Maher. Aside from foreclosures and wealth lost in the bursting of the last housing bubble, many in the current millennial generation either are choosing to rent or they cannot afford the home prices in the urban areas where they want to live. In addition, new caps on state and local property tax deductions for homeowners could hurt home sales and prices in high-cost housing markets such as California and New York, he adds.

The multifamily sector continues to benefit from challenges in the homeownership market. Apartment fundamentals have held up even with construction activity that has delivered a surge in new supply in recent years. In fact, the forecast for both vacancy rates and rental rate growth are more optimistic as compared with the spring forecast. Vacancy rates will remain flat in 2018 at 4.9 percent and inch higher to 5.1 percent in 2020. Following two years of subdued rent growth in 2016 and 2017, the ULI Forecast anticipates that rent growth will accelerate to 2.9 percent this year, followed by slower growth of 2.5 percent and 2 percent in 2019 and 2020, respectively.

Bifurcated Retail Market 

Panelists in the ULI forecast webinar agreed that survey results do not tell the whole story in the retail sector. Current and past forecasts have tended to suggest healthy performance in retail. Since peaking at 12.8 percent in 2011, vacancies have improved to 9.5 percent, which is just under the 20-year average of 9.7 percent. Vacancies are expected to edge higher to 9.6 percent in 2019 and 9.8 percent in 2020.

Forecast data also show that rents accelerated to a post-recession high of 3.1 percent in 2017 with a forecast that rent growth will drop to 1.8 percent this year, 1.6 percent in 2019, and a relatively flat 0.6 percent in 2020. Yet those numbers don’t capture the bifurcation in the market, says Reagan. Some properties are doing really well and achieving annual net operating income (NOI) growth of 3 to 4 percent, while other shopping centers are falling well short of that, she says.

Retail is going through a multiyear transformation with more experiential and service tenants, which requires a lot of capital investment, adds Wang. So, it is not just a story about increasing rent growth when capital expenditures also are rising. “Real appreciation is not there. That’s the challenge for the retail sector today,” he says.

Downside Risks

Panelists said there are certainly potential wildcards that could pose some downside risks further out in 2019 or 2020, such as the impact of tariffs on GDP growth or inflation. “That’s where we are spending our time. Where are the risks? And I think they are more on the downside than the upside,” said Maher.

Attendees of the 2018 ULI Fall Meeting will hear additional discussion of the forecast in a session titled: “Learning in Real Time: Experts Share Their Forecasts for Real Estate in ’18, ’19, and ’20