What’s next for CRE?
Commercial Real Estate investors believe the market is facing a downturn – but they’re not sure how soon it will happen or how long it will last. Investors are looking for answers by carefully eyeing the appreciation or depreciation of asset values. Even though net operating income levels have been relatively stable, the change in the capital return component has been flat and in some cases negative, placing a drag on total returns (income plus capital return).
“The peak of this CRE cycle is here,” says Situs RERC President Ken Riggs. “Despite this, we don’t believe history will repeat itself and certainly don’t expect anything like another Great Recession. Asset price changes are expected to be more subdued compared to the last cycle, and CRE is still an attractive investment alternative in this low-return environment.”
The annual income component of realized returns for institutional real estate investments over the past 10 years has been relatively consistent (see Exhibit 1). The asset value gain or value loss (i.e., capital appreciation or capital depreciation) has been the key reason that total returns have been so volatile.
Exhibit 1: Historical and Forecast Income and Capital Return – All Property Types
Sources: Situs RERC, NCREIF, 1Q 2017.
To get a glimpse into the future, Situs RERC surveys institutional investors each quarter to examine “expected’ or “required” cap and discount rates (IRR) for the major property types. By analyzing the spread between the cap and discount rates, we can assess investor growth expectations. Situs RERC’s required rate of return in first-quarter 2017 was almost 8 percent (see Exhibit 2).
Exhibit 2: Situs RERC IRR (Discount Rate) and Cap Rate Composition – All Property Types
Source: Situs RERC, 1Q 2017
However, Situs RERC’s Total Return Forecast compared to recent history for the base case scenario has total return decreasing to just below 6 percent by the end of 2017, and falling under 5 percent by the end of 2018 (refer back to Exhibit 1). In this scenario, capital appreciation is expected to decrease substantially.
“In short, investors’ required or hoped-for expectations for CRE total returns will come under stress, and it appears their expectations will not be met,” Riggs says. “But solid fundamentals are expected to keep income stable – which is good news for investors seeking safe havens in this uncertain environment – and still keep CRE total returns competitive in this low-return global environment.”
Concerns of Soft Manhattan Office Market Overblown
Colliers International says the Manhattan office market is holding steady. The assertion runs counter to recent concerns that a handful of high-profile leases were masking soft leasing activity.
While the total square footage of new leases and renewals dipped slightly compared to last year, according to a report in The Real Deal, the supply of available space is shrinking in sharp contrast to 2016, when more square footage was coming on the market than companies were taking. In addition, the borough’s average asking rent inched upward to $73.07.
Brokers had expressed concern about a weak market, especially for midsize leases topping out at 100,000 square feet, The Real Deal reported. However, leasing volume in this segment was virtually unchanged from the same time last year.
read more: Crain’s
Help Wanted — Good, Bad or Ugly for Housing & Mortgage Industries?
222,000 new jobs were created in June as hiring accelerated in the spring, the largest increase in four months and second biggest haul of the year. Hiring was also stronger in May and April than previously reported, according to the government. The unemployment rate, meanwhile, rose to 4.4 percent from 4.3 percent as more people entered the labor force in search of work. The jobless rate had fallen to a 16-year low in May.
“There is both good and bad news here for the housing and mortgage industries,” says The Collingwood Group Managing Director Tom Booker. “The good news is that more people seeking work are finding it. Unfortunately, wages were less bullish, suggesting there are still more people seeking full-time work. As a result, the housing market will continue to be tight but recessionary fears may be overblown.”
Hourly pay rose a moderate 0.2 percent to $26.25 an hour in June, the government said. Wages have advanced a modest 2.5 percent in the past 12 months, up slightly from the prior month but still well below the usual gains at this late stage of an expansion. Companies continue to find ways to restrain labor costs.
Home Prices Climb Higher and Higher
CoreLogic reports home prices are up strongly both year over year and month over month.
Home prices nationally increased year over year by 6.6 percent from May 2016 to May 2017, and on a month-over-month basis, home prices increased by 1.2 percent in May 2017 compared with April 2017, according to the CoreLogic Home Price Index.
