COMMERCIAL REAL ESTATE OUTLOOK: 2016.Q2

National Association of REALTORS®

COMMERCIAL REAL ESTATE

OUTLOOK: 2016.Q2

Commercial Real Estate Outlook: 2016.Q2

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

©2016 | NATIONAL ASSOCIATION OF REALTORS®

All Rights Reserved.

Reproduction, reprinting or retransmission in any form is prohibited without written permission.

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……………………….…………………………………………………………………………..

5 8 12 14


OUTLOOK


OUTLOOK

Gross Domestic Product

The U.S. economy sputtered during the first quarter

of 2016, as global economic activity throttled back

and companies found financial markets’ volatility

unsettling. Based on the first estimate from the

Bureau of Economic Analysis, real gross domestic

product (GDP) rose at an annual rate of 0.5 percent.

The figure is in line with last year’s first quarter

reading of 0.6 percent. The GDP number remained

well below the long-run historical average of 3.0

percent.

Consumer spending was soft, rising at an annual

rate of 1.9 percent in the first quarter, with most of

the gain driven by services. Retail sales, which were

weak during the winter holiday season, posted

further slowdown. Spending on goods was virtually

flat, given the 0.1 percent increase. Spending on

durable goods—cars, furnishing, appliances and

recreational goods—declined 1.6 percent.

Consumers spent more on food and gasoline during

the quarter, lifting nondurable goods consumption

1.0 percent. Consumer spending on services rose

2.7 percent on an annual basis, with transportation,

recreation, healthcare, as well as lodging and

restaurants driving expenditures.

The corporate outlook took a downward turn, with

business investments dropping 5.9 percent on an

annual basis in the first quarter. Businesses cut

back investments in equipment and commercial real

estate to the tune of 8.6 percent and 10.6 percent,

respectively. Investments in residential real estate—

aided by a warmer winter—picked up, rising by 14.9

percent annual rate. Spending on intellectual

property products—software, R&D—rose by 1.7

percent.

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

With the dollar rising, international trade bore the

brunt of a weakening economic environment.

Exports declined by 2.6 percent, while imports

moved sideways with a 0.2 percent annual rate of

growth.

Government spending moderated as well, notching

a 1.2 percent annual growth rate. The federal

government continued slashing spending, with a 1.6

percent decline, driven by cuts in defense

expenditures. State and local governments

increased spending at a 2.9 percent annual rate,

focused on infrastructure investments.

GEORGE RATIU Director, Quantitative & Commercial Research

[email protected]

5

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Exhibit 1.1: Real GDP (% Annual Chg.)

Source: NAR, BEA

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Employment

The first quarter employment landscape offered a

few high points. Payrolls rose at a solid pace,

adding 609,000 net new jobs. Average weekly

earnings of private employees rose by 2.1 percent in

the first quarter of this year, compared to one year

earlier.

Employment in private service-providing industries

provided the main thrust for new job growth during

the first quarter of the year, with 561,000 net new

jobs. The retail trade boosted payrolls during the

quarter by 157,500 net positions. Education and

health gained 146,000 new positions. With warmer-

than-usual weather, leisure and hospitality payrolls

rose by 95,000 net new positions. Employment in

professional and business services gained 70,000

net new jobs, the slowest pace in five years.

Financial services added 39,000 new positions to

payrolls during the period, keeping demand for

office space positive.


OUTLOOK


With demand for industrial properties rising,

transportation and warehousing employment gained

22,200 new positions, while wholesale trade

employment rose by 24,700 jobs.

The unemployment rate averaged 4.9 percent in the

first quarter 2016. At the end of December there

were 7.9 million unemployed Americans, while an

additional 6.0 million were employed part-time for

economic reasons. The average duration of

unemployment declined from 31 weeks in the first

quarter of 2015 to 29 weeks in the first quarter of

this year.

The labor force participation (LFP) rate rose slightly

as more Americans returned to the labor markets, -1000

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Exhibit 1.2: Payroll Employment (Change, '000)

Source: BLS

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Mining/Logging

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

Source: BLS

7

but continued to hover at historic lows. The LFP

rate was 62.8 percent in the first quarter of 2015,

slid to 62.5 percent in the third and fourth quarters,

and rose to 62.9 percent in the first quarter of 2016.

