Economists Predict “Little Likelihood of a CRE Downturn in 2015”

Property assessment professionals responsible for forecasting business related to commercial real estate transactions can take solace in the fact that with the market closing in on the end of the first quarter, conditions are steady and holding their own. Even better, leading real estate economists see little cause for concern for the rest of the year.

Recent market updates universally reflect a positive view overall for property markets this year. “There is little likelihood of a commercial real estate downturn in 2015,” predicted Bob O’Brien, Deloitte’s Global Real Estate Sector Leader. Gradual recovery continues, with the expectation for slow to modest growth through the remaining three quarters of the year. Here’s a snapshot of what economists are predicting for the near-term.

1. Robust growth across all property types.

Investment in all of the major asset classes year-on-year paints a picture of percentage growth in the teens or higher (based on dollar volume). Notably, multifamily volume appears to be leveling off, an inevitable development given the intensely robust growth of the past few years. For the latest outlook by asset class, Deloitte’s research indicates that office is starting to look like the brightest star:

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In addition to shifting sands among property types is much higher investment by foreign investors in the U.S. market. “Transaction volume is recovering, and the ongoing recovery in the economy will only help,” Ryan Severino, Senior Economist and Director of Research at Reis, noted in a recent client update. “Also, Chinese capital is beginning to make waves that we’ve never seen before in U.S. commercial real estate.”

2. Early signs of weaker underwriting.

The good news is that total commercial property investment is close to its mid-2006 levels leading up to the Great Recession. The not-so-good news is underwriting standards are starting to loosen a bit. During a recent Deloitte webinar, more than 2,000 attendees were asked to share their thoughts on risk tolerance, and responses were very much in line with EDR Insight’s fall surveys of commercial real estate lenders. The majority clustered around “same standards” with some starting to witness “capital expanding out to riskier positions.” (The minority, or 11%, cited “tighter standards and less availability of capital.”)

“We are at an inflection point where underwriting is loosening up, and that’s more important to watch than pricing and rent growth. We don’t see aggressive underwriting, but we are seeing a loosening.”
Ken Riggs, President, Real Estate Research Corporation (RERC)

3. Don’t expect strong origination growth.

In capital markets, conditions are starting to look more and more like the days of 2005 and 2006. Banks are lending more on commercial properties, but not aggressively. There is also a fair amount of disparity by bank size. For instance, RERC reported that debt originations increased for regional banks last year, but declined for national banks and insurance companies. In 2014, the Mortgage Bankers Association estimates that outstanding debt for commercial and multifamily mortgages increased by seven percent, and a similar growth rate is expected for 2015 slowing to four to five percent in 2016.

Look for rising demand for environmental due diligence as the next wave of loan maturities hits. It is worth noting that the fate of these soon-to-be-maturing loans is certainly looking better than it was a few years ago, but many are loans for “zombie” properties that could face an uphill battle getting refinanced.

4. Wide disparity in metro performance.

Demand is rising in all major property types and most major markets, but “there is wide disparity in metro-level performance,” according to Paul Briggs, Vice President and Head of U.S. Research with Bentall Kennedy. “Secondary and tertiary markets are seeing significant inflows of capital.”

Top 10 markets like Houston, San Francisco, San Jose, San Diego and New York City are losing their appeal given their limited room for further growth. This means smaller markets with growth potential are drawing investor interest.

In general, those that are outperforming the market tend to have above-average employment growth (an Austin vs. a Las Vegas) and are being fueled by a specific driver, like the energy boom in Dallas and Houston. This trend is supported by output from EDR’s ScoreKeeper model. Among secondary/tertiary commercial real estate markets, strongest growth in Phase I ESA activity last year was found in the ten metros shown in the accompanying table. Secondary markets likely to continue to see strong growth include areas like Seattle, which is seeing a lot of new supply due to good job creation, especially from companies like Amazon that are building new space there. Briggs noted that “Tech companies like LinkedIn, Salesforce and Google are worried they won’t have space where they want to be hiring, and are snapping up real estate now in hot areas.”

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Here’s what you can expect

Property assessment professionals hoping for a healthy pipeline of deal-making this year can be reasonably optimistic. Based on the latest forecasts from real estate economists, we are looking at a near term characterized by these conditions:

  • Transaction volume remaining on the mend, but not accelerating very quickly over the near term.
  • Likewise, moderate growth in new originations. While reports of loosened underwriting are concerning, new bank regulations and other investment requirements are expected to prevent another credit crisis from occurring.
  • Pricing about to peak for quality properties in primary markets, especially coastal ones, driving activity to secondary and ter¬tiary markets.
  • Favorable low interest rate environment (with high probability of increase over the next few years).

“2015 will be one of the strongest years we’ve seen in commercial real estate since the credit crisis and it’s for all the right reasons.” Ken Riggs, RERC

“Optimism is highest it’s been since the downturn.” Ryan Severino, Reis

Watch for ScoreKeeper 1Q15 Results

First quarter data from EDR’s ScoreKeeper model will be released in early April, and what it will likely show is slow, steady improvement in the market overall and the continued strength of secondary and tertiary metros referenced by the economists in the brief above. For the latest stats, register for our free 1Q15 Client Market Update on Thursday, April 2 at 1 pm.

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