As the market approaches the mid-year mark, EDR Insight’s Dianne Crocker and Jessica Doerner, Director of Market Research at Nova Consulting Group, collaborated on this Q&A with well-known economist Ryan Severino at Reis. This interview is based on Severino’s presentation at EDR’s Client Summit last month.
In this candid Q&A below, Severino shares his inside perspective on the state of the economy, the transactional climate and the health of the commercial real estate market coming off a slower-than-expected Q1. Read on and learn what you can expect to see in the second half of 2014 and why you may sleep better at night.
Dianne Crocker: Let’s start with the question on everyone’s mind. After such optimistic forecasts in January, why was the first quarter of 2014 so disappointing?
Ryan Severino: Clearly, the inclement winter weather had a lot to do with that. The winter probably knocked 1.5% to 2.0% off of GDP growth on an annualized basis. So without the unusually bad winter, growth likely would have still been positive. The good news is this is an ephemeral problem, and we have already seen the economy strengthening since the first quarter.
Jessica Doerner: Geographically, where do you see the strongest opportunities for growth in commercial real estate over the near term?
Severino: It depends on how you define growth and it differs by property sector, but if I had to generalize I would say the best opportunities for growth in the short-term are still in the technology and energy markets like San Francisco, San Jose, New York, Houston, etc.
Crocker: Thus far in the recovery multifamily has been the belle of the ball. Do you see this continuing? Anything that might cause work for this asset class to lose favor?
Severino: The situation is definitely changing in the apartment sector after four years of tremendous performance. The key issue for this sector going forward is supply growth. The strong fundamentals are serving as a catalyst for new construction activity…so much so that it seems unlikely that demand will be able to keep pace with new supply over, say, the next five years. Expect vacancies to slowly rise in many markets and rent growth to slow, a significant divergence from what we have observed over the last four years with plummeting vacancy rates and accelerating rent growth.
Doerner: There’s been a lot in the media lately about the impact of open office space on the overall market? Is it decreasing demand for space?
Severino: In short, no. The real culprit holding the office sector back is the lack of office-using employment. Open-plan office space is a red herring because while individual work spaces shrink in these formats, that space is simply being reallocated to common areas such as conference rooms, quiet room, coffee bars, even bathrooms.
Crocker: On the job growth front, are we seeing enough new creation to impact commercial real estate yet?
Severino: Not meaningfully; however, things are improving. Job growth is clearly accelerating and eventually that will translate into increased demand for space – office space for workers, industrial space for goods being sold to consumers, and retail goods in shopping centers. We are heading in the right direction, but we are not there yet.
Crocker: What are you seeing in the commercial mortgage backed securities sector? What’s different about that sector now versus 2006?
Severino: The key issue with CMBS is that competition is really heating up. We have already been observing a deterioration in underwriting standards, but the fear is that it could accelerate. Volumes over the next year or two, even at their most optimistic, are a fraction of what they were at the heights of the vertiginous boom years in 2006 and 2007. Yet, the number of organizations seeking to do securitizations is basically the same. Many of these are new entrants to the market who have invested significant dollars hiring staff and building the infrastructure to do this. They will not to be sitting idly after all of that investment, so that might mean getting somewhat aggressive to get deals done. This could cause the deterioration in underwriting that we have observed to accelerate.
Crocker: What would you tell professionals at property assessment firms who rely on a healthy commercial property transaction market and an active lending climate, and are worried that their 2014 forecasts might not pan out?
Severino: I would say do not be afraid, and certainly not of the headlines. The market is clearly in recovery. However, recoveries are never perfectly linear. There are always bumps in the road. Yet, the trend is clearly for improvement. There are few, if any, serious risks to the economy and the real estate market at the moment. Barring some sort of idiosyncratic shock, the economy should continue to grow, real estate fundamentals should continue to improve, debt origination volume will rise, and the transactions market will recover. Just do not be surprised if things do not always go according to plan. Economics does not work that way.
Crocker: What keeps you up at night? What worries you the most about the market’s future?
Severino: Watching Alien or Aliens at home by myself. As far as what worries me about the market, not too much right now. There are some weaknesses out there, such as the wobbly housing market, and there is always the risk from something truly idiosyncratic – geopolitical concerns, disasters and weather, etc., but this is most sanguine I have felt about the economy’s and market’s prospects since before the downturn.
About Ryan Severino
Ryan Severino is senior economist and associate director of research in the research and economics department at Reis. Prior to Reis, Ryan served in a number of research positions for investment management firms such Starwood Capital Group and Prudential Real Estate Investors. Additionally, Ryan is a professor of finance and economics at Columbia University and New York University. Ryan holds a master’s degree from Columbia University, a bachelor’s degree from Georgetown University, and is a CFA Charterholder.