The U.S. property market landscape in 2017 will be characterized by continued strong fundamentals, increased investor flows, and high transaction volume. As for the economic landscape, the U.S. continues to grow moderately and add jobs. U.S. employment gains continue to be strong, with unemployment dropping below 5 percent earlier last year, and adding to demand for commercial real estate in a variety of sectors. Many are surprised we have not reached the end of the current economic growth cycle. The fact that the recovery was so protracted and that growth relatively anemic over the last seven years leads me to believe that we may have another two years left in the current growth cycle.
The U.S. Federal Reserve made it clear last December that the central bank sees U.S. growth as relatively stable, notching the federal funds rate higher by a quarter point in early December. This is only the second time since 2006 that the Fed has raised rates (the last time was in December 2015). “Economic growth has picked up since the middle of the year,” said Janet Yellen, the Fed’s chair. “We expect the economy will continue to perform well.” Nevertheless, underlying inflation is extremely tame in the United States and in major emerging markets (with worries of deflation in some sectors and countries), providing no impetus for significantly higher rates. Lending rates and fixed-income rates of return will still be very low by historical standards, inducing continued levered purchases of real estate assets.
These five trends will play a significant role in commercial real estate in 2017 (Trends 4-5 are presented here, with Trends 1-3 in Part 1):
4. Volatile Energy Markets
Energy market volatility has already affected certain regional U.S. economies (Houston, North Dakota) and producer nations (Saudi Arabia, Venezuela). 2015 saw a dramatic drop in oil prices, and the drop continued through the year, followed by substantial volatility through the year and prices rising in the last quarter of 2016. Increased production and reduced demand due to slowing global growth led to the decline which saw oil prices fall from 105.79 in June, 2014 per barrel to a 13-year low $30.32 in February, 2016 per barrel with recovery to just $49.78 in October, 2016. The world is oversupplied, and major oil-producing countries have barely reduced production. This has had a profound economic impact and carries with it implications for property market fundamentals and commercial real estate pricing.
Exhibit 4: Cushing OK WTI Spot Price FOB Dollars per Barrel (Source: U.S. Energy Information Administration)
The impacts of this environment vary considerably by region and sector. Negative effects are largely concentrated in a few metropolitan areas with high economic exposure to the energy industries (including Houston, Texas and the oil shale region in North Dakota). For most metro areas and property types, lower oil prices have been a net positive. Spending less on gasoline encourages consumers to spend more on other items, which help retail and hotel market fundamentals. Lower oil and energy costs will also reduce certain construction, manufacturing, and logistics costs.
This aids business investment and expansion, which, in turn, increases demand for industrial and manufacturing space. Property markets will see a short-term lift due to a combination of improving tenant fundamentals and lower operating costs.