Trotter: CRE's Momentum Rolls On

NORWALK, CT—At a recent meeting the leadership of GE Capital Real Estate had with some of North America's leading real estate investors and commercial mortgage bankers, the consensus was that fundamentals have rarely been better. As evidence, consider that the recovery is becoming more widespread, pricing has exceeded the 2007 peaks in gateway markets and new supply continues to come on line at a slower pace than historical norms in most asset types and markets. Against that backdrop, GlobeSt.com recently spoke with Brad Trotter, GE Capital Real Estate's North America President, for his view on the outlook for 2015.

GlobeSt.com: The tone of the country has changed in 12 months. The lingering uncertainty seems to have evaporated. How do you see that translate to commercial real estate in terms of fundamentals?

Brad Trotter:  In 2014, general economic recovery gained momentum throughout the US and bolstered real estate markets, especially in gateway cities and surrounding suburban areas.  We expect that momentum to accelerate in 2015.  I think we'll see greater foreign investment in the US commercial real estate market, especially given the relative economic strength and volatility in other parts of the world. The attractive yields in secondary markets will direct this investor capital more broadly within the US. This will translate into more broad-based improvement in fundamentals and pricing.

GlobeSt.com: In terms of investment targets, assuming a recovery raises all boats, how does real estate hold up compared to other investment opportunities?

Trotter: At present, real estate is a more attractive investment alternative than stocks and bonds.  Achievable yields of 5-6% are on par with more volatile stock investments and far more lucrative than treasuries, trading at 1.8% or corporate bonds, yielding 3-4. You've got strong returns and rents are sticky, so the yield off of the assets is stickier. When you transact and get capital growth, that's going to help as well. Interest rates remain low and lending spreads continue to tighten. All those things lead to better free cash flow off the assets, so it's an attractive investment class and one that I think will outperform. And you're in a space where a lot of lenders and investors have yet to fill up their allocations. There's still demand to put money out the door and into the real estate market.

GlobeSt.com: We can't have a conversation about the investment outlook without talking about interest rates, cap rates and bid-ask spreads.  What do you see for 2015?

Trotter: At the moment, the spreads between cap rates and the 10-year have widened, due to the fall of the 10-year. Now, we're in the part of the yearly cycle where everyone's re-upping allocations and figuring out where they're going to invest, and that works its way into the math. So given the attractiveness of real estate and increase in investor capital, we are likely to see cap rates continue to compress. As long as interest rates remain low, even if cap rates tick back up a bit, given spreads remain healthily above the long term average, the impact should be relatively minor. We're not in a state of irrational exuberance around real estate. We're still making good risk-adjusted decisions; you're not seeing a lot of leverage around individual transactions. There's a lot of money and a lot of pent-up demand for real estate, and that's what we're seeing transact.

GlobeSt.com: We have heard much lately about the influx of foreign capital, with foreign players such as Germany and China investing heavily here. As prices rise here, do you expect that to continue?

Trotter: If the pension funds and sovereign funds could, they would put out over $1 trillion into global real estate, the US being one of the best places to do that right now. The private equity funds and institutional funds have nearly a quarter of a trillion dollars that needs to go to work. We're going to continue to see a lot of money flowing into the US market. Given where interest rates are right now, the cost of keeping that cash is a real opportunity cost to simply be sitting on the money versus putting it to work. I don't think we're going to see a lot of change there.

Now, will some of the oil-based pension funds change their outlook, as the price of oil works into their cash flows? Maybe. It really comes down to what kind of reserves they have. Does this redouble their efforts to put that money to work and diversify away from oil? Potentially. They're very rich funds, so I don't think we should get too concerned about that.

GlobeSt.com: In what is really a very positive investment environment, what concerns you, and what could derail the momentum?

Trotter: The geopolitical environment is probably the riskier part of the outlook. And there will always be externalities that you can't manage your business by, but just have to prepare for.

GlobeSt.com: Assume for a second that you and I meet a year from now for a year-end 2015 wrap-up. What will be the 2015 real estate headline?

Trotter: For the US, it will be much more capital flow, moving from core markets into suburban markets. You're going to see more transaction activity in secondary markets. I think we'll have healthy overall transaction volume and broader improvement in real estate fundamentals. The lending market will be more competitive, CMBS will continue to grow and lending spreads will tighten further. We're optimistic about real estate and we're anticipating strong growth for GE Capital Real Estate's lending business.