National Association of REALTORS COMMERCIAL REAL ESTATE : 2016.Q2
Commercial Real Estate Outlook: 2016.Q2 Download: www.realtor.org/reports/commercial-real-estate-outlook 2016 NATIONAL ASSOCIATION OF REALTORS All Rights Reserved. Reproduction, reprinting or retransmission in any form is prohibited without written permission. Although the information presented in this survey has been obtained from reliable sources, NAR does not guarantee its accuracy, and such information may be incomplete. This report is for information purposes only.
COMMERCIAL REAL ESTATE NATIONAL ASSOCIATION OF REALTORS 2016 OFFICERS President Tom Salomone President-Elect Bill Brown First Vice President Elizabeth Mendenhall, GRI, ABR, ABRM, CIPS, CRB, PMN Treasurer Michael McGrew, CRB, CRS Immediate Past-President Chris Polychron, CIPS, CRS, GRI Vice President Michael Labout, GRI Vice President Sherri Meadows, GRI, CIPS, CRB, PMN Chief Executive Officer Dale Stinton, CAE, CPA, CMA, RCE
COMMERCIAL REAL ESTATE CONTENTS 1 Economic Overview 2 Commercial Real Estate Investments.. 3 Commercial Real Estate Fundamentals 4 Outlook... 5 8 12 14
COMMERCIAL REAL ESTATE Gross Domestic Product The U.S. economy sputtered during the first quarter of 2016, as global economic activity throttled back and companies found financial markets volatility unsettling. Based on the first estimate from the Bureau of Economic Analysis, real gross domestic product (GDP) rose at an annual rate of 0.5 percent. The figure is in line with last year s first quarter reading of 0.6 percent. The GDP number remained well below the long-run historical average of 3.0 percent. Consumer spending was soft, rising at an annual rate of 1.9 percent in the first quarter, with most of the gain driven by services. Retail sales, which were weak during the winter holiday season, posted further slowdown. Spending on goods was virtually flat, given the 0.1 percent increase. Spending on durable goods cars, furnishing, appliances and recreational goods declined 1.6 percent. Consumers spent more on food and gasoline during the quarter, lifting nondurable goods consumption 1.0 percent. Consumer spending on services rose 2.7 percent on an annual basis, with transportation, recreation, healthcare, as well as lodging and restaurants driving expenditures. The corporate outlook took a downward turn, with business investments dropping 5.9 percent on an annual basis in the first quarter. Businesses cut back investments in equipment and commercial real estate to the tune of 8.6 percent and 10.6 percent, respectively. Investments in residential real estate aided by a warmer winter picked up, rising by 14.9 percent annual rate. Spending on intellectual property products software, R&D rose by 1.7 percent. 5.0 4.0 3.0 2.0 1.0 0.0-1.0-2.0 GEORGE RATIU Director, Quantitative & Commercial Research gratiu@realtors.org Exhibit 1.1: Real GDP (% Annual Chg.) Source: NAR, BEA With the dollar rising, international trade bore the brunt of a weakening economic environment. Exports declined by 2.6 percent, while imports moved sideways with a 0.2 percent annual rate of growth. Government spending moderated as well, notching a 1.2 percent annual growth rate. The federal government continued slashing spending, with a 1.6 percent decline, driven by cuts in defense expenditures. State and local governments increased spending at a 2.9 percent annual rate, focused on infrastructure investments. 5
2007 - Jan 2007 - Aug 2008 - Mar 2008 - Oct 2009 - May 2009 - Dec 2010 - Jul 2011 - Feb 2011 - Sep 2012 - Apr 2012 - Nov 2013 - Jun 2014 - Jan 2014 - Aug 2015 - Mar 2015 - Oct COMMERCIAL REAL ESTATE Employment The first quarter employment landscape offered a few high points. Payrolls rose at a solid pace, adding 609,000 net new jobs. Average weekly earnings of private employees rose by 2.1 percent in the first quarter of this year, compared to one year earlier. Employment in private service-providing industries provided the main thrust for new job growth during the first quarter of the year, with 561,000 net new jobs. The retail trade boosted payrolls during the quarter by 157,500 net positions. Education and health gained 146,000 new positions. With warmerthan-usual weather, leisure and hospitality payrolls rose by 95,000 net new positions. Employment in professional and business services gained 70,000 net new jobs, the slowest pace in five years. Financial services added 39,000 new positions to payrolls during the period, keeping demand for office space positive. 