The slowdown in U.S. commercial property markets that began last year has continued into the first half of 2017, though activity picked up during the second quarter and transactions levels remain relatively robust by historical standards.
After peaking in Q4 2015, year-over-year transaction volumes have declined in five of the last six quarters, including Q1 and Q2 this year. However, the rate of decline has been falling, perhaps suggesting markets are stabilizing.
More encouraging for investors and landlords is that price appreciation has renewed after some market weakness this winter. Price gains have been broad-based across most sectors, particularly in the major markets. Nonetheless, pricing per square foot has been flat to falling in some sectors, reflecting the inferior quality of buildings being offered for sale. But prices for assets of a given quality — and especially trophy assets — are pushing further into record territory, even if the investor pool is shrinking.
The news of the summer was China’s announcement that offshore investment will receive greater scrutiny from Beijing, likely sharply reducing direct acquisitions from Chinese entities, particularly for big-dollar properties. But impacts from any Chinese pullback are likely to be relatively limited and focused on a few key markets (especially New York), and overall demand for U.S. property remains robust.
- Overall transaction volumes for the first half of 2017 (1H 2017) are down 19% from 2H 2016 and down 7% from a year ago (1H 2016). While these are meaningful declines, the rate of decrease has been falling in the last two quarters. Indeed, volumes gained modestly in Q2, up 4% since Q1.
- Investment capital flows remain robust by historical standards. Sales volumes are on pace to log the third greatest annual total since the recession.
- Portfolio and entity purchases continue to account for a disproportionate share of the recent sales declines, while individual property transactions have been relatively stable.
- Office and industrial buildings account for larger shares of all transactions than they did a year ago, while retail and especially multifamily transactions have decreased.
- Investment momentum continues to shift from primary into secondary markets, and from CBDs into inner suburban submarkets, particularly for offices and apartments, as both foreign and domestic investors eschew premium pricing in the top markets.
- Private Investors were once again the dominant buyers of U.S. property in 1H 2017 and increased their share of acquisitions, while foreign and institutional shares declined. Taking dispositions into account as well, foreign entities, REITs and private sources of capital were all net buyers in the first half of 2017, while institutional investors and owner/users were once again net sellers.
- Despite the slowdown in sales activity this year, pricing remains strong and most sectors saw increased values per square foot in 1H 2017 over 2H 2016 and a year ago. Appreciation was particularly strong in Q2 2017, reversing several quarters of moderate gains. In general, appreciation was greater in the primary markets, especially for office and industrial properties, while multifamily and especially retail property prices lagged.
- The relative strength and stability of the U.S. economy and ultralow interest rates will continue to make real estate a compelling option for investors, which is likely to keep property capital markets strong, attracting offshore capital to our markets.
What to Expect in Late 2017
U.S. property transaction volumes are continuing to trend down this year, while price appreciation generally remains moderate, consistent with our conclusion that we are nearing the end of this real estate markets cycle. While property markets seem to have peaked for this cycle, they are by no means crashing, or even falling. Transaction levels remain relatively robust by historical standards while prices continue to edge further into peak territory, particularly in major markets.
The increase in leasing and sales transactions during the second quarter was encouraging and likely reflected the improvement in GDP and job growth this spring. But absent significant changes in policy directions from Washington that would recharge economic growth, we anticipate the recent slowing trends in the property markets to continue. Consensus economic forecasts call for continued moderate growth during the rest of this year and into 2018, providing little additional fuel for space absorption or rent growth.
On the other hand, the fed is unlikely to raise rates again more than once this year, if at all. This should keep interest rates down and financing expenses relatively affordable for funding new acquisitions. Moreover, risk-adjusted rates of return for U.S. real estate remain attractive for domestic and foreign investors alike, which will keep attracting more capital to the sector.
Finally, concerns about the Chinese pullback are likely to be relatively isolated to a few markets, as investors from other countries are stepping up to acquire. The exception may be for trophy assets, where Chinese investors had been emerging as the top bidders in many transactions. Pricing for these assets may be less aggressive without Chinese buyers.
Andrew provides thought leadership about commercial real estate, capital markets, financial investment and related sectors. He’s held a variety of leadership roles in both the public and private sectors.
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