Looking ahead, the CoreLogic HPI Forecast indicates that home prices will increase by 5.3 percent on a year-over-year basis from May 2017 to May 2018, and on a month-over-month basis home prices are expected to increase by 0.9 percent from May 2017 to June 2017. The CoreLogic HPI Forecast is a projection of home prices using the CoreLogic HPI and other economic variables. Values are derived from state-level forecasts by weighting indices according to the number of owner-occupied households for each state.
“The market remained robust with home sales and prices continuing to increase steadily in May,” said Frank Nothaft, chief economist for CoreLogic. “While the market is consistently generating home price growth, sales activity is being hindered by a lack of inventory across many markets. This tight inventory is also impacting the rental market where overall single-family rent inflation was 3.1 percent on a year-over-year basis in May of this year compared with May of last year. Rents in the affordable single-family rental segment (defined as properties with rents less than 75 percent of the regional median rent) increased 4.7 percent over the same time, well above the pace of overall inflation.”
“For current homeowners, the strong run-up in prices has boosted home equity and, in some cases, spending,” said Frank Martell, president and CEO of CoreLogic. “For renters and potential first-time homebuyers, it is not such a pretty picture. With price appreciation and rental inflation outstripping income growth, affordability is destined to become a bigger issue in most markets.”
read more: CoreLogic
Fast Track to Skyrocketing Real Estate Prices: The New Public-Transit Effect
New York City homeowner Tina Larsson watched for nearly a decade as a new subway station was built right across the street from her brick midcentury co-op on Manhattan’s Upper East Side. The excavation blasts shook her walls and sent dust spewing into the air; the noise and disruption choked off business to once-busy restaurants and shops.
It was, in short, a terrible mess.
Then in January, the heavy construction machinery suddenly disappeared, the sidewalk scaffolding was taken down, and the endless clutter seemed to vanish overnight. After nearly a century of starts and stops, the $4.5 billion Second Avenue subway — one of the nation’s most notoriously delayed large-scale transit projects — was finally open for business. It was sleek, modern, and even festooned with original Chuck Close portraits. Now, Larsson, 51, and many of her longtime neighbors, are finally ready to reap the real estate rewards.
Prices in Larsson’s building have shot up about 60% over the last three years — a bonus for existing owners and a burden for local renters, who may soon be priced out of the market. Larsson attributes the appreciation to her building’s proximity to one of the three new stations on the subway, which now connects the far east side of Manhattan to the rest of the city.
“The people who are buying [here now], not only in this building, are very well off,” says Larsson, CEO of the FolSon Group, a consulting firm that advises co-ops and condo associations on efficiency and management. “The people who bought [years ago], I doubt they could buy now.”
New York City’s Second Avenue line isn’t the only high-profile public transit initiative with the potential to fundamentally transform its local real estate market — in ways both good and bad. Home and rental prices are on the rise near the New York City line as well as in cities across the nation, like Los Angeles, Charlotte, NC, and Phoenix, where long-anticipated mass transit lines or extensions have opened or are in the works.
read more: Realtor.com
Mall Owners Spending Big Bucks to Stay Relevant
The owner of the Newgate Mall plans to pour $500,000 into overhauling the outdated food court in a bid to lure restaurateurs and hungry shoppers. Rent payments from eateries are never going to recoup the renovation costs, but for landlord Time Equities Inc., that’s not the point. The point is survival.
The food hall is part of an effort to breathe new life into the entire 718,000-square-foot (67,000-square-meter) center and increase foot traffic, according to Ami Ziff, director of national retail at New York-based Time Equities. The company, which bought Newgate in Ogden, Utah, from GGP Inc. for $69.5 million last year, is one of many landlords wagering that elaborate makeovers will keep them competitive as they reinvent their properties in the age of Amazon.
Costs are escalating as mall owners work to keep their real estate up to date and fill the void left by failing stores. The companies are turning to everything from restaurants and bars to mini-golf courses and rock-climbing gyms to draw in customers who appear more interested in being entertained during a trip to the mall than they are in buying clothes and electronics. The new tenants will pay higher rents than struggling chains such as Macy’s and Sears, and hopefully attract more traffic for retailers at the property, according to Haendel St. Juste, an analyst at Mizuho Securities USA LLC.
“The math is pretty obvious, pretty compelling, but there are risks,” St. Juste said in an interview. “This hasn’t been done before on a broad scale.”
