Commercial Real Estate: Economic expansion: More room to run?

Economic expansion: More room to run?

Ken Riggs, president of Situs RERC, believes that, despite its near-record length, the recovery seems far from over, and contends that key indicators point to further growth ahead.

The US economy is approaching its longest expansion in history. If it continues through June 2019, it will reach 120 months and surpass the previous longest-ever expansion, from 1991 to 2001, going back to when records started being kept in the 1850s. As the commercial real estate cycle continues into its ninth year amid rising interest rates, commercial real estate total returns are expected to continue to decline from their recent peaks. With price and value gains now slowing to more of a measured pace, and net operating income (NOI) continuing on pace with a slow level of growth, commercial real estate will rely on income to drive total returns moving forward, versus value or price appreciation. This is especially true of the gateway cities and involves major core assets.

It has taken longer for the economy and financial markets to recover from the scale and severity of the global financial crisis, which was structurally different from previous economic downturns and mostly compared to the Great Depression. GDP growth has been slow and steady during this expansion, averaging 2.3 percent. For comparison, GDP growth ranged from 2.9 percent to 7.0 percent (averaging 4.6 percent) across all other recovery cycles since the aftermath of World War II. Historically, slower economic growth has been associated with longer expansion periods. The tax cuts passed last year gave the economy an extra boost — to the tune of 4.2 percent GDP growth in the second quarter of 2018, the highest rate in almost four years.

At 3.9 percent, the August 2018 unemployment rate is at an 18-year low. However, it took the jobless rate, which peaked at 10 percent in October 2009, more than seven years to reach the trough of the previous cycle, and wage growth has been unusually stagnant. According to the Federal Reserve Bank of Atlanta’s calculations, three-month smoothed wage growth was 3.2 percent in the second quarter of 2018, but it has averaged 2.6 percent during this recovery. Going back to 1983, the earliest time period for which data is available, wage growth averaged 4.6 percent during previous recovery periods. Despite the falling unemployment rate, the labor force participation rate (LFPR) remains lower than it was before the global financial crisis: The average LFPR was 62.8 percent in 2018 compared to 66 percent in 2008. In past expansions, beginning in the 1970s — after women began entering the workforce in large numbers — the LFPR average was 64.2 percent.

Moreover, according to the Congressional Budget Office, the output gap — the difference between the economy’s actual performance and its potential — for the U.S. economy has stayed wider and more negative since the global financial crisis as compared to prior recessions. The output gap has remained negative for the past 35 quarters since the global financial crisis. Comparatively, the output gap was negative for 17 quarters after the 2001 recession and 22 quarters after the 1991 recession.

With this rather unusual economic backdrop in mind, we will have to wait and see how the commercial real estate market shakes out. Inves­tors are expecting income to be the major com­ponent of future total returns, and they will either need to learn to be satisfied with in-place income or find other ways to strengthen their NOIs and earn value or price gains. This is especially true of core properties in the major markets. The gains in smaller markets and industrial are helping propel overall price gains to almost 4.0 percent year-to-date. Space market fundamentals remain strong for many property types, but the across-the-board gains created by cap rate compression, which favored all property types without regard to qual­ity and location, are over.

The good news is that despite its length, the economic recovery seems far from over, and recent economic indicators suggest growth ahead. This means we likely have more room to run before we hit the next bust, and commercial real estate is positioned to continue to provide a strong case for investment.

This article appeared in Commercial Property Executive on Wednesday. To view the article at Commercial Property Executive, click here.

Resilient multifamily market sees rising occupancies, rents

Buoyed by a strong economy and continued healthy demand, the average US apartment rent rose $2 in August to $1,412, up 3.1 percent year-over-year, reported Yardi Matrix, Santa Barbara, CA.

Rents have grown steadily all year, reaching new highs seven months in a row, the Yardi Matrix Multifamily Monthly report said.

“The sector’s performance is highlighted by rising occupancy rates in the face of robust supply growth,” Yardi said. Since January, the occupancy rate for stabilized properties has increased 25 basis points, which the firm called particularly impressive because 2018 is on pace for a third straight year with nearly 300,000 new apartment unit deliveries.

Growth continues to be led by metros in the south and west, which occupy the top nine spots in the ranking, Yardi said.

