The CRE Industry Has Concerns

Real Estate Roundtable CEO Jeff DeBoer

WASHINGTON, DC—It should come as little surprise that respondents to The Real Estate Roundtable’s quarterly sentiment index are worried. They are worried about global economic weakness. They are worried about financial market volatility. Plunging oil prices. Regulations emanating from Dodd-Frank and Basel III that could well dry up liquidity. And as always, Congress can’t seem to give it a rest. The latest proposal that is ringing alarm bells in the industry is one offered up by President Obama and Sen. Bernie Sanders (I-VT) to limit “like-kind” (Section 1031) exchanges. The after-glow of the inclusion of FIRPTA in the budget deal last December only lasted so long. A Dramatic Drop All of this is the backdrop to dramatic quarter over quarter drop in the Real Estate Roundtable’s sentiment index. The Overall Sentiment Index slid from 57 to 50 in Q1. Since late 2014,  the index has posted a 20-point decline. The Current-Conditions Index posted a 32 point decline over the same five quarters. The Future-Conditions Index is now at 45 points, down from 52 in the previous quarter and down 20 points since the Q4-2014 Survey. The survey is not completely pessimistic. Respondents did point to the overall strength of the US commercial real estate markets, according to Roundtable CEO and President Jeffrey D. DeBoer. There is the “steadily improving job creation across the economy” and the US’ role as safe haven in turbulent times, he said. The general equilibrium between supply and demand, and the overall strength of debt and equity capital availability also registered as positives, DeBoer said. It is possible that the concerns voiced in the survey were due to the time period in which it was conducted: the data was gathered in January by Chicago-based FPL Associates on The Roundtable’s behalf. A Tough Crowd But probably not. Anyone who lasts at least one cycle in the CRE sector tends to have an unvarnished view of what is happening in the industry and economy and is unlikely to be swayed by topical events — unless those events are part of a larger, more permanent trend. The sentiment survey, DoBoer has told GlobeSt.com in an earlier interview, tends to be spot on in terms of highlighting trends that then materialize. As one respondent said: “It remains to be seen whether we’ll face a recession this year, though it’s looking more like 2018.” Other comments had similarly realistic assessments of the environment.

All you have to do is look at the volatility index, especially on the public side, to see the uncertainty that’s been caused by growth fears in China and the perception of growth fears in the US,” said one.  “We’re trending to a negative bias right now because of that volatility.

And another, regarding the global and US economy:

On one hand, obviously the US economy is doing better than most other parts of the world. The challenge for all of us is beginning the process of letting interest rates find their independent level after they have been artificially controlled by Fed for so long. Since we don’t have a good sense of how to price things, it’s hard to know what premiums should be for different asset classes.

Capital continues to flow into the industry, was the general observation. The nuanced commentary about the shifts in these flows was very telling.

Stronger real estate fundamentals and capital investments are flowing more broadly into secondary markets… It used to be a tale of six markets where everyone else was lagging. Today you’ve still got the top six or so, but the next 15 have improved dramatically.

And

There has been a dearth of new supply since construction costs continue to rise in most markets. There are very few markets with construction starts ahead of 1% of inventory which is historically low… will be more redevelopment and repositioning of assets.

There wasn’t as much consensus about the direction of asset values, however.

It feels like asset values are peaking with cap rates so low and interest rates picking up. Will total returns outpace rental growth in 2016? It’s hard to imagine cap rates compressing further, so we’re going to have to drive returns through NOI growth.

And another:

I see asset values as flat to down over the next 12 months. Valuations have been sentiment driven, and central banks are less powerful today than they were last time around. My worry is that when sentiment changes, we won’t have enough within monetary policy to fix the issue, and nobody’s been able to enact fiscal policy.

But then this person said that:

Though we’ve seen some flattening of the increase, I think asset values will slightly appreciate by the end of the year. Residential asset values in particular will continue trending upwards over the next 2-4 quarters notwithstanding some type of correction.”

Stay tuned. The next Sentiment Survey covering Q2 2016 will be released in early May.