It’s more costly to build and maintain large, customized spaces that require extensive updates such as commercial kitchens, according to St. Juste. Landlords’ capital expenditures — including repairs, remodeling and leasing costs — are rising relative to the income being generated by retail properties.
read more: Bloomberg
Fed Divided on When to Unwind Balance Sheet
A divided Federal Reserve policy committee couldn’t reach an agreement in June on the timing of when to begin shrinking its massive balance sheet, according to minutes of the meeting.
“Several preferred to announce a start to the process within a couple of months,” the minutes of the June 13-14 meeting showed. “Some others emphasized that deferring the decision until later in the year would permit additional time to assess the outlook for economic activity and inflation.”
U.S. central bankers in June raised the benchmark lending rate for a second time this year to a range of 1 percent to 1.25 percent, while describing monetary policy as “accommodative” in their statement. They reiterated their support for continued gradual rate increases, according to the minutes.
Fed officials updated their balance-sheet policy in the gathering, laying out a path of gradual reductions with caps. The central bank wants to start winding down the $4.5 trillion bond portfolio without roiling longer-term interest rates, while gradually raising the policy rate. The minutes indicated that the committee wants to begin the balance-sheet process this year.
read more: Bloomberg
Will the Bank of England’s 10-year Hiatus on Rate Hikes End Soon?
It’s been over 10 years since the Bank of England last raised interest rates, but traders should think twice about remaining complacent about the ultra-loose policy stance.
Chatter that the central bank is getting ready to raise borrowing costs sooner than later has picked up markedly over the past two weeks, with some saying it could happen as early as November.
The increased speculation comes after a raft of policy makers themselves have hinted its time for interest rates to be hiked from the current record low of 0.25%.
“Despite elevated political and economic uncertainty, the Bank of England seems to be heading for a first rate hike soon. Domestic inflationary pressures are building,” wrote Kallum Pickering, senior U.K. economist at Berenberg, in a Wednesday note. Inflation rose to 2.9% in May, the highest level since June 2013.
BOE policy maker Michael Saunders told the Guardian newspaper that “households should prepare for interest rates to go higher at some point.”
That echoed sentiment sounded late last month by BOE Chief Economist Andrew Haldane, while central bank Gov. Mark Carney’s suggestion last week that he could support an upward move for rates pushed the pound up by more than 1% to a then three-week high above $1.29.
The Bank of England’s Monetary Policy Committee, including Carney, whose been the bank boss since 2013, voted in mid-June to leave policy unchanged. But the market received somewhat of a shock to see that three out of eight policy makers wanted to raise the rate at that meeting. One dissenter was expected, at most.
Policy makers who’ve indicated they’re leaning toward a rate hike also predicated such a move on improving economic fundamentals. But dovish members are concerned the British economy isn’t quite ready for higher rates.
read more: MarketWatch
Two-Thirds of Jobs in this City Could be Automated by 2035
We are walking down the strip in Las Vegas in the year 2035.
The lights are glaringly flashing, music is pounding your ears, the usual nine Elvis look-alikes try to pose with you for a few dollars. A few robots are crisscrossing between the legs of passersby, offering ticket services, information and to be their guide. Self-driving vehicles bring gamblers from casino to casino. A robot group performs a break dance, and you can compete against Robo-MJ in basketball.
Vegas is still Vegas, so nothing has really changed. Or has it?
Maybe it won’t be visible to the eye, but robots may have taken the place where people currently toil to keep the Vegas machine humming. About 65% of all jobs in Vegas are susceptible to automation by 2035 — a bigger share than in any other part of the country. Across the U.S., 55% (or more) of jobs in almost all metropolitan areas face this same scenario.
Scientists are heatedly debating whether robots and artificial intelligence (AI) will appear as colossally in our lives as some studies predict. Will we really see mass adoption of robots and AI gadgets?
The reality is both technologies already have seen mass adoption and it is foolish not to expect it to accelerate. Every smartphone already is essentially an AI device, and 1.5 billion of those were shipped in 2016. Some 1.6 million industrial robots operated worldwide in 2015, a total that’s expected to increase to 2.6 million by 2019.
Research shows that if all these 1 million additional robots worldwide are merely as productive as those that already exist, each robot would on average replace the work done by 5.7 U.S. workers, or 5.7 million workers in all.
read more: MarketWatch
Have a prosperous day and week ahead; beware the robots.
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