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Portfolio > Alternative Investments > Real Estate

Commercial Property Deals Heading for 10-Year High

By Michael S. Fischer

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Commercial property transaction volume in 2016 will exceed 2006 levels, reaching $430 billion, according to a U.S. real estate forecast released Tuesday.

The latest outlook from the Urban Land Institute and EY (Ernst & Young), covering 2014 through 2016, projects steady growth for the U.S. economy sustained strength from real estate capital markets and continued improvement in both commercial real estate fundamentals and the housing sector.

The findings are based on a survey of 39 leading industry economists and analysis conducted between Feb. 19 and March 14 to gauge their sentiment about the direction of the real estate industry. The forecast reflects consensus reached on 27 economic and real estate indicators.

A statement accompanying the latest forecast noted that it was more optimistic than the previous one from October. Although survey respondents moderated their expectations for the housing sector — housing starts will remain below the 20-year annual average through 2016 — the overall industry outlook remains positive.

The issuance of commercial mortgage-backed securities, a key source of financing for commercial real estate, is expected to continue its rebound with consistent growth through 2016.  Hotel occupancy rates are also expected to continue improving, while vacancy rates will decrease modestly for office, retail and industrial properties. 

In addition, the forecast expects retail rental rates to rise this year for the first time since 2007.

“Respondents to the Consensus Forecast survey project consistent growth in the real estate industry, bringing some key factors back to prerecession levels and others moderating to long-term averages,” Anita Kramer, vice president at ULI Center for Capital Markets and Real Estate, said in the statement.

“Fundamentals beyond multifamily continue to improve with the retail sector now joining in. This overall outlook for real estate is supported by expected ongoing improvements in the economy.”

The Consensus Forecast expects the overall economy to continue expanding a rate equivalent to the 20-year average. It projected that GDP would grow by 2.8% in 2014 and then 3% in both 2015 and 2016.

Survey respondents predicted that employment would grow by more than 7.5 million jobs in the next three years, with the unemployment rate expected to fall to 6.3% by the end of this year, 6% by the end of 2015 and 5.8% by the end of 2016.

The forecasters expected inflation to grow by 1.9% in 2014, and then increase by 2.2% in 2015, followed by 2.5% in 2016. At the same time, 10-year Treasury rates are projected to continue moving up, reaching 3.4% by the end of 2014, 4% by the end of 2015, and 4.4% by the end of 2016.

Even though Treasury rates will increase borrowing costs for real estate investors, survey respondents did not expect these changes to substantially affect NCREIF capitalization rates for institutional quality investments, which are expected to remain at 5.7% in 2014 and then rise to 5.9% in 2015 and 6.2% in 2016.

Prices and total returns for commercial real estate investments are projected to increase at moderate rates. Institutional real estate assets are expected to provide total returns of 9.4% in 2014, moderating slightly up to 8.5% by 2016.

NCREIF total returns in 2014 are projected to be fairly consistent across property types, with retail and industrial at 10%, followed by office and apartments at 9%. Total office returns are expected to remain at 9% by 2016, while retail, industrial, and apartments are all expected to moderate downward.

“Although we’ve made significant improvement over the past year, the recovery has been uneven globally and many risks still exist, including high global unemployment, high government debt, deflationary pressure in advanced economies, weak domestic demand, capital flow volatility in emerging markets and the potential impact from Fed tapering in the US,” Howard Roth, EY’s global real estate leader, said in the statement.

“Still, all signs point to a continued gradual improvement in both the economy and real estate market fundamentals.”

Housing Looks Bright

After single-family starts plunged to a half-century low of 430,600 starts in 2011, they rose to 618,300 in 2013. The Consensus Forecast projects that starts will increase to 742,500 in 2014, 850,000 in 2015 and 900,000 in 2016.

Despite this growth, the 2016 projection remains below the 20-year annual average for housing starts. Still, the single-family housing sector is expected to experience solid gains through 2016, with expected increases in home prices of 6% in 2014, 4.4% in 2015 and 4% in 2016.

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