600 400 200 0-200 -400-600 -800 Exhibit 1.2: Payroll Employment (Change, '000) With demand for industrial properties rising, transportation and warehousing employment gained 22,200 new positions, while wholesale trade employment rose by 24,700 jobs. Exhibit 1.3: Payroll Employment: 12- Month Change ('000) Government Leisure/Hospitality Educ./Health Prof./Bus. Services Financial Activities Information Utilities Transp./Warehousing Retail Trade Wholesale Trade Manufacturing Construction Mining/Logging Source: BLS -200 0 200 400 600 800 The unemployment rate averaged 4.9 percent in the first quarter 2016. At the end of December there were 7.9 million unemployed Americans, while an additional 6.0 million were employed part-time for economic reasons. The average duration of unemployment declined from 31 weeks in the first quarter of 2015 to 29 weeks in the first quarter of this year. -1000 Source: BLS The labor force participation (LFP) rate rose slightly as more Americans returned to the labor markets, 6
2001 - Jan 2001 - Nov 2002 - Sep 2003 - Jul 2004 - May 2005 - Mar 2006 - Jan 2006 - Nov 2007 - Sep 2008 - Jul 2009 - May 2010 - Mar 2011 - Jan 2011 - Nov 2012 - Sep 2013 - Jul 2014 - May 2015 - Mar 2016 - Jan 2001 - Jan 2001 - Dec 2002 - Nov 2003 - Oct 2004 - Sep 2005 - Aug 2006 - Jul 2007 - Jun 2008 - May 2009 - Apr 2010 - Mar 2011 - Feb 2012 - Jan 2012 - Dec 2013 - Nov 2014 - Oct 2015 - Sep COMMERCIAL REAL ESTATE but continued to hover at historic lows. The LFP rate was 62.8 percent in the first quarter of 2015, slid to 62.5 percent in the third and fourth quarters, and rose to 62.9 percent in the first quarter of 2016. In comparison, before the Great Recession the LFP rate was 65.9 percent. With the Baby Boomers retirement wave rising and discouraged workers staying out of the labor force, economic growth is likely to remain moderate. 68 67 66 65 Exhibit 1.4: Labor Force Participation Rate Exhibit 1.5: Unemployment 12 Unemployment Rate (%) Average Unemployment Duration (Weeks) 10 8 6 4 2 0 45 40 35 30 25 20 15 10 5 0 64 63 62 Source: BLS Source: BLS Consumer confidence, as measured by The Conference Board, was unchanged at 96.0 in the first quarter of 2015, compared with the prior quarter. Separately, the Consumer sentiment index compiled by the University of Michigan moved up slightly in the first quarter of the year to 91.6, compared with the 91.3 value from the fourth quarter. Both remain lower on a year-over-year basis. 7
06Q1 06Q4 07Q3 08Q2 09Q1 09Q4 10Q3 11Q2 12Q1 12Q4 13Q3 14Q2 15Q1 15Q4 COMMERCIAL REAL ESTATE Commercial space is heavily concentrated in large buildings, but large buildings are a relatively small number of the overall stock of commercial buildings. Based on Energy Information Administration data approximately 72 percent of commercial buildings are less than 10,000 square feet in size. 1 An additional eight percent of commercial buildings are less than 17,000 square feet in size. In short, the commercial real estate market is bifurcated, with the majority of buildings (81 percent) relatively small (SCRE), but with the bulk of commercial space (71 percent) in the larger buildings (LCRE). Commercial sales transactions span the price spectrum, but tend to be measured and reported based on size. CRE deals at the higher end $2.5 million and above comprise a large share of investment sales, and generally receive most of the press coverage. Smaller commercial transactions tend to be obscured given their size. However, these smaller properties provide the types of commercial space that the average American encounters on a daily basis e.g. neighborhood shopping centers, warehouses, small offices, supermarkets, etc. These