COMMERCIAL REAL ESTATE OUTLOOK: 2016 - realtor.org

National Association of REALTORS®

COMMERCIAL REAL ESTATE

OUTLOOK: 2016.Q3

Commercial Real Estate Outlook: 2016.Q3

Download: www.realtor.org/reports/commercial-real-estate-outlook

©2016 | NATIONAL ASSOCIATION OF REALTORS®

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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.

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


OUTLOOK

CONTENTS 1 | Economic Overview………………………………………………………………………………… 2 | Commercial Real Estate Investments…………………………………………………….. 3 | Commercial Real Estate Fundamentals…………………………………………………… 4 | Outlook……………………….…………………………………………………………………………..

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OUTLOOK


OUTLOOK

Gross Domestic Product

Economy activity in the second quarter was

disappointing, as the corporate outlook took a

slightly bearish undertone. Based on the first

estimate from the Bureau of Economic Analysis, real

gross domestic product (GDP) rose at an annual

rate of 1.2 percent, considerably below most

economists’ projections. The figure remained well

below the long-run historical average of 3.2 percent,

typical of second quarter performance.

Businesses accounted for the noticeable weakness,

with a 2.3 percent decline in nonresidential private

investment during the second quarter. Businesses

cut back investments in equipment and commercial

construction to the tune of 3.5 percent and 7.9

percent, respectively. The 12.0 percent gain in

industrial equipment spending was not enough to

offset cuts in information processing and

transportation equipment. Spending on intellectual

property products—software, R&D—increased by

3.6 percent. Investments in residential real estate

decreased at a 6.1 percent annual rate.

International trade posted positive results, even with

a rising dollar. Exports rose by 1.4 percent, while

imports declined at a 0.4 percent annual rate of

growth.

Consumer spending turned out to carry the quarter’s

economic activity. Personal consumption rose at an

annual rate of 4.2 percent in the second quarter,

with most of the gain driven by purchases of goods.

Spending on durable goods rose 8.4 percent, driven

by double-digit increases in consumer spending on

recreational goods and vehicles (up 14.3 percent).

Sales of nondurable goods also posted solid growth,

with an annual increase of 6.0 percent, as

consumers spent more on food and beverages in

NATIONAL ASSOCIATION of REALTORS® | RESEARCH DIVISION | www.realtors.org/research-and-statistics

grocery stores. Consumer spending on services

rose 3.0 percent on an annual basis, with housing,

health care, as well as lodging and restaurants

driving expenditures.

Government spending declined at a 0.9 percent

annual growth rate. The federal government

continued making spending cuts, with a 0.2 percent

decline, driven by cutbacks in defense expenditures.

State and local governments also decreased

spending at a 1.3 percent annual rate, due to cuts in

infrastructure investments (down 9.6 percent).

GEORGE RATIU Director, Quantitative & Commercial Research

[email protected]

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Exhibit 1.1: Real GDP (% Annual Chg.)

Source: NAR, BEA

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Employment

The employment landscape provided the silver

lining to the disappointing economic performance in

the first half of the year. Payrolls rose at a solid

pace, adding 460,000 net new positions in the

second quarter, in the wake of 587,000 net new jobs

in the first quarter of this year. Average weekly

earnings of private employees rose by 2.2 percent in

the second quarter of this year, compared to one

year earlier.

Employment in private service-providing industries

drove new job growth during the second quarter of

the year, with 405,000 net new jobs. Education and

health services had the highest number of net new

employees—151,000. Professional and business

services added 142,000 net new payroll positions,

while financial services added 52,000 new positions

to payrolls, keeping demand for office space

positive. Employment in leisure and hospitality

advanced 70,000 new positions, mirroring positive


OUTLOOK


demand for the hotel sector. With demand for

industrial properties rising, transportation and

warehousing employment gained 9,700 new

positions, while wholesale trade employment rose

by 600 jobs.

The unemployment rate averaged 4.9 percent in the

second quarter of 2016, flat with the first quarter’s

average. At the end of July there were 7.8 million

unemployed Americans, while an additional 5.9

million were employed part-time for economic

reasons. The average duration of unemployment

declined from 30 weeks in the second quarter of

2015 to 27 weeks in the second quarter of this year.

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Exhibit 1.2: Payroll Employment (Change, '000)

Source: BLS

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Mining/Logging

Construction

Manufacturing

Wholesale Trade

Retail Trade

Transp./Warehousing

Utilities

Information

Financial Activities

Prof./Bus. Services

Educ./Health

Leisure/Hospitality

Government

Exhibit 1.3: Payroll Employment: 12-Month Change ('000)

Source: BLS

7

The labor force participation (LFP) rate declined

slightly, from 62.9 percent in the first quarter to 62.7

percent in the second quarter. 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,

the low participation rate is likely to lead to

continued sluggishness in economic growth.


