More Gains in Commercial Real Estate Sector to Come

All major sectors of commercial real estate will continue to improve, but widely-anticipated increases in short-term interest rates could complicate market growth in the year ahead.

That was the forecast from NAR Chief Economist Lawrence Yun at the commercial real estate outlook session last week at the REALTORS® Conference & Expo in San Diego. He said that vacancy rates in the office, retail, manufacturing, hotel, and multifamily housing sectors are likely to continue their decline in 2016, even as new projects come online to expand capacity.

Yun predicted that vacancy rates in the office sector would drop to 15.6 percent this year from 16 percent in 2014, and that they’d further improve to 15 percent in 2016. In the industrial sector, vacancies should end the year at 11.7 percent, down from 12 percent, likely dropping further to 8.8 percent in 2016. In retail, vacancies will end up at 13.2 percent at year’s end, compared to 13.8 percent last year, with an expected drop to 12 percent next year. And in the multifamily sector, which has seen massive growth as young households struggle to buy, vacancies are expected to stabilize at 7.1 percent, this year and next year.

Expected action by the Federal Reserve to tighten monetary policy by raising short-term interest rates either in December or January creates some unknowns for commercial markets. But Yun pointed out that higher financing costs won’t necessarily follow the move, because many other factors influence the direction of interest rates.

Against continued strengthening of the commercial sector, some analysts worry about the formation of an asset bubble similar to the one that brought down markets half a dozen years earlier. But Jim Costello, senior vice president of Real Capital Analytics, who also spoke at the forum said that’s unlikely. He noted that properties today are far more conservatively underwritten than they were before the last downturn and there remains a comfortable spread between cap rates and financing costs.

One potential threat out of Washington is the curbing or even possible elimination of 1031 tax-deferred exchanges. The provision plays an important role in many commercial transactions, including smaller ones that are the bread-and-butter of many of NAR’s commercial members. While it’s currently just one among a number of options proposed by Congress to help reduce the federal budget deficit, NAR will be closely watching legislative developments next year.


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