are the types of buildings that are important in local communities, and REALTORS are active in serving these markets. Large Commercial Real Estate Markets The pace of commercial transactions dropped in the first quarter of 2016, following an upbeat 2015. The volume of commercial sales in LCRE markets totaled $111 billion, a 20 percent year-over-year decrease, according to Real Capital Analytics (RCA). The first quarter data saw yearly declines in both individual and portfolio transactions, of 11 percent and 24 percent, respectively. Continuing the trends from 2015, apartment transactions comprised the largest share of first quarter volume, with $38.6 billion in sales, followed by office properties, which accounted for $31.2 billion. Retail and industrial sales totaled $17.9 billion and $12.6 billion, respectively. $180.00 $160.00 $140.00 $120.00 $100.00 $80.00 $60.00 $40.00 $20.00 $- Exhibit 2.1: CRE Sales Volume ($2.5M+) Individual Portfolio Entity Source: Real Capital Analytics 1 Smith and Ratiu, (2015), "Small Commercial Real Estate Market," National Association of REALTORS 8
2001 - Q1 2002 - Q1 2003 - Q1 2004 - Q1 2005 - Q1 2006 - Q1 2007 - Q1 2008 - Q1 2009 - Q1 2010 - Q1 2011 - Q1 2012 - Q1 2013 - Q1 2014 - Q1 2015 - Q1 2016 - Q1 COMMERCIAL REAL ESTATE Even with declining sales volume, prices in LCRE markets rose. However, the advances moderated from the fast pace of the past two years. Prices in markets covered by Real Capital Analytics gained 8.6 percent during the first quarter of 2016, based on RCA s Commercial Property Price Index. The advance was driven by strong appreciation in prices of retail and apartment properties, which advanced 11.8 percent and 11.2 percent, respectively. Prices for office properties in central business districts (CBD) advanced 10.5 percent. 300 Exhibit 2.2: Commercial Property Price Indices NCREIF Real Capital Analytics Green Street Advisors Capitalization rates in LCRE markets averaged 6.7 percent in the first quarter, based on RCA reports, 30 basis points lower compared with the prior year. Cap rate compression continued for apartment and office CBD properties, reaching values of 5.7 percent and 5.4 percent, respectively. Exhibit 2.3: NCREIF Property Index Returns 2016.Q1 NATIONAL 2.21% OFFICE 1.72% INDUSTRIAL 2.96% RETAIL 2.96% APARTMENT 1.87% Source: National Council of Real Estate Investment Fiduciaries 250 200 150 100 50 0 Separately, additional price indices also advanced. The Green Street Advisors Commercial Property Price Index rose 8.4 percent on a yearly basis during the first quarter, reaching a value of 123.4. The National Council of Real Estate investment Fiduciaries (NCREIF) Price Index increased 8.7 percent year-over-year in the first quarter of 2016, to a value of 257.3. 9
2008.Q4 2009.Q2 2009.Q4 2010.Q2 2010.Q4 2011.Q2 2011.Q4 2012.Q2 2012.Q4 2013.Q2 2013.Q4 2014.Q2 2014.Q4 2015.Q2 2015.Q4 2008.Q4 2009.Q2 2009.Q4 2010.Q2 2010.Q4 2011.Q2 2011.Q4 2012.Q2 2012.Q4 2013.Q2 2013.Q4 2014.Q2 2014.Q4 2015.Q2 2015.Q4 COMMERCIAL REAL ESTATE Small Commercial Real Estate Markets Commercial real estate in smaller markets maintained its upward momentum during the first quarter, with REALTORS reporting continued improvement in fundamentals and investment sales. The volume of investment sales in REALTORS markets totaled $51.6 billion during the first quarter. The pace of sales picked up, with volume rising 8.5 percent from the first quarter of 2015. The proportion of members who closed deals in the fourth quarter of 2015 declined to 58 percent, from 66 percent in the fourth quarter, and was also lower than the 60 percent recorded in the prior year. The direction of commercial business opportunities during the first quarter of 2016 rose 5.2 percent from the prior quarter, and was up 16.0 percent yearover-year. 200% 150% 100% 50% Exhibit 2.4: Sales Volume (YoY % Chg) Real Capital Analytics CRE Markets REALTOR CRE Markets 20.0% 10.0% 0.0% -10.0% -20.0% -30.0% -40.0% Exhibit 2.5: Sales Prices (YoY % Chg) Real Capital Analytics CRE Markets REALTOR CRE Markets Sources: NAR, Real Capital Analytics