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, economic growth is

likely to remain moderate.


OUTLOOK


Consumer confidence, as measured by The

Conference Board, was unchanged at 96.0 in the

first quarter of 2015, compared with the prior

quarter. Separately, the Consumer sentiment index

compiled by the University of Michigan moved up

slightly in the first quarter of the year to 91.6,

compared with the 91.3 value from the fourth

quarter. Both remain lower on a year-over-year

basis.

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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

The pace of commercial transactions dropped in the

first quarter of 2016, following an upbeat 2015. The

volume of commercial sales in LCRE markets

totaled $111 billion, a 20 percent year-over-year

decrease, according to Real Capital Analytics

(RCA). The first quarter data saw yearly declines in

both individual and portfolio transactions, of 11

percent and 24 percent, respectively.

Continuing the trends from 2015, apartment

transactions comprised the largest share of first

quarter volume, with $38.6 billion in sales, followed

by office properties, which accounted for $31.2

billion. Retail and industrial sales totaled $17.9

billion and $12.6 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. However, the advances moderated

from the fast pace of the past two years. Prices in

markets covered by Real Capital Analytics gained

8.6 percent during the first quarter of 2016, based

on RCA’s Commercial Property Price Index. The

advance was driven by strong appreciation in prices

of retail and apartment properties, which advanced

11.8 percent and 11.2 percent, respectively. Prices

for office properties in central business districts

(CBD) advanced 10.5 percent.

Separately, additional price indices also advanced.

The Green Street Advisors Commercial Property

Price Index rose 8.4 percent on a yearly basis

during the first quarter, reaching a value of 123.4.

The National Council of Real Estate investment

Fiduciaries (NCREIF) Price Index increased 8.7

percent year-over-year in the first quarter of 2016, to

a value of 257.3.

Capitalization rates in LCRE markets averaged 6.7

percent in the first quarter, based on RCA reports,

30 basis points lower compared with the prior year.

Cap rate compression continued for apartment and

office CBD properties, reaching values of 5.7

percent and 5.4 percent, respectively.

NATIONAL 2.21%

OFFICE 1.72%

INDUSTRIAL 2.96%

RETAIL 2.96%

APARTMENT 1.87%

Source: National Council of Real Estate Investment Fiduciaries

Exhibit 2.3: NCREIF Property Index Returns—2016.Q1

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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

Commercial real estate in smaller markets

maintained its upward momentum during the first

quarter, with REALTORS® reporting continued

improvement in fundamentals and investment sales.

The volume of investment sales in REALTORS®

markets totaled $51.6 billion during the first quarter.

The pace of sales picked up, with volume rising 8.5

percent from the first quarter of 2015.

The proportion of members who closed deals in the

fourth quarter of 2015 declined to 58 percent, from

66 percent in the fourth quarter, and was also lower

than the 60 percent recorded in the prior year. The

direction of commercial business opportunities

during the first quarter of 2016 rose 5.2 percent from

the prior quarter, and was up 16.0 percent year-

over-year.

The shortage of available inventory continued as the

number one concern for NAR members, pushing

price growth upward. Commercial properties traded

at average prices 5.1 percent higher compared with

the same period in 2015. The average transaction

price reached $1.4 million in the first quarter of

2016.

Average capitalization rates declined to an average

7.2 percent across all property types, a 57 basis

point compression on a yearly basis. Apartments

posted the lowest cap rate, at 6.9 percent, followed

by hotel properties with average cap rates at 7.1

percent. Office and retail spaces tied with cap rates

of 7.3 percent. Industrial transactions reported the

highest comparative cap rates—7.4 percent. It is

worth noting that these cap rates are higher than

those in LCRE markets, reflecting activity in markets

where REALTORS® are more engaged.

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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 - 2015.Q4

RCA Markets REALTOR® Markets


11


OUTLOOK


The interest rate on 10-year Treasury Notes—a

standard measure of risk-free investments—

averaged 1.8 percent during the first 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 490 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


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OUTLOOK


Large Commercial Real Estate Markets

Demand for commercial leases continued rising

during the first quarter of 2016. Construction has

been growing across all property types, but the gap

between demand and supply exerted downward

pressure on availability.

