"It's Too Early to Batten Down the Hatches"

CHICAGO—With unemployment near a 50-year low and more job openings than there are unemployed people to fill them, the US economy is healthy. Fiscal stimulus and positive momentum will sustain real estate absorption and there will be solid growth throughout the remainder of this year and likely into next year. Limited by rising construction costs and labor shortages, supply should remain manageable and with vacancy rates already low, this environment should generate healthy rent growth, according to a recent report by DWS Group.

“The underlying fundamentals of the real estate market remain healthy. Therefore, our view is that it is too early to batten down the hatches, shunning growth oriented sectors, markets, and assets that can thrive amid strong fundamentals,” said Todd Henderson, Head of Real Estate for the Americas at DWS.

According to the report, rising short-term interest rates will limit cap rates and slow down investment returns. Cyclical risks also appear to be increasing as the yield curve is flattening thus raising the specter of an inversion (long-term interest rates falling below short-term rates) which is historically a reliable indication of a recession.

This, however, does not mean that a downturn is imminent as recessions usually appear 18-24 months after a yield-curve inversion, and the curve remains positively sloped, albeit mildly. However, it does imply that the cycle is in its later stages, Henderson tells GlobeSt.com.

The report also includes how various factors of the commercial real estate marketplace will fare.

Apartments

With primarily new luxury, urban apartments coming onto the market, supply has pushed vacancies and NOIs higher. Homeownership has also increased as aging millennials have now entered the housing market although there is still a demand for apartments. With the amount of construction currently underway, supply will remain elevated through 2019. Henderson and his team expects that financial imperatives, including mortgage rates, rising home prices plus the capping of federal housing tax benefits will sustain rental demand despite shifting demographics. Finally, markets facing less near-term supply pressure and markets with strong population growth such as Florida and Phoenix, Arizona will continue to outperform.

Office

“Performance is expected to continue with modest growth,” says Henderson. “Owners are now realizing substantial NOI gains as they roll leases signed five or 10 years ago to today’s higher market rates. However, we are more cautious over the medium term for several reasons including constraints on future job creation amid low unemployment, the ongoing densification of corporate space usage, an aging workforce, and more restrictive immigration policies.” Even so, several dynamic markets, including Los Angeles, Seattle, and Austin, will continue to outperform.

Retail

As eCommerce continues to dominate the landscape, retail is kept afloat by strong consumer fundamentals and service-oriented retailing, says the report. Although malls may struggle a bit, neighborhood and community centers, whose tenant mix features more in-demand services such as dining, health care, and fitness, produced decent returns. DWS’s report believes that well-located neighborhood and community centers, with a diverse tenant mix, will continue to fare reasonably well, and can provide income and downside protection to a portfolio.

Industrial

The industrial sector has established a wide lead over other sectors. The strength of the industrial market is difficult to overstate, as of the third quarter, the vacancy rate for core industrial properties was 3.4%, its lowest level on record and well below its 30-year, 8.4% average, according to the report. NOI growth has also accelerated to a record 8.5%.

“The industrial sector, particularly in locations with significant supply constraints and located proximate to large population bases, is projected to outperform the other major sectors,” observes Henderson. “The combination of traditional industrial demand coupled with the structural shift in demand due to eCommerce and customers expectations for delivery create NOI growth dynamics that should propel the industrial sector to outperformance over the next three years.”