Fall 2014 Commercial Real Estate Review

On a national scale, money from both equity and lending sources are pumping more liquidity into commercial real estate market.  Equity capital has come from local investors, 1031s, REITs, private equity, and sovereign wealth funds.  Commercial mortgages, which dropped over 10% during the credit crisis, reached a new high in mid-2014.  Credit unions and banks have picked up more fixed and floating rate loans, Commercial Mortgage Backed Security volume is strong; insurance and government sponsored agency lenders are active as well as mezzanine funds.

This reflects a positive outlook for CRE and an economy that has been strengthening has supported the momentum.  New additional hiring has passed the number of jobs lost during the recession while the number of people underemployed or leaving the work force have tempered growth and allowed the Fed to hold rates steady.  The job gains have been matched with very limited income growth.  But in many ways, the slow growth has been good for CRE performance.  The incremental growth has kept construction from roaring back during a recovery cycle, as is often typical.  This has prevented over-building and is pushing up values and lowering cap rates.

Apartments are the overall star among property types.  Demographics are favorable for more apartment demand as the growing echo-boomer generation is set to expand by 2.1 million over the next six years.  This could support demand for another 1.4 million apartment units.  The recent poor economy has also pushed 3.3 million echo boomers living with family.  As job creation accelerates, many of these young adults will have no choice but to move into apartments with high levels of student debt keeping them from house ownership.  In some areas of the Dakotas, new apartments cannot be brought on line fast enough.

Vacancy rates on a national basis dropped to 4.4%.  Rents have risen and are now 18% higher than the dip in 2010. Developers have taken notice and another 238,000 units are expected to come on line in 2014, the highest level recorded.  National average cap rates for high quality apartments have dropped below 6%.

Retail has been a slower performer with needs-based anchored centers with national retailers outperforming local retailer centers.  Retail sales have averaged a 4.3% annual growth since the recession, which is in line with long term averages.  Typically, retail space will change as retail sales change.  But space and sales will not track exactly in tandem in the future as more people gravitate to on-line shopping.  A small amount of new supply has come on line in 2014 quarter 2, representing only ½% of the national total retail space.  Prices per square foot have reached new highs at around $180/sf and cap rates have hit new lows at around 7%.  Even with this performance, there are still vacant retail spaces in various markets. 

Office hiring has increased demand for office locations on a national basis.  It is estimated another 2 million office jobs will be created in 2014-15 and much of the vacated space left from corporate layoffs will begin to be filled.  New office space coming on line is at historic lows.  The national office vacancy rate stands at 15.6%, currently, and may only drop another 30 bps by the end of the year. 

Industrial space demand is strong with much coming from the e-commerce sector and other demand from housing, auto sales, and international trade.  Nearly 380 million sf will be absorbed in 2013-14.  This pushed the vacancy rate down to 7.1%.  Cap rates tend to be tightening across the industrial space sector with warehouses making the largest gains. 

The expansion of the US economy is also creating a growth in hotel room demand.  National occupancy has risen 220 bps to 66%.  Higher group demand accounts for some of the growth as hotels recorded another 2.1 million additional group rooms in the first half of 2014 compared to the same period in the prior year.  Supply growth has stayed slow with available rooms up only 0.8% from last year.  Spending on hotel construction has not been at the same level as it was during the peak of the last building surge and is now expected to even out.

With the increase in demand outpacing supply, hotel operators are enjoying a 4.4% rise in average daily rates for the first eight months of 2014.  The increase in both occupancy and ADR has risen revenue per available room (RevPAR) by 8%.  RevPAR growth is continuing to pick up with nearly half of the nation’s largest 25 markets experiencing double digit gains this year. 

These trends are on a national basis and the local market are that you operate in may, or may not, track with the national trends.  It is important to understand the factors in your area as you judge the market conditions for the existing and new loan requests you have.