OUTLOOK


Consumer confidence, as measured by The

Conference Board, declined to 94.8 in the second

quarter of 2016, from 96.0 in the first quarter.

Separately, the Consumer sentiment index compiled

by the University of Michigan moved up slightly in

the second quarter of the year to 92.4, compared

with the 91.6 value from the first quarter. Both

remain lower on a year-over-year basis.

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Exhibit 1.4: Labor Force Participation Rate

Source: BLS

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Exhibit 1.5: Unemployment

Unemployment Rate (%)

Average Unemployment Duration (Weeks)

Source: BLS

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

Commercial real estate sales in large cap markets

declined in the first half of 2016 (H1.2016), due to a

weak first quarter. The volume of commercial sales

in LCRE markets totaled $219.2 billion in H1.2016, a

16 percent year-over-year decrease, according to

Real Capital Analytics (RCA). The data saw yearly

declines in both individual and portfolio transactions

during the first six months, of 4 percent and 39

percent, respectively.

Continuing past year’s trends, apartment

transactions comprised the largest share of H1.2016

volume, with $72.0 billion in sales, followed by office

properties, which accounted for $63.4 billion. Retail

and industrial sales totaled $36.6 billion and $25.7

billion, respectively.

8


OUTLOOK


1 Smith and Ratiu, (2015), "Small Commercial Real Estate Market," National Association of REALTORS®

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Exhibit 2.1: CRE Sales Volume ($2.5M+)

Individual Portfolio Entity

Source: Real Capital Analytics

9


OUTLOOK


Even with declining sales volume, prices in LCRE

markets rose. Based on preliminary data, prices in

markets covered by Real Capital Analytics gained

9.0 percent during the first half of 2016. The

advance was driven by strong appreciation in prices

of apartment and retail properties, which advanced

11.0 percent and 9.1 percent, respectively. Prices

for industrial properties increased 5.3 percent year-

over-year, while office properties recorded a slight

0.5 percent rise.

Separately, additional price indices also advanced.

The Green Street Advisors Commercial Property

Price Index advanced 6.6 percent on a yearly basis

during the second quarter, reaching a value of

124.7. The National Council of Real Estate

investment Fiduciaries (NCREIF) Price Index

increased at a slower 1.7 percent year-over-year in

the second quarter of 2016, to a value of 254.6.

Capitalization rates in LCRE markets averaged 6.8

percent in the second quarter, based on RCA

reports, 10 basis points lower compared with the

prior year. Cap rate compression continued for

apartment and office properties, with the average

yields tied at 5.6 percent in the second quarter of

this year.

NATIONAL 2.03%

OFFICE 1.74%

INDUSTRIAL 2.90%

RETAIL 2.17%

APARTMENT 1.88%

Source: National Council of Real Estate Investment Fiduciaries

Exhibit 2.3: NCREIF Property Index Returns—2016.Q2

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Exhibit 2.2: Commercial Property Price Indices

NCREIF Green Street Advisors

Real Capital Analytics

10 NATIONAL ASSOCIATION of REALTORS® | RESEARCH DIVISION | www.realtors.org/research-and-statistics


OUTLOOK

Small Commercial Real Estate Markets

In contrast, commercial real estate in small cap

markets maintained its upward momentum during

the first half of 2016, with REALTORS® reporting

continued improvement in fundamentals and

investment sales. Following on the first quarter’s

8.5 percent increase in sales volume, second

quarter transactions rose 8.4 percent on a yearly

basis.

The proportion of members who closed deals in the

second quarter of 2016 advanced to 66 percent,

from 58 percent in the first quarter. The direction of

commercial business opportunities during the

second quarter of 2016 rose 5.6 percent from the

prior quarter.

The shortage of available inventory remained the

number one concern for NAR members, pushing

price growth upward. During the second quarter of

this year, commercial properties exchanged hands

at average prices 5.3 percent higher compared with

the same period in 2015. The average transaction

price was level at $1.4 million in the first and second

quarters of 2016. A perceived pricing gap between

sellers and buyers remained the second highest

ranked concern. With banks tightening underwriting

standards for commercial loans in the wake of

increased regulatory scrutiny, financing availability

increased as a concern in REALTORS®’ markets—

15.0 percent of members ranked it as a main

challenge in the second quarter, up from 7.0 percent

in the first quarter.

Average capitalization rates continued compressing,

to an average 7.2 percent across all property types,

a 20 basis point compression on a yearly basis.