Average capitalization rates declined to an average 7.2 percent across all property types, a 57 basis point compression on a yearly basis. Apartments posted the lowest cap rate, at 6.9 percent, followed by hotel properties with average cap rates at 7.1 percent. Office and retail spaces tied with cap rates of 7.3 percent. Industrial transactions reported the highest comparative cap rates 7.4 percent. It is worth noting that these cap rates are higher than those in LCRE markets, reflecting activity in markets where REALTORS are more engaged. Exhibit 2.6: Cap Rates - 2015.Q4 0% 10.0% RCA Markets REALTOR Markets -50% -100% Sources: NAR, RCA The shortage of available inventory continued as the number one concern for NAR members, pushing price growth upward. Commercial properties traded at average prices 5.1 percent higher compared with the same period in 2015. The average transaction price reached $1.4 million in the first quarter of 2016. 8.0% 6.0% 4.0% 2.0% 0.0% Office Industrial Retail Apartment Hotel Sources: NAR, Real Capital Analytics 10
COMMERCIAL REAL ESTATE The interest rate on 10-year Treasury Notes a standard measure of risk-free investments averaged 1.8 percent during the first quarter of 2016, the lowest point since 2013. Based on the prevailing rates, the spread between cap rates and 10-year Treasury Notes ranged from 490 basis points in LCRE markets to 540 basis points in SCRE markets. The spread indicates that CRE investors continue to enjoy healthy returns in the markets. 1200 1000 800 600 400 200 0 Exhibit 2.7: CRE Spreads: Cap Rates to 10- Yr. T-Notes (bps) RCA Cap Rates REALTORS Cap Rates Sources: NAR, Real Capital Analytics 11
COMMERCIAL REAL ESTATE Large Commercial Real Estate Markets Demand for commercial leases continued rising during the first quarter of 2016. Construction has been growing across all property types, but the gap between demand and supply exerted downward pressure on availability. Office net absorption totaled 7.7 million square feet in the first quarter of the year, a decline from last quarter s 18.7 million square feet, based on data from JLL. Occupancy growth expansionary leases drove leasing activity during the quarter, coupled with increases in shared office space. Office construction added 10.6 million square feet to the supply pipeline during the quarter. Overall office vacancies rose 10 basis points on a yearly basis, to 14.8 percent in the first quarter. CBD office properties continued posting lower availability than their suburban counterparts. Rents for office properties rose 3.2 percent during the first quarter. employment and confidence. Retain net absorption totaled 18.6 million square feet in the first quarter of 2016, a 20.8 percent increase from a year ago, according to JLL. Retail development activity remained modest, driving rent growth. Rents for retail properties rose 1.5 percent during the quarter. Vacancy rates for retail buildings declined 40 basis points, to 5.6 percent, based on JLL data. Demand for multifamily properties continued on an upward path. Renter occupied housing units totaled 42.9 million units in the first quarter of 2015, a 363,000 unit advance from the first quarter of 2015, based on U.S. Census Bureau data. National vacancy rates averaged 7.0 percent for rental housing during the first quarter, 10 basis points lower than the same period in 2015. Median rents for rental units averaged $870 in the first quarter of this year. The industrial sector recorded rising fundamentals in the first quarter, with rising demand and declining vacancies. Industrial net absorption totaled 52.3 million square feet in the first quarter, up 6.6 percent year-over-year, according to JLL. Warehouse and distribution centers accounted for the largest share of demand, followed by manufacturing and special purpose buildings. Speculative supply increased, as well. New completions totaling 48.8 million square feet, of which 37.5 million square feet were speculative. Demand continued outpacing supply, driving industrial vacancies down to 6.2 percent, 50 basis points from the prior year. Industrial rents rose 5.9 percent, to an average of $4.92 per square foot in the first quarter. The retail sector is tracking demographic changes and affluent buyers and growing markets. Demand for retail properties increased in tandem with rising 12