How much time is left in the commercial real estate cycle is an open question. “There are few modern examples of cycles that last more than eight years, so every quarter the market goes without a downturn seems to be tempting fate in the eyes of many observers,” Yardi said. But the multifamily market shows no signs of nearing the end of its cycle. “While it might be overstating the case to say that the sector is picking up steam, August rent data indicates that deceleration no longer seems to be an accurate term for the state of the market,” the report said.

Read more: Mortgage Bankers Association

These sites no longer make goods. Now they’ll get them to you faster.

As the United States economy continues its shift away from manufacturing, locations that once housed industries such as automobiles or chemicals are being remade as distribution hubs for the millions of items bought by consumers online.

Developers are trying to meet growing demand by modifying industrial buildings to meet the requirements of the logistics business or, more likely, demolishing them to make way for facilities built for the distribution industry. These sites offer many benefits ideal for distribution, including easy access to highways, ports and rail links and a proximity to major markets.

“Logistics and fulfillment is really the segment of the industrial world that has backfilled the void that manufacturing has left in terms of employment and economic activity,” said Thomas J. Hanna, president of Harvey Hanna & Associates, which plans to tear down a former General Motors assembly plant at Newport, Del., to create a three-million-square-foot complex for distribution companies.

Read more: New York Times

NYSDFS sues to block the OCC’s Special Purpose National Bank Charters for fintech companies

On September 14, 2018, Superintendent of the New York State Department of Financial Services (“NYSDFS”) Maria T. Vullo filed a complaint in federal court against the U.S. Office of the Comptroller of the Currency (“OCC”) to block the OCC from issuing any special purpose national bank (“SPNB”) charters. The OCC announced last month, after much industry anticipation, that a nondepository financial technology (“fintech”) company that engages in a core banking activity, such as paying checks or lending money, can now apply for a SPNB charter (the “Fintech Charter Decision”).

In its complaint, the NYSDFS argues that the Fintech Charter Decision exceeds the OCC’s authority under the National Bank Act (“NBA”), which limits national bank charters to institutions engaged in the “business of banking.” Through a regulation, the OCC has interpreted this phrase to include receiving deposits, paying checks, or lending money, whereas the NYSDFS’s suit takes the position that the “business of banking . . . at a minimum requires taking deposits.”

In addition, the complaint argues that the NBA does not expressly authorize the preemption of state law under a SPNB charter as would be required by the Tenth Amendment to the US Constitution for the charter to have preemptive effect.

Read more: National Law Review

Regulators propose new capital treatment for higher-risk CRE exposures

Federal bank regulators on Tuesday proposed capital rule changes for certain higher-risk commercial real estate loans as required by the regulatory relief law signed by President Trump in May.

Under the new regulatory relief law, agencies may only require a depository institution to assign a heightened risk weight to a “high-volatility commercial real estate” exposure if the exposure in question is an acquisition, development or construction loan.

The agencies also proposed that certain types of loans be excluded from the amended High Volatility Commercial Real Estate (HVCRE) category, such as those secured by 1-4 family residential properties, and those that involve an investment in community development.

The Federal Reserve Board, OCC and Federal Deposit Insurance Corp. asked for public comment on the changes, which would apply to all banking organizations subject to the agencies’ capital rules. The comment period will last 60 days.

Read more: American Banker

Final holdout of Times Square’s rejuvenation to get $100 million makeover

The Times Square Theater on West 42nd Street has been closed for nearly three decades, detached from the transformation of the blighted area into a tourist destination with Hershey’s Chocolate World, an Old Navy clothing store and the Nasdaq Stock Market.

Now, a New York developer is reviving it. Stillman Development International LLC, which last year signed a lease for up to 73 years, is planning to restore the theater’s historic architecture, combine it with fresh design and lease the entire property to retailers.

Stillman is betting that the former theater’s high ceilings, views of the Times Square neighborhood and large outdoor space will appeal to brands that want a store that can double as an attraction and lure online shoppers from their couches.

It is a formula that has been used by other retailers nearby. Recent offerings include interactive retail and entertainment concepts such as the NFL Experience Times Square, which allows football fans to simulate calling a play in a team huddle. Another attraction from National Geographic animates ocean life in an immersive exhibit using advanced digital technology, 3-D imagery and other special effects.

Read more: Wall Street Journal

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