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Exhibit 2.4: Sales Volume (YoY % Chg)

Real Capital Analytics CRE Markets

REALTOR® CRE Markets

Sources: NAR, RCA

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Exhibit 2.5: Sales Prices (YoY % Chg)

Real Capital Analytics CRE Markets

REALTOR® CRE Markets

Sources: NAR, Real Capital Analytics

0.0%

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Office Industrial Retail Apartment Hotel

Exhibit 2.6: Cap Rates - 2016.Q2

RCA Markets REALTOR® Markets

11


OUTLOOK


Apartments posted the lowest cap rate, at 6.5

percent, followed by office properties with average

cap rates at 6.8 percent. Hotel and retail spaces

recorded cap rates of 7.0 percent and 7.1 percent,

respectively. Industrial transactions reported the

highest comparative cap rates—7.4 percent.

The interest rate on 10-year Treasury Notes—a

standard measure of risk-free investments—

averaged 1.2 percent during the second 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 500 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.

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Exhibit 2.7: CRE Spreads: Cap Rates to 10-Yr. T-Notes (bps)

RCA Cap Rates REALTORS® Cap Rates

Sources: NAR, Real Capital Analytics

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OUTLOOK


Large Commercial Real Estate Markets

Demand for commercial spaces remained robust in

the first half of 2016, with solid second quarter

fundamentals. With construction taking a breather,

the gap between demand and supply exerted

downward pressure on availability.

Office net absorption totaled 19.4 million square feet

in the first half of the year, with 11.5 million square

feet in the second quarter, based on data from

CBRE. Office construction decelerated, adding 7.5

million square feet to the supply pipeline during the

quarter. Overall office vacancies declined 10 basis

points on a yearly basis, to 13.0 percent in the

second quarter. CBD office properties continued

posting lower availability—10.5 percent—than their

suburban counterparts—14.4 percent. However,

office CBD vacancy rose for two quarters, while

suburban availability declined. Rents for office

properties rose 6.2 percent during the second

quarter, to an average of $30.88 per square foot.

Strengthening fundamentals characterized the

industrial sector as well during the second quarter,

as demand outpaced supply. Industrial net

absorption totaled 66.4 million square feet in the

second quarter, marking the 25th positive demand

quarter, according to CBRE. While industrial

developers took notice of the upward trend, new

completions totaled 41.6 million square feet. As

demand continued outmatching new construction,

industrial vacancies declined to 5.2 percent.

Industrial rents rose 6.6 percent on a yearly basis, to

an average of $5.96 per square foot in the second

quarter.

The retail sector mirrors changing demographics

and growing markets. Demand for retail properties

increased in tandem with rising employment and

confidence. Retain net absorption totaled 15.5

million square feet in the second quarter of 2016,

according to JLL. Retail development activity

remained modest, with 7.7 million square feet of

new completions. Rents for retail properties rose 1.9

percent during the quarter. Vacancy rates for retail

buildings declined 20 basis points, to 5.0 percent,

based on JLL data.

Demand for multifamily properties continued on an

upward path. The national vacancy rate averaged

4.8 percent for apartment housing during the second

quarter. Apartment rents rose 2.3 percent in the

second quarter of this year, according to

Axiometrics.

13


OUTLOOK


Small Commercial Real Estate Markets

Commercial fundamentals in smaller markets

continued improving during the second quarter of

2016. Leasing volume accelerated during the

quarter, with an 8.7 percent increase over the prior

quarter. Leasing rates advanced at a steady pace,

rising 3.7 percent in the second quarter. Office

properties posted rents averaging $32 per square

foot, while retail and industrial leases recorded $38

and $22 per square foot, respectively. Average

apartment rents for the first quarter were $535 per

unit.

NAR members’ average gross lease volume for the

quarter was $229,658, 51.4 percent lower than the

previous period. New construction picked up,

posting a 5.3 percent gain from the first quarter of

2016.

Tenant demand remained strongest in the 5,000

square feet and below segment, accounting for 82.0

percent of leased properties. Demand for space in

the 10,000 – 49,999 square feet segment rose from

5.0 percent in the first quarter of 2016, to 8.0

percent in the second quarter of this year. Lease

terms remained steady, with 36-month and 60-

month leases capturing 60.0 percent of the market.

Two-year leases made up 15.0 percent of total.

Vacancy rates continued declining, ranging from a

low of 5.0 percent for apartments to a high of 13.2

percent for hotel properties. Office vacancies

declined 365 basis points year-over-year, to 12.3

percent. Industrial availability witnessed a yearly

decrease of 95 basis points—to 9.8 percent. Retail

vacancies slid 70 basis points on a yearly basis, to

11.8 percent. With declining vacancies, lease

concessions declined 5.5 percent.

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% C

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Exhibit 3.1: REALTORS® Fundamentals

New Construction Leasing Volume

Source: National Association of Realtors®

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30.0%

Exhibit 3.2: REALTORS® Commercial Vacancy Rates

Office Industrial Retail

Multifamily Hotel

Source: National Association of Realtors®

14


OUTLOOK


Economy

Looking ahead at the second half of 2016, the GDP

annual rate of growth is expected to moderately

outperform the first half. However, in light of the

weak first quarter, the annual growth is pegged at

1.9 percent. Payroll employment is projected to post

1.6 percent annual growth rate for the year. The

unemployment rate is projected to fall to 4.8 percent

by the end of 2016.

