The Chicago commercial real estate market is going strong, but its comeback isn’t complete.
Six years after the market hit bottom, an index of Chicago-area commercial property values is still about 7 percent shy of its 2007 pre-crash peak. But the price measure, tracked by Real Capital Analytics and Moody’s Analytics, rose a healthy 7.1 percent in 2016, the seventh straight annual gain for the Chicago market, fueled by a growing economy, low interest rates and an ample supply of debt.
High prices have allowed owners of apartment, office and other commercial buildings to pocket big profits by selling or refinancing their properties. While rising interest rates may cool down the market this year, Moody’s doesn’t expect it to get too chilly, forecasting another 3.5 percent gain for the index this year.
Politics are one wild card: With Donald Trump in the White House and tax and regulatory reform on Congress’ agenda, many real estate investors are uncertain about how potential policy changes could affect property values, said Jim Costello, senior vice president at New York-based Real Capital.
Proposals to allow for faster depreciation of capital expenditures would help the industry, while an idea floating around Capitol Hill to eliminate tax deferrals on property sales would hurt, he said.
“Till we see the rules, (investors) are going to be a lot more cautious,” he said.
On the other hand, the growing economy should continue to boost demand for commercial space, lifting property incomes. Rising interest rates tend to depress property values, but occupancy and rent gains theoretically should help offset the impact.
Still, prices are likely to rise more slowly than they have in the past, Costello said.
“If you’re getting stronger growth in the economy, stronger job growth, that should be good for leasing,” he said. “I don’t think it will ever grow enough to give you double-digit growth” in prices.
A national index tracked by Real Capital and Moody’s increased 9.9 percent last year and is forecast to rise another 3.4 percent in 2017.
A couple of big deals over the past year illustrate the upward price trend in Chicago. Earlier this year, Chinese investor HNA Group agreed to pay almost $360 million for 181 W. Madison St., an office tower that last sold for $302 million in October 2013. In December, Chicago apartment landlord Bill O’Kane paid $225 million for Axis Apartments & Lofts, a Streeterville high-rise that traded for $188 million in February 2013.
But many properties are still worth less than they were before the crash of 2008-09. In January, after going through foreclosure, the office building at 123 N. Wacker Drive sold for $147 million, well below its 2005 sale price of $170 million.
Foreign investors have played a larger role in the U.S. commercial real estate market the past few years, one reason prices have risen and first-year returns—capitalization, or “cap,” rates in industry parlance—have dropped.
Overseas investment fell last year, but rising interest rates tend to attract money from foreign investors seeking higher returns. Whether that lifts real estate values is an open question.
“The wild card is whether further rate hikes will continue to bolster the dollar, and whether prospects of dollar strengthening will drive overseas investors into (U.S. commercial real estate) assets,” Heidi Learner, chief economist at real estate brokerage Savills Studley, said in a statement. “It’s too soon to tell whether 2017 cross-border volumes will fall again, but it’s unlikely that there will be a wave of foreign capital that will be competing with dollar investors to drive cap rates lower.”
Source: Crain’s Chicago Business, Abby Galun March 13th, 2017
Despite Economic and Regulatory Uncertainties, Most See Continued Growth in US Debt and Equity Markets
A pair of new surveys point to continued favorable market conditions for US commercial real estate this year, with a strengthening economy paired with improved property fundamental and ready access to capital shoring up the real estate expansion through 2017.
A survey by KPMG LLP of senior U.S. real estate executives further finds that uncertainties over President Trump’s tax and regulatory policies, rising interest rates and the threat of data breaches and other cybersecurity risks have not dampened bullishness among real estate owners and investors.
Fifty-two percent of real estate executives polled believe that improving real estate fundamentals in 2017 will be the biggest driver of their company’s revenue growth, while 91% of investors are bullish on access to equity capital, with 25% expecting an improvement in 2017 and two-thirds believing that the positive trend will remain the same.
“Although prices of Class A assets in the U.S. are high and yields are lower, the promise of reliable returns leads to sustained interest in the sector overall, especially when compared to other global markets,” noted said Greg Williams, national sector leader for KPMG’s Building, Construction & Real Estate division. “A growing US economy, coupled with healthy real estate fundamentals and strong access to financing and capital, make real estate leaders optimistic about a continued boom in the US market,”
“A growing U.S. economy, coupled with healthy real estate fundamentals and strong access to financing and capital, make real estate leaders optimistic about a continued ‘boom’ in the U.S. market.”
KPMG anticipate continued growth in the open-ended and debt funds due to their stable yield, diversification, and higher levels of liquidity for open-ended funds, said Phil Marra, national real estate funds leader.
“We also expect to see an influx of new investment in real estate, both from existing investors as well as new entrants,” Marra said.
A recent survey of Commercial Real Estate Finance Council members finds that the real estate finance market to benefit from economic growth, the incremental nature of rising interest rates, low levels of new construction and ample availability of capital and credit to borrowers for new loans and refinancings.
Spreads on commercial mortgage-backed securities (CMBS) are likely to remain volatile in 2017, mainly due mainly to external factors such as geopolitical trends and potential contagion from other asset classes.