2010.Q1 2010.Q3 2011.Q1 2011.Q3 2012.Q1 2012.Q3 2013.Q1 2013.Q3 2014.Q1 2014.Q3 2015.Q1 2015.Q3 2016.Q1 % Change, Quarter-over-quarter 2009.Q2 2009.Q4 2010.Q2 2010.Q4 2011.Q2 2011.Q4 2012.Q2 2012.Q4 2013.Q2 2013.Q4 2014.Q2 2014.Q4 2015.Q2 2015.Q4 COMMERCIAL REAL ESTATE Small Commercial Real Estate Markets Commercial fundamentals in smaller markets continued improving during the first quarter of 2016, but at a slower pace. Leasing volume during the quarter rose 1.3 percent over the prior quarter. Leasing rates advanced at a slower pace as well, rising 1.9 percent in the first quarter, compared with the 2.5 percent advance recorded during the fourth quarter. Office properties posted leases averaging $43 per square foot, while retail and industrial leases recorded $29 and $38 per square foot, respectively. Average apartment rents for the first quarter were $785 per unit. 10% 5% 0% -5% -10% -15% -20% -25% -30% Exhibit 3.1: REALTORS Fundamentals New Construction Leasing Volume Source: National Association of Realtors NAR members average gross lease volume for the quarter was $473,000, 36.4 percent lower than the previous period. New construction picked up, posting a 5.3 percent gain from the fourth quarter of 2015, compared with 3.7 percent in the prior quarter. Tenant demand remained strongest in the 5,000 square feet and below segment, accounting for 80.0 percent of leased properties. Demand for space in the 10,000 49,999 square feet segment slowed during the first quarter, comprising 5.0 percent of total. Lease terms remained steady, with 36-month and 60-month leases capturing 59 percent of the market. Vacancy rates varied across regional and product types in REALTORS markets. Office vacancies declined 174 basis points, to 13.4 percent during the first quarter. Industrial availability reached 11.1 percent, a 23-basis point decrease on a yearly basis. Even with soft retail sales, retail vacancies declined 122 basis points, to 12.5 percent during the quarter. As rising new supply loosens major markets, apartments in SCRE markets experienced availability decreases, with the national average declining 61 basis points year-over-year, to 7.2 percent in the first quarter of 2016. Lease concessions declined 3.9 percent. Tenant improvement (TI) allowances averaged $9 per square foot per year nationally. 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% Exhibit 3.2: REALTORS Commercial Vacancy Rates Office Industrial Retail Multifamily Hotel Source: National Association of Realtors 13
COMMERCIAL REAL ESTATE Economy Looking ahead at the next three quarters of 2016, the GDP annual rate of growth will pick up toward the latter half of the year. However, in light of the weak first quarter, the annual growth is pegged at 1.6 percent. Payroll employment is projected to post 1.6 percent annual growth rate for the year. The unemployment rate is projected to fall to 4.7 percent by the end of 2016. The markets continue to weigh the expected Federal Reserve s increases in the funds target rate. Prices are expected to rise 1.7 percent over 2016, accelerating in the latter quarters as housing costs are adding upward pressures. In light of increased market volatility and slowing economic growth, consumer confidence has moderated and is expected to hover below its longterm average. Exhibit 4.1: U.S. ECONOMIC May 2016 2014 2015 2016 2017 Annual Growth Rate, % Real GDP 2.4 2.4 1.6 2.2 Nonfarm Payroll Employment 1.9 2.1 1.6 1.8 Consumer Prices 1.6 0.2 1.7 3.0 Level Consumer Confidence 87 98 97 104 Percent Unemployment 6.2 5.3 4.8 4.6 Fed Funds Rate 0.1 0.1 0.5 1.3 3-Month T-bill Rate 0.1 0.1 0.5 1.4 Corporate Aaa Bond Yield 4.2 3.9 4.0 4.7 10-Year Gov t Bond 2.5 2.1 2.1 2.8 30-Year Gov t Bond 3.3 2.8 2.9 3.4 Source: National Association of REALTORS 14
