Investors Dial Back Transactions Amid Murky Policy Outlook
Investors scale back activity as the market recalibrates to higher interest rates and awaits clarity on government policy. The November election sparked a rapid rise in interest rates and introduced a wide range of prospective reform initiatives. Proposed changes to tax, fiscal, and regulatory policies raise a variety of questions that will continue to influence investor decisions. During the first two months of 2017, early estimates place commercial real estate transactions down by 20 to 25 percent compared with the same period last year. This comes on the heels of an estimated 15 percent decline in the fourth quarter. Though the pause is significant, sales last year were near record levels. As greater clarity on the range of economic, tax and fiscal policy changes emerges, investor activity will likely recover.
Private investor transactions peaked in 2015, and then tapered modestly last year. Sales of commercial real estate properties between $1 and $10 million hit their highest level on record in 2015 with 44,600 closed transactions, up 26.9 percent from their pre-recession peak set in 2006. Volatility of the financial market in the beginning of 2016, with questions arising from the contentious election, reined in sales slightly over the course of last year, but the rapid postelection surge in interest rates sparked a significant 15 percent slowdown in sales in the fourth quarter. The private investor segment remains particularly sensitive to tax and policy changes.
Lull In Activity Opens Window of Opportunity
While some investors have stepped back from the market to assess the implications of potential policy changes, many buyers are seeking to capitalize on the reduced competition for assets. The outlook for continued economic momentum, including accelerating wage growth and steady job creation, remain strong drivers of asset performance. At the same time, restrained development in all but apartment properties will help the sector sustain positive fundamentals. Though interest rates have risen since the election, rates still remain low by historical standards. Many investors are locking in the current rates as the Federal Reserve has signaled steady monetary normalization over the course of the year.
Pricing Stabilizes as Supply and Demand Post Favorable Metrics
Pricing and yields have remained remarkably steady despite ease of transaction velocity. Buyers looking for large discounts are facing sellers who are generally benefiting from elevated occupancies and a lack of distress. Balanced debt levels and limited development this cycle have helped sustain market equilibrium. Another key ingredient has been steady economic momentum that has offered a tailwind to space demand drivers for commercial real estate, pressuring vacancy rates. Apartment, retail, and industrial properties achieved their tightest year-end vacancy level in 16 years, while office properties set a seven-year low.
Elevated Space Demand Reinforces Fundamentals; 2017 Likely to Offer Steady Rent Growth
Against the backdrop of higher long-term interest rates and an evolving economic landscape, U.S. commercial property sectors are performing well. A steady decline in vacancy rates for the major property types has been a hallmark of the current cycle, while overdevelopment has thus far been largely averted. The 2017 economic outlook points to strong support of another positive year for apartment, retail, industrial and office fundamentals, but uncertainty surrounding government policies and global markets has encouraged investors to become increasingly tactical in their decisions.
Rising wages will lift discretionary income and, together with elevated consumer confidence, spur spending that will support demand for retail space. Although the sector faces challenging headlines spurred by the downfall of Sears, Kmart, J.C. Penney and other retailers, neighborhood retail centers have performed exceptionally well. Expanding grocery stores, restaurants and service-based businesses that cannot be supplanted by e-commerce have filled retail centers and pushed vacancy rates to their lowest levels since 2000. Tight construction levels will also be a significant factor as just 50 million square feet come online in 2017, about one-third of average pace completions seen in themid-2000s.