Industrial N Illinois

Industrial Insider: NAIOP 2018 forecast

Industrial Insider: NAIOP 2018 forecast,ph01

I recently attended the NAIOP Chicago chapter forecast breakfast that was headlined by Dr. Mark Eppli, Bell Chair in Real Estate at Marquette University. This is the seventh consecutive year that Dr. Eppli has presented to this audience.

There were many key takeaways from Dr. Eppli’s forecast, which are summarized below from the information published from his presentation.

It is significant to note that his overall perspective is bullish on the economy and current CRE markets and values for at least the next 24 months, at which time it becomes a little more difficult to forecast.

The Economy

• Since the Great Recession commenced in December 2007, GDP growth has been a modest 2.1 percent. This economic cycle is the third longest of the 33 economic cycles since 1854, having lasted 102 months thus far, a near record;

• Corporate profits are strong and business investment will re-emerge with the lower tax rates; corporate spending will push growth;

• Consumers are 68 percent of the U.S. economy and they continue spending because of the “wealth effect,” as net worth has returned. Consumers’ higher net worth, combined with modest debt and low debt service payments, will be the stable force behind GDP growth;

• GDP growth looks sustainable through 2018 and probably 2019;

• Projections for 2018 include the following:

1. GDP growth will be 2.75 to 3 percent, driven by business spending;

2. Employment growth of 130,000 to 150,000 new jobs per month;

3. Cap rates increase about 25 basis points;

4. A lack of productivity growth from the services sector;

5. Industrial real estate remains the preferred property type in 2018.

Commercial Real Estate Equity Investment

• U.S. CRE transaction volume was down year over year through November 2017. All property transaction volumes were down 31 percent, with retail transactions at -54 percent, office transactions at -50 percent, industrial transactions -31 percent, apartment transactions at -7 percent and hotel transactions at -3 percent;

• Pension fund investment in commercial real estate will remain strong, as many institutional investors are increasing their allocations to commercial real estate;

• Property cap rates are at all time lows with a lot of money chasing all CRE types—possibility for risk of a bubble;

• Solid NOI growth has justified part of the price inflation—no risk of bubble.

Commercial Real Estate Debt Investment

• Total outstanding real estate debt is growing sustainably, and banks are making money because of low charge-off rates, so they will stay in the game.

• Banks reveal solid discipline and are tightening lending standards on the heels of new regulations. The HVCRE (high volatility commercial real estate) regulation, effective as of January 1, 2015, mandates the following: in order to be exempt from an HVCRE designation, borrowers who originate commercial acquisition, development and construction loans must meet a 14 percent equity requirement, and the leverage on such loans cannot exceed 80 percent of the estimated completed value of the project. If these conditions are not met, the loans will be subject to a 150 percent risk weight requirement, which is an increase from the previous 100 percent requirement.

Capital Markets

• Commercial real estate transaction volume is down the last two years;

• Commercial real estate debt volumes are growing at a sustainable pace;

• Institutional and other investors are likely to continue to invest in commercial real estate;

• Lenders have tightened lending standards (see new HVCRE rules above);

• Debt and equity markets are functioning in an appropriate and sustainable manner;

• CRE is fully-priced but not over-priced relative to risk spreads for other asset classes, and there is no speculative bubble.

New Construction and/or Existing Inventory

• With the exception of narrow pockets of apartment overbuilding, construction is being maintained at sustainable levels;

• Assets are “fully-priced” but not “speculatively priced;”

• Space markets are not overbuilt;

• Equity capital markets are in check, and stepped back in 2017.

• Debt capital markets are at a sustainable level.

• Wage inflation will push interest rates higher.

Employment

• 86 months of employment growth is the longest in history, averaging 196,000 jobs per month, has dramatically tightened the job market and limited the pool of qualified candidates. The college-educated worker pool is fully-employed;

• Wages have been outpacing inflation since 2012 because of the retirement of “baby boomers,” and low unemployment and higher wages have increased labor force participation;

• The current unemployment rate of 4.1 percent is the lowest in 16 years, and 16.8 million jobs is the largest job growth in a U.S. expansion;

• Approximately 70 percent of everything we purchase is labor, and labor rates will increase in the coming year.

In Summary

• There are both positive and negative GDP risk factors impacting U.S. growth. Positive factors include: sustained consumer confidence; lower corporate and personal tax rates; reduced regulations keeps business confident and new tax regulations increase the possibility of repatriating corporate retained earnings;

• Negative GDP growth risk factors include: wage increases lift inflation; the erosion of middle-class jobs through automation; Federal Reserve interest rate increases as quantitative easing (QE) comes to an end;

• CRE prices have increased 6.2 percent annually over the past decade, in excess of the rate of inflation;

• Private equity and pension funds have a continuing demand for CRE investment, and property cap rates are at an all-time low.

Dr. Eppli’s presentation and perspective indicates that both consumption and business spending is well positioned for the coming 12 to 18 months. He expects that cap rates will climb 25 basis points, and the preferred property type in 2018 will be industrial. Assets are fully-priced but not speculatively-priced, and space markets are not overbuilt. Debt capital markets are at a sustainable level.

Wishing all of my readers and colleagues a healthy and prosperous 2018!