200 200 200 200 20'0 200 Billions COMMERCIAL REAL ESTATE Commercial Real Estate 2014.Q4 2015.Q1 2015.Q2 2015.Q3 2015.Q4 2016.Q1 2016.Q2 2016.Q3 2016.Q4 2017.Q1 2017.Q2 2017.Q3 2015 2016 2017 Exhibit 4.2: Commercial Real Estate Vacancy Forecast (%) Office 14.9 15.1 15.9 16.0 14.3 13.4 13.2 12.9 12.5 12.2 11.9 11.6 14.3 13.0 11.7 Industrial 11.6 11.3 10.8 11.5 11.4 11.1 10.9 10.6 10.7 10.6 10.5 10.4 11.4 10.8 10.4 Retail 12.5 13.7 13.2 13.0 12.9 12.5 12.3 12.0 11.8 11.8 11.5 11.3 12.9 12.2 11.4 Multifamily 6.8 8.4 6.6 7.4 6.2 7.8 7.9 8.1 8.4 8.6 8.7 9.0 6.2 8.0 8.9 Source: National Association of REALTORS Commercial fundamentals continue on an expansionary path, with three of the four core sectors tilting in landlords favor. As employment gains drive demand, office vacancies are projected to decline to 12.5 percent by the fourth quarter of 2016 and decline to 11.7 in 2017. Industrial availability is estimated to drop from an average of 11.4 percent in 2015 to 10.8 percent in 2016. Retail availability will continue shrinking, as vacancies are projected to decline from 12.9 percent in 2015 to 12.2 percent in 2016. The multifamily sector diverges from the others, as new supply coming on the market has been exerting upward pressure on availability. Multifamily vacancies are expected to average increase over the next couple of years, from 6.2 percent in 2015 to 8.4 percent by the end of 2016, and 8.9 percent in 2017. On the investment side, financial markets jitters about interest rates will likely dampen the sales pace in LCRE markets. In SCRE markets, increased scrutiny from banking regulators has already tightened lending conditions, with slower capital flows into CRE transactions. $250 $200 $150 $100 $50 $- Exhibit 4.3: CRE Sales Volume ($2.5M+) Forecast Source: NAR, RCA However, In light of current global uncertainty, U.S. CRE is likely to remain an attractive alternative for investors this year. Investors will probably take a more measured approach, leading to a moderation in CRE prices. With cap rates at very low levels and interest rates expected to rise, the price slowdown is projected to impact Class A assets in top-tier markets, where inventory shortages and crowding of capital have led to the recent run-ups. Properties in smaller markets, where the recovery only began in 2013 are likely to see continued price appreciation. Exhibit 4.4: Commercial Property Price Indices Forecast 2009 2010 2011 2012 2013 2014 2015 2016 2017 NCREIF 165.1 168.2 186.5 195.2 211.9 224.9 246.7 249.1 254.6 Green St. Advisors 63.5 74.4 87.1 92.2 99.4 106.7 118.0 120.1 123.8 Sources: NAR, NCREIF, Green Street Advisors 15
COMMERCIAL REAL ESTATE The National Association of REALTORS, The Voice for Real Estate, is America s largest trade association, representing over 1 million members, including NAR s institutes, societies and councils, involved in all aspects of the real estate industry. NAR membership includes brokers, salespeople, property managers, appraisers, counselors and others engaged in both residential and commercial real estate. The term REALTOR is a registered collective membership mark that identifies a real estate professional who is a member of the National Association of REALTORS and subscribes to its strict Code of Ethics. Working for America's property owners, the National Association provides a facility for professional development, research and exchange of information among its members and to the public and government for the purpose of preserving the free enterprise system and the right to own real property. NATIONAL ASSOCIATION OF REALTORS RESEARCH DIVISION The Mission of the National Association of REALTORS Research Division is to collect and disseminate timely, accurate and comprehensive real estate data and to conduct economic analysis in order to inform and engage members, consumers, and policy makers and the media in a professional and accessible manner. To find out about other products from NAR s Research Division, visit www.realtor.org/research-and-statistics NATIONAL ASSOCIATION OF REALTORS RESEARCH DIVISION 500 New Jersey Avenue, NW Washington, DC 20001 202.383.1000
COMMERCIAL REAL ESTATE 2016.Q2