Is the U.S. Commercial Real Estate Sector Headed for a Slowdown?

The 2016 real estate market has been off to a volatile start. In the first part of 2016, a number of sources have advised caution for CRE investors, with predictions ranging from a plateauing of prices all the way to a bursting of a pricing bubble.
And true enough, commercial real estate prices have been on a spectacular rise for the past 5 years, up 93% on average since the 2010 market lows.  The continuing  wave of investment in commercial real estate investment has banks holding  outstanding CRE loans of $1.7 trillion in 2015, less than 3% off the all-time highs of 2009, after which a correction set in.

Here are some warning signs investors should keep in mind:

• One major lender, Morgan Stanley, believes U.S. commercial estate prices could be flat this year, despite earlier forecasts of 5% growth (which is still tame by earlier standards).
• U.S. industrial rent growth hit 9% last year, but is expected to decelerate in 2017 (still growing, but more slowly).
• At least one Federal Reserve regional president has shown worry that an unusually loose monetary policy has encouraged looser lending policies, unnaturally inflating market prices, and that a gradual increase in interest rates is necessary to keep prices down to earth.
• The market has not been equally kind to all areas. Major urban centers like New York, Chicago, Los Angeles, Boston, and Atlanta have seen price increases many times over those of the rest of the country. In the country as a whole, the commercial property price indexes have plateaued.
• Suburban office spaces have a vacancy rate of 18.3%, at least 5% higher than their urban counterparts. Even San Francisco, one of the country’s hottest office space markets is showing some hesitation.

Still there are a number of factors that are still working in the market’s favor:

• As millennials show their preference for urban areas, commercial real estate prices in those areas still have room to run, though many of the bargain deals are now gone.
• The unemployment rate, which is a reliable indicator of occupancy rates, is the lowest it has been in a decade, at 5%.
• Interest rates are still near record lows, encouraging investment. After the Federal Reserve raised interest rates for the first time in a decade last December, many thought that this would be the end of low rates. Instead, rates have been on a steady decline all year, reaching the lowest point they’ve been at in the past 3 years.
• Volatility in international markets, such as that in China, Russia, and Brazil, is driving more money into the U.S. real estate market, which is viewed favorably because of its relative stability.

Investors should be aware of challenges ahead of the CRE market (prices can’t keep rising at the same rate forever), but also not give in to market hysteria. No concrete evidence points to any drastic changes in CRE markets over the next 12 months.

In fact, it is worth considering that a temporary cooling of the commercial real estate market may not be an entirely bad thing. Prices have been on a nonstop increase for the better part of a decade, and a similar pace would be unsustainable in the long run. A plateauing of prices followed by more gradual increases is certainly more desirable than continued sharp appreciation followed by a hard correction.

Should investors have immediate worries? The current data doesn’t show evidence of a bubble or a drastic correction in sight, but, as always, investors should show caution and evaluate every deal on its own merit. Good deals are certainly harder to find in major urban markets now than they were in 2010, and investors should make sure not to loosen their standards and get carried away with property valuations.

Need help navigating the stormy seas of commercial real investment? As a trusted due diligence consultant, RMC Realty Advisors provides the necessary resources to critically evaluate real estate investments. Our expertise doesn’t only come from being able to find answers to critical questions—it’s knowing which questions to ask in the first place that can be crucial for the success of real estate investments.

Contact RMC Realty Advisors today to speak to a commercial real estate investment advisor you can trust.