The markets continue to weigh the expected

Federal Reserve’s increases in the funds target rate.

Inflation is expected to average 1.4 percent over

2016, accelerating in the third quarter.

In light of increased market volatility and slowing

economic growth, consumer confidence has

moderated and is expected to hover just below its

long-term average.

Exhibit 4.1: U.S. ECONOMIC OUTLOOK—August 2016

2014 2015 2016 2017

Annual Growth Rate, %

Real GDP 2.4 2.4 1.9 2.2

Nonfarm Payroll Employment 1.9 2.1 1.6 1.8

Consumer Prices 1.6 0.2 1.4 2.7

Level

Consumer Confidence 87 98 99 102

Percent

Unemployment 6.2 5.3 4.9 4.7

Fed Funds Rate 0.1 0.1 0.4 0.9

3-Month T-bill Rate 0.1 0.1 0.3 0.9

Corporate Aaa Bond Yield 4.2 3.9 3.6 3.8

10-Year Gov’t Bond 2.5 2.1 1.8 2.3

30-Year Gov’t Bond 3.3 2.8 2.5 3.0

Source: National Association of REALTORS®

15


OUTLOOK


Commercial Real Estate

Commercial fundamentals remain on an upward

trajectory, with three of the four core sectors tilting in

landlords’ favor. As employment gains drive

demand, office vacancies are projected to decline to

11.5 percent by the fourth quarter of 2016 and

decline to 10.6 in 2017. Industrial availability is

estimated to drop from an average of 11.4 percent in

2015 to 9.4 percent by the end of 2016. Retail

availability will continue shrinking, as vacancies are

projected to decline from 12.9 percent in 2015 to

11.8 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

increase over the next couple of years, from 6.1

percent in 2016 to 6.2 percent in 2017.

On the investment side, while financial markets’

volatility left a mark on the sales volume in large cap

CRE markets during the first half of 2016, volume is

expected to rebound slightly in the latter half of the

year. In small cap CRE markets, increased scrutiny

from banking regulators has tightened lending

conditions, leading to more cautious capital flows

into CRE transactions.

Exhibit 4.2: Commercial Real Estate Vacancy Forecast (%) 2015.Q1 2015.Q2 2015.Q3 2015.Q4 2016.Q1 2016.Q2 2016.Q3 2016.Q4 2017.Q1 2017.Q2 2017.Q3 2017.Q4 2015 2016 2017

Office 15.1 15.9 16.0 14.3 13.4 12.3 11.9 11.5 11.1 10.8 10.4 9.9 14.3 12.3 10.6 Industrial 11.3 10.8 11.5 11.4 11.1 9.8 9.4 9.4 9.1 8.9 8.7 8.4 11.4 9.9 8.8 Retail 13.7 13.2 13.0 12.9 12.5 11.8 11.5 11.2 11.1 10.8 10.5 10.3 12.9 11.8 10.7 Multifamily 8.4 6.6 7.4 6.2 7.8 5.0 5.9 5.8 6.6 6.3 6.1 5.8 6.2 6.1 6.2 Source: National Association of REALTORS®

Exhibit 4.4: Commercial Property Price Indices Forecast

2009 2010 2011 2012 2013 2014 2015 2016 2017

NCREIF 165.1 168.2 186.5 195.2 211.9 224.9 246.7 244.3 249.0

Green St. Advisors 63.5 74.4 87.1 92.2 99.4 106.7 118.0 119.4 124.2 Sources: NAR, NCREIF, Green Street Advisors

Given the global low yield environment, U.S. CRE is

well-positioned to continue as an attractive

alternative for investors this year. Investors’

approach will remain moderated, leading to a

slowdown in CRE prices. With cap rates at very low

levels and markets’ eyes on the Federal Reserve’s

interest rate action this year, the price slowdown is

likely to be felt stronger in Class A assets in top-tier

markets. Properties in smaller markets, remain on

an upward path, given the three-year lag in the

recovery.

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17

Q2

20

18

Q1

Bill

ion

s

Exhibit 4.3: CRE Sales Volume ($2.5M+) Forecast

Source: NAR, RCA

The National Association of REALTORS®, “The Voice for Real Estate,” is America’s largest trade association, representing over 1.2 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.


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


RESEARCH DIVISION

500 New Jersey Avenue, NW

Washington, DC 20001

202.383.1000


OUTLOOK

http://www.realtor.org/research-and-statistics





COMMERCIAL REAL ESTATE OUTLOOK | 2016.Q3

Documents

COMMERCIAL REAL ESTATE OUTLOOK: 2016 - realtor.org