Office net absorption totaled 7.7 million square feet

in the first quarter of the year, a decline from last

quarter’s 18.7 million square feet, based on data

from JLL. Occupancy growth—expansionary

leases—drove leasing activity during the quarter,

coupled with increases in shared office space.

Office construction added 10.6 million square feet to

the supply pipeline during the quarter. Overall office

vacancies rose 10 basis points on a yearly basis, to

14.8 percent in the first quarter. CBD office

properties continued posting lower availability than

their suburban counterparts. Rents for office

properties rose 3.2 percent during the first quarter.

The industrial sector recorded rising fundamentals in

the first quarter, with rising demand and declining

vacancies. Industrial net absorption totaled 52.3

million square feet in the first quarter, up 6.6 percent

year-over-year, according to JLL. Warehouse and

distribution centers accounted for the largest share

of demand, followed by manufacturing and special

purpose buildings. Speculative supply increased, as

well. New completions totaling 48.8 million square

feet, of which 37.5 million square feet were

speculative. Demand continued outpacing supply,

driving industrial vacancies down to 6.2 percent, 50

basis points from the prior year. Industrial rents rose

5.9 percent, to an average of $4.92 per square foot

in the first quarter.

The retail sector is tracking demographic changes

and affluent buyers and growing markets. Demand

for retail properties increased in tandem with rising

employment and confidence. Retain net absorption

totaled 18.6 million square feet in the first quarter of

2016, a 20.8 percent increase from a year ago,

according to JLL. Retail development activity

remained modest, driving rent growth. Rents for

retail properties rose 1.5 percent during the quarter.

Vacancy rates for retail buildings declined 40 basis

points, to 5.6 percent, based on JLL data.

Demand for multifamily properties continued on an

upward path. Renter occupied housing units totaled

42.9 million units in the first quarter of 2015, a

363,000 unit advance from the first quarter of 2015,

based on U.S. Census Bureau data. National

vacancy rates averaged 7.0 percent for rental

housing during the first quarter, 10 basis points

lower than the same period in 2015. Median rents

for rental units averaged $870 in the first quarter of

this year.

13


OUTLOOK


Small Commercial Real Estate Markets

Commercial fundamentals in smaller markets

continued improving during the first quarter of 2016,

but at a slower pace. Leasing volume during the

quarter rose 1.3 percent over the prior quarter.

Leasing rates advanced at a slower pace as well,

rising 1.9 percent in the first quarter, compared with

the 2.5 percent advance recorded during the fourth

quarter. Office properties posted leases averaging

$43 per square foot, while retail and industrial

leases recorded $29 and $38 per square foot,

respectively. Average apartment rents for the first

quarter were $785 per unit.

NAR members’ average gross lease volume for the

quarter was $473,000, 36.4 percent lower than the

previous period. New construction picked up,

posting a 5.3 percent gain from the fourth quarter of

2015, compared with 3.7 percent in the prior quarter.

Tenant demand remained strongest in the 5,000

square feet and below segment, accounting for 80.0

percent of leased properties. Demand for space in

the 10,000 – 49,999 square feet segment slowed

during the first quarter, comprising 5.0 percent of

total.

Lease terms remained steady, with 36-month and

60-month leases capturing 59 percent of the market.

Vacancy rates varied across regional and product

types in REALTORS® markets. Office vacancies

declined 174 basis points, to 13.4 percent during the

first quarter. Industrial availability reached 11.1

percent, a 23-basis point decrease on a yearly

basis. Even with soft retail sales, retail vacancies

declined 122 basis points, to 12.5 percent during the

quarter. As rising new supply loosens major

markets, apartments in SCRE markets experienced

availability decreases, with the national average

declining 61 basis points year-over-year, to 7.2

percent in the first quarter of 2016.

Lease concessions declined 3.9 percent. Tenant

improvement (TI) allowances averaged $9 per

square foot per year nationally.

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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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Exhibit 3.2: REALTORS® Commercial Vacancy Rates

Office Industrial Retail

Multifamily Hotel

Source: National Association of Realtors®

14


OUTLOOK


Economy

Looking ahead at the next three quarters of 2016,

the GDP annual rate of growth will pick up toward

the latter half of the year. However, in light of the

weak first quarter, the annual growth is pegged at

1.6 percent. Payroll employment is projected to post

1.6 percent annual growth rate for the year. The

unemployment rate is projected to fall to 4.7 percent

by the end of 2016.

