University of St. Thomas Minnesota Commercial Real Estate Survey December 2017
Minnesota Commercial Real Estate Outlook Remains Optimistic With Some Concerns on the Horizon The December 2017 University of St. Thomas / Minnesota Commercial Real Estate Survey is beginning to show to show some changes in the sentiment of our panelists as they look out over the next two years. The biannual survey projects a two-year-ahead outlook for Minnesota s commercial real estate industry and forecasts potential opportunities and challenges affecting all commercial real estate sectors. As was done with all fourteen of our previous surveys, the same group of 50 commercial real estate industry leaders involved in development, finance, and investment were polled regarding their expectations of near-term, future commercial real estate activity. The decisions that these industry leaders are making today will determine what the CRE markets will look like two years from now. One thing we have observed in recent surveys is there has been less variation in the responses and that has caused a more uniform response rate reflecting the panel s increased certainty in their views. December 2017 Results Observations from December 2017 have recorded several notable changes in the panel s expectations that were observed in the last survey conducted in May 2017. "There is some concern that we are near the top of the cycle and that overbuilding may occur in some product types and submarkets. says Herb Tousley, Director of the Real Estate Programs at the University of St Thomas. While the forecast for 2019 is still generally optimistic, the increase in online shopping, higher interest rates, changes in housing trends and the continued and the redefinition of the office environment will remain major factors in the performance of commercial real estate in the coming two years. Our panelists seem to be most concerned about the expected increase in land and building material prices and their potential impact on future development activity. That being said, the panel is generally expecting to see a continuation of the favorable market conditions for commercial real estate that we have been experiencing for the last several years. The composite index of all of the other indices the survey continues to indicate a slightly less than neutral expectation looking ahead two years to late 2019. The composite index was recorded at 44. This is slightly more optimistic than the 42 that was recorded last May. Index values greater than 50 represent a more optimistic view of the market over the next two years, with values of less than 50 indicating a more pessimistic view. More detailed information about each of the individual indices may be found below.
Minnesota Commercial Real Estate Survey - Dec 2017 100 90 80 70 60 50 40 30 20 10 0 Rents Occupancy Land Price Bldg. Mat. Rate of Return Equity/LTV Composite The individual indexes are detailed below: Rent Expectations The outlook for rental rates has become even more optimistic. Market conditions expected in late 2019 are best described by the price for space (rental rates) and the supply of space (occupancy levels). The index for rental rates was 67. This is the highest level that has been recorded since 2011. This means the panel now has even a higher expectation that rents will increase for all property types over the next two years. The panel s sentiment is that the economy will continue to grow and that business conditions will continue improve creating more competition for commercial space. Occupancy A modestly optimistic outlook for occupancy levels continues. For the third consecutive survey the index for occupancy levels remains at 52. This indicates the panelist s belief that occupancy levels and space absorption will remain at current levels during the next two years. As new buildings have been completed the market continues to be able to absorb the new space. This is a continuation of a trend that began 2 years ago. Businesses will continue to grow but they are concentrating on reducing their cost of occupancy by doing more with less space.
Land Price Expectations A higher expectation that land prices will continue to increase. The panel s outlook for land prices reveals an expectation that land prices will continue to increase between now and late 2019. The land price index has decreased (become more pessimistic) in the current survey moving from 42 last spring to 38 this fall. The low point for the index was recorded at 31 in the fall 2013 survey. This index has moved even farther into pessimistic territory. It indicates a higher expectation that land prices will increase during the next two years. Increasing land prices increase total project costs and are a hindrance to new development, making it more difficult to obtain financing and adequate returns for investors. Building Material Price Expectations Increases in the price of building materials are expected accelerate. The index for the price of building supplies remains strongly negative, moving from 30 in May 2017 to 24 in December 2017. This reflects the panel s expectations that the rate of increase in building material prices will accelerate over the next two years. They believe that commodity prices for lumber, concrete, steel and many of the other materials used in construction will continue to increase. Since building materials are a major cost component of any development project any increases in prices will make it difficult to provide suitable returns on future developments. Return on Investment Expectations Investors return on investment expectations have improved. The index for investor s return expectations has become markedly less pessimistic moving from 42 to 47. This indicates that investors will be expecting to achieve slightly higher returns. The consensus among survey respondents indicates that investors will be seeking higher returns due to their expectation of increasing interest rates over the next two years. Investors will continue to seek out quality investments but they will be much more diligent about how they price risk and evaluate return when considering their investment options. Lending Expectations Equity and loan to value requirements are expected to remain essentially unchanged. The index for the amount of equity required by lenders has eased slightly, rising from 40 in May 2017 to 42 in December. This indicates the panel s belief that even if interest rates increase moderately credit will still be available for good projects. However, they expect lenders will continue be more risk adverse by tightening their underwriting criteria in the coming two years.
100 90 80 70 60 50 40 30 20 10 0 Rents Occupancy Land Price Bldg. Mat. Rate of Return Equity/LTV Composite May-10 Nov-10 May-11 Nov-11 May-12 Nov-12 May-13 Nov-13 May-15 Nov-15 May-16 "Dec-16" May-17 Dec-17