Magazine article Mortgage Banking

Weather Eye

Magazine article Mortgage Banking

Weather Eye

Article excerpt

Market observers wonder just how long current sunny conditions will prevail over the commercial/multifamily real estate markets. Industry forecasts call for robust results well into 2016. Here's some of what else showed up on the radar.

Commercial real estate markets are ending 2015 in extraordinarily strong shape. Property incomes and property values are rising. Sales transactions and mortgage origination volumes are strong. Loan delinquencies are down. [paragraph] This is a time when many seasoned commercial real estate professionals--having lived through so many cycles--start peering for signs the market is reaching a top. Some investors are taking the opportunity to take cash off the table, while others are doubling down. [paragraph] Can the near-term forecast for commercial real estate possibly remain sunny? The answer appears to be a qualified "yes."

Property fundamentals

Property fundamentals are in the best shape they have been in years.

During 2015, multifamily vacancy rates hit lows not seen since the 1980s, with the Census Bureau recording an apartment vacancy rate of 7.9 percent in the second quarter and New York-based Reis Inc. calculating a rate of just 4.2 percent for professionally managed properties.

Vacancy rates for other major property types are not as tight as multifamily, but also have improved in the past five years. The vacancy rate for office properties dropped from 17.6 percent in 2010 to 16.5 percent in the third quarter of 2015, retail properties dropped from 11 percent to 10.1 percent and industrial properties dropped from 11.7 percent to 9 percent.

The stabilization of occupancy has prompted growth in rents. According to Reis, between third-quarter 2014 and third-quarter 2015, average asking rents increased 4.2 percent for apartment properties, 3.3 percent for office properties and 2 percent for retail properties.

So where do things go from here?

The classic story of the real estate cycle would indicate that as markets tighten, new construction activity picks up and the new supply begins to eat into occupancy and rent growth. That story appears to be playing out--but slowly.

Different property types are clearly at different points in the real estate cycle. The strength of the multifamily market has drawn heavy new development, with more units currently under construction than at any time since the mid-1970s. The value of multifamily construction put in place in September 2015 was 27 percent higher than a year earlier and 334 percent higher than its recession trough--and it set a new series high.

Meanwhile, other property types are still getting their legs under them. The value of office properties put in place in September rose 21 percent from a year earlier and 126 percent from its recession trough, but still stands 15 percent below its pre-recession level. The value of commercial properties put in place, which includes retail and warehouse, declined from a year earlier, and stands 83 percent above its recession low and 30 percent below its pre-recession level.

In terms of fundamentals, there still appears room to improve.

For most property types, vacancies can still decline and rents increase as the economy grows. Even for multifamily, tight market conditions mean that growth in rents is likely to offset forecast increases in national vacancy rates in coming quarters.

Cap rates

The improving property markets--and indications there is still room left to grow--have attracted investors like never before. As a result, it's hard to imagine the cap-rate picture getting any better, if by better one means lower.

On an absolute basis, investors have never accepted a lower yield for their investments in commercial and multifamily properties, with capitalization rates matching and/or beating all-time lows in recent quarters.

At the end of the third quarter of 2015, New York-based Real Capital Analytics Inc. …

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