The markets continue to weigh the expected

Federal Reserve’s increases in the funds target rate.

Prices are expected to rise 1.7 percent over 2016,

accelerating in the latter quarters as housing costs

are adding upward pressures.

In light of increased market volatility and slowing

economic growth, consumer confidence has

moderated and is expected to hover below its long-

term average.

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

2014 2015 2016 2017

Annual Growth Rate, %

Real GDP 2.4 2.4 1.6 2.2

Nonfarm Payroll Employment 1.9 2.1 1.6 1.8

Consumer Prices 1.6 0.2 1.7 3.0

Level

Consumer Confidence 87 98 97 104

Percent

Unemployment 6.2 5.3 4.8 4.6

Fed Funds Rate 0.1 0.1 0.5 1.3

3-Month T-bill Rate 0.1 0.1 0.5 1.4

Corporate Aaa Bond Yield 4.2 3.9 4.0 4.7

10-Year Gov’t Bond 2.5 2.1 2.1 2.8

30-Year Gov’t Bond 3.3 2.8 2.9 3.4

Source: National Association of REALTORS®

15


OUTLOOK


Commercial Real Estate

Commercial fundamentals continue on an

expansionary path, with three of the four core

sectors tilting in landlords’ favor. As employment

gains drive demand, office vacancies are projected

to decline to 12.5 percent by the fourth quarter of

2016 and decline to 11.7 in 2017. Industrial

availability is estimated to drop from an average of

11.4 percent in 2015 to 10.8 percent in 2016. Retail

availability will continue shrinking, as vacancies are

projected to decline from 12.9 percent in 2015 to

12.2 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

average increase over the next couple of years,

from 6.2 percent in 2015 to 8.4 percent by the end of

2016, and 8.9 percent in 2017.

On the investment side, financial markets’ jitters

about interest rates will likely dampen the sales

pace in LCRE markets. In SCRE markets, increased

scrutiny from banking regulators has already

tightened lending conditions, with slower capital

flows into CRE transactions.

Exhibit 4.2: Commercial Real Estate Vacancy Forecast (%) 2014.Q4 2015.Q1 2015.Q2 2015.Q3 2015.Q4 2016.Q1 2016.Q2 2016.Q3 2016.Q4 2017.Q1 2017.Q2 2017.Q3 2015 2016 2017

Office 14.9 15.1 15.9 16.0 14.3 13.4 13.2 12.9 12.5 12.2 11.9 11.6 14.3 13.0 11.7 Industrial 11.6 11.3 10.8 11.5 11.4 11.1 10.9 10.6 10.7 10.6 10.5 10.4 11.4 10.8 10.4 Retail 12.5 13.7 13.2 13.0 12.9 12.5 12.3 12.0 11.8 11.8 11.5 11.3 12.9 12.2 11.4 Multifamily 6.8 8.4 6.6 7.4 6.2 7.8 7.9 8.1 8.4 8.6 8.7 9.0 6.2 8.0 8.9 Source: National Association of REALTORS®

Exhibit 4.4: Commercial Property Price Indices Forecast

2009 2010 2011 2012 2013 2014 2015 2016 2017

NCREIF 165.1 168.2 186.5 195.2 211.9 224.9 246.7 249.1 254.6

Green St. Advisors 63.5 74.4 87.1 92.2 99.4 106.7 118.0 120.1 123.8 Sources: NAR, NCREIF, Green Street Advisors

However, In light of current global uncertainty, U.S.

CRE is likely to remain an attractive alternative for

investors this year. Investors will probably take a

more measured approach, leading to a moderation

in CRE prices. With cap rates at very low levels and

interest rates expected to rise, the price slowdown is

projected to impact Class A assets in top-tier

markets, where inventory shortages and crowding of

capital have led to the recent run-ups. Properties in

smaller markets, where the recovery only began in

2013 are likely to see continued price appreciation.

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1…

20

1…

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 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

COMMERCIAL REAL ESTATE OUTLOOK | 2016.Q2

Documents

COMMERCIAL REAL ESTATE OUTLOOK: 2016.Q2