CMBS issuers have adjusted to new risk-retention requirements that took effect on Dec. 24, and portfolio lenders, private equity and a new generation of other lenders are stepping in to fill gaps and enable opportunity in the investment marketplace, said CRE Finance Council Executive Director Lisa Pendergast.
“Though there is some concern that we are nearing the peak of the current U.S. real estate cycle, valuations are generally holding with ample credit available for new loans and refinancings of maturing quality loans,” Pendergast said.
Source: CoStar News Randyl Drummer February 1, 2017
Last year, most prognosticators for the multifamily sector predicted a record number of new units would cause rents to moderate and vacancies to increase. Sales of multifamily properties would dip below the record high levels of 2015, and price growth would slow down.
But that’s not what happened. Sales volume for 2016 is on pace for another record year and per unit sale prices were once again rocketing up in the fourth quarter after holding fairly steady most of the year.
So one can understand if market experts are a bit hesitant to hazard a prediction this year. But here is what is generally expected to happen in 2017: sales volume will dip below the record high levels of 2016 and price growth will slow down. From a predictive standpoint, it just makes sense, after all moderation has to set in sooner or later, right?
“Nonetheless, the forces that have produced the best multifamily market in recent memory remain largely in place,” said John Affleck, apartment research strategist for CoStar Group. In other words, the recent remarkable run in apartment demand and property values could just as well keep rolling.
The multifamily market continues to outperform other property sectors and has the lowest vacancy rate of all the major property types at 5.2% (as of the end of third quarter 2016.) In addition, also as of the third quarter, average rental rates experienced a 3.9% increase from 2015.
Aggressive pricing aside, the sector’s record of steady rent growth and high occupancy with low volatility continue to make apartment properties an ideal defensive asset as the economic cycle extends into a seventh year, Affleck said.
He concedes that some cracks are beginning to appear, however.
“The unprecedented propensity to rent, even among the most affluent, represents the chief risk to the cycle. Historically low-interest rates and homeownership costs that have risen more slowly than rents have already coaxed some renters toward owning.”
Affleck said the trend is expected to intensify, especially among higher-income renters who can qualify for mortgages, those who would otherwise rent the priciest apartments.
“The [latest 2016] data points to a maturing cycle for multifamily, particularly for the priciest markets and properties,” Affleck added.
Although the national vacancy rate for multifamily property is projected to increase to 5.6% in 2017 and to 5.7% in 2018, even at the expected peak that is still below the 15-year average vacancy rate of 6.1%, according to CoStar Group. Meanwhile rental rate growth is expected to moderate over the next two years to 2.3% in 2017 and 2.2% in 2018, but still above the 15-year average growth rate of 1.9%.
Freddie Mac is among those who are confident that the multifamily market is being driven by solid economic fundamentals rather than leverage and speculation.
“We believe the fundamentals the market tracks, including values and rents, appear likely to continue growing, albeit at a more moderate pace,” said David Brickman, executive vice president and head of multifamily business at Freddie Mac.
Several economic and demographic factors are driving demand, according to Freddie Mac. Renter households are poised to grow in every generational cohort due to a range of economic and demographic factors. Positive job growth and a stable economy should help more Millennials form households and enter the market.
In addition, the combination of sluggish income growth, rising home prices and higher mortgage rates will likely delay home buying by many Gen Xers and prolong their tenure as renters. Finally, a significant fraction of the nation’s 67 million aging Baby Boomers are poised to downsize into more easily managed rental units.
On the supply side, absorption rates and occupancy levels exceed their historic averages. Tightening conditions for construction lending, plus significantly rising construction costs are likely to slow the pace of new deliveries. This will help mitigate the risk of overbuilding and keep inventory levels tight in all but a few markets.
Take all the above in consideration, and apartment rents are likely to rise in most markets, Brickman said. The exception, he noted, are in a select few coastal markets where the “friction” between elevated rents and modest income growth and a relatively strong supply of new units, is expected to slow or flatten rent growth for the next year or two.
“Properties are being priced fairly in most markets,” Brickman said. “When we take these factors together with today’s generally strong economy, we project annual new multifamily originations to keep expanding, albeit at a more moderate pace.”
Fannie Mae also joined the consensus of those forecasting a bit of a slowdown in the pace of rent increases and a slow rise in vacancy levels over the next 12 to 24 months.
“Considering the remarkable strength that the nation’s multifamily markets have demonstrated over an extended period, this easing off should come as no surprise,” said Kim Betancourt, Fannie Mae’s director of economics.
But then she added, don’t expect the moderation to be long-term. Easing multifamily fundamentals lasting several quarters, or even a year or two, are to be expected in any typical business cycle.
In the short term, expect concessions to rise before apartment property owners decide to lower rents.
“Considering that rent concessions have declined steadily for nearly seven straight years, and that their current level is now below 1%, it is probably only a question of ‘when’ and not ‘if’ concessions begin to rise again,” Fannie’s Betancourt added.
The industry considers concession levels of 2% as reflecting aligned and in balance apartment supply and demand, Betancourt added.