McCulloch: u201cTop-tier properties are enjoying the strongest demand.u201d

LOS ANGELES—December’s 2014 forecasts predicted significant economic expansion in 2014, but have the early months of the year lived up to investor expectations? At RealShare Los Angeles on March 25, industry experts on the Where We Are and Where Are We Headed panel will answer that question. Moderated by Faris Lee Investments’ president and CEO Rick Chichester, panel speakers Ethan Penner, founder of CBRE Capital Partners; Rene Circ, director of industrial research at CoStar Group; Andrew McCulloch, managing director at Green Street Advisors; and Jan Perry, interim head of the City of Los Angeles Economic and Workforce Development Department, will discuss where we are in the real estate clock and if we will reach the forecasted goals.

To get a sneak preview of the panel’s discussion, we sat down with McCulloch to find out his economic outlook and what he is itching to discuss on the panel. What are some of the major trends we should expect in 2014? 

Andrew McCulloch: Most investors predicted the US would experience meaningful economic expansion in ’14, but so far, the data has been disappointing. We agree with our new Fed Chair that the uptick in “soft data” can be partially attributed to the unduly cold weather.  Economic growth in ’14 should accelerate, and be strong enough to drive respectable demand for space in all property sectors.  Job growth has been unimpressive, but it’s been “good enough” to fill space, and with supply still limited in most sectors outside of apartments, this translates into pretty good operating fundamentals. Top-tier properties are enjoying the strongest demand, but demand in the middle rungs is improving. What are the major challenges to expect this year? 

McCulloch: Yellen has done a good job providing consistent language about Fed intentions, which combined with the recent suspension of the nation’s debt ceiling until March of ’15, has had a calming effect on the bond market (Treasury rates were virtually unchanged in February). That said, the continued unwinding of QE remains a big risk and the market is likely to remain hypersensitive to any change in course in the economy. With plausible explanations for the recent economic weakness, and a decent February jobs number, the Fed is likely to stay its course—closing out its asset purchase program by the end of the year.

eCommerce and anchor obsolescence will also remain very topical in real estate circles.  A sea change is occurring in consumer behavior, and eCommerce has, and will, continue to capture market share and be a substantial drag on brick and mortar retail sales growth.  High-end retail properties are likely to adapt and thrive, but the risk of obsolescence in lower quality assets is increasing.

New supply is also going to become an increasing risk. It is unlikely to derail fundamentals in most sectors in ‘14 (outside of certain apartment markets like DC), but development pipelines are ramping. What are some of the key points you hope to make or you think are really important to discuss on the panel? 

McCulloch: Commercial real estate values have continued to inch higher despite last year’s pop in interest rates. While cap rates have flat-lined since last summer, healthy NOI growth across property sectors is putting upward pressure on asset values. Green Street’s Commercial Property Price Forecast—which combines signals from the bond and REITs markets—calls for private-market values to continue to drift higher over the next 6 months.  The increasingly bullish signal from the high-yield bond market has been especially notable.

Another key point, is that the market seems to be overly myopic on the direction of interest rates and its resulting impact on commercial property values—but is paying far too little attention on why rates are rising.  If higher real rates are the cause for higher interest rates, then watch out, as this will be bad for asset values.  But, if an improved economy begins to drive inflation higher and that is the reason behind higher rates, then commercial real estate should do OK as operators will be able to charge higher rents. What sectors are performing the strongest?

McCulloch: Operating fundamentals will be solid in every sector in ’14, but performance across sectors is converging. Slow-to-recover sectors like industrial, strips, and office are gaining momentum, while growth is slowing for apartments and malls. At the market level, tech and energy hubs such as the Bay Area, Seattle, and Houston are going to have another good year and will likely be leaders when it comes to rent growth. That said, some of the housing bust markets such as Atlanta, the Florida markets, and California’s Inland Empire should see meaningful improvements in operating fundamentals as the US housing market continues to recover.