Still Crazy (Strong) After All These Years

Our 2017 Capital Flows Year-end Review and 2018 Outlook addresses how vibrant the commercial real estate industry remains, in terms of property market fundamentals and capital markets, nearly nine years since the Great Recession ended. Occupancies and rents across most property sectors and both sales and leasing transaction levels remain at historically high levels, while assets in many markets command record pricing.

If there’s a notable weakness, it’s the pullback in cross-border capital flowing into the U.S. The pullback is accounted for by China and reflects not waning investor interest, but rather, mandates by Chinese regulators. With Chinese authorities continuing to pressure Chinese firms to refrain from offshore investing and even divesting from current holding, the impact on U.S. capital markets are material, particularly for trophy assets in leading markets.

Still, U.S. markets retain their appeal for both domestic and cross-border capital due to its compelling returns and relative security, which will limit near-term downside risks to the U.S. capital markets.

Key takeaways from this report include:

  • Overall U.S. transaction volumes in 2017 fell 7% from a year ago, after dropping 9% the prior year. While sales volumes remain robust by historical standards, sales have fallen from their peak in 2015, with year-over-year volumes declining in seven of the past eight quarters.
  • Entity purchases continue to account for a disproportionate share of the recent sales declines, while individual property transactions have been relatively stable.
  • The industrial property sector continues its star turn as the only major property sector to register sales gains in 2017. Both industrial and multifamily properties continue to maintain larger shares of transactions than they have historically, while office, hotel and especially retail all account for smaller shares than before.
  • Cross-border flows into U.S. property markets continued to decline last year after dropping significantly in 2016. However, China alone essentially accounted for all of the decline last year.
  • The decline in sales by foreign investors far exceeds those by domestic investors, but foreign investors remain net buyers of assets—buying more than they sell—in contrast to most types of domestic investors, who are net sellers.
  • 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.
  • Average prices per square foot fell in the second half of 2017 for most property types, as income growth is slowing and capitalization (cap) rates are flattening or rising. With investors opting for less expensive assets, falling average prices also reflect lower asset quality.
  • U.S. commercial real estate remains a compelling investment option for both domestic and offshore investors, which is likely to keep property capital markets strong. While Q1 2018 GDP is likely to disappoint, continuing a pattern of weak first quarter growth, economic growth is forecast to strengthen this year, supporting property fundamentals. Nonetheless, rising interest rates and rising tensions with our trading partners will act as an increasing headwind this year.