Real estate, alternative real assets and other diversions

Real Estate Market Cycle Monitor – Fourth Quarter 2018 Analysis

The Professor

The Physical Market Cycle Analysis of 5 Property Types in 54 Metropolitan Statistical Areas (MSAs).

The 2018 economic expansion continued at a moderate pace with a slightly higher GDP growth rate than the past five years. Employment growth continued to increase at an average 200,000+ job increase per month. The Federal Reserve recently put their interest rate hikes on hold, with expectations of a cooling economy, and 10- year treasury rates dropped back below 3%, thus CRE debt costs remain moderate. All favorable trends for real estate. New supply growth is slowing in all property types with higher labor and construction costs.

Office occupancy increased 0.4% in 4Q18, and rents grew 0.3% for the quarter and 2.0% annually. Industrial occupancy was flat in 4Q18, and rents grew 2.4% for the quarter and 5.9% annually.

Apartment occupancy decreased 0.1% in 4Q18, and rents were flat for the quarter, but grew 3.1% annually. Retail occupancy increased 0.1% in 4Q18, and rents grew 0.1% for the quarter and 1.5% annually.

Hotel occupancy declined 0.1% in 4Q18, and room rates were flat for the quarter but grew 3.9% annually.

The National Property Type Cycle Locations graph shows relative positions of the sub-property types.

The cycle monitor analyzes occupancy movements in five property types in 54 MSAs. Market cycle analysis should enhance investment-decision capabilities for investors and operators. The five property type cycle charts summarize almost 300 individual models that analyze occupancy levels and rental growth rates to provide the foundation for long-term investment success. Commercial real estate markets are cyclical due to the lagged relationship between demand and supply for physical space. The long-term occupancy average is different for each market and each property type. Long-term occupancy average is a key factor in determining rental growth rates — a key factor that affects commercial real estate income and thus returns.

Rental growth rates can be characterized in different parts of the market cycle, as shown below.

Office

The national office market occupancy level increased 0.4% in 4Q18 and was up 0.6% year-over-year. Office demand continued to improve, as employment growth above 200,000 jobs per month created additional need in this moderately growing economy. New supply at a lower growth rate than demand helped to inch the national occupancy level higher. There were only five markets where occupancy increased enough to advance them one point in the cycle graph. Local “economic base” industries creating different demand growth levels, have spread cities across all points in the expansion phase of the cycle. Average national rents increased 0.3% in 4Q18 and produced a 2.0% increase year-over-year.

Note: The 11-largest office markets make up 50% of the total square footage of office space we monitor. Thus, the 11-largest office markets are in bold italic type to help distinguish how the weighted national average is affected.

Industrial

Markets that have moved since the previous quarter are now shown with a + or – symbol next to the market name and the number of positions the market has moved is also shown, i.e., +1, +2 or -1, -2. Markets do not always go through smooth forward-cycle movements and can regress or move backward in their cycle position when occupancy levels reverse their usual direction. This can happen when the marginal rate of change in demand increases (or declines) faster than originally estimated or if supply growth is stronger (or weaker) than originally estimated.

Industrial occupancies were flat in 4Q18 and increased 0.1% year-over-year as market demand and supply equilibrium continues. Industrial demand is highly competitive, and the national occupancy level is the highest in twenty years. Supply lagged demand by almost 30 million square feet in 2018. Peak equilibrium occupancy was maintained in almost all markets, with only San Diego having an occupancy decline that pushed it into the hyper-supply phase of the cycle. This strong level of occupancy is expected to continue for many years. Industrial national average rents increased 2.4% in 4Q18 and increased 5.9% year-over-year.

Note: The 12-largest industrial markets make up 50% of the total square footage of industrial space we monitor. Thus, the 12- largest industrial markets are in bold italic type to help distinguish how the weighted national average is affected.

Markets that have moved since the previous quarter are now shown with a + or – symbol next to the market name and the number of positions the market has moved is also shown, i.e., +1, +2 or -1, -2. Markets do not always go through smooth forward-cycle movements and can regress or move backward in their cycle position when occupancy levels reverse their usual direction. This can happen when the marginal rate of change in demand increases (or declines) faster than originally estimated or if supply growth is stronger (or weaker) than originally estimated.

Apartment

The national apartment occupancy average declined -0.1% in 4Q18 and improved 0.4% year-over-year. Demand growth was strong in 2018 as job growth averaged above 200,000 per month, the problem continues to be too much supply growth in many cities. With the Federal Reserve now on hold with future interest rate increases, the cost to finance apartments continues to be attractive, drawing developers to continue to produce more units. We do not expect supply to slow in the near future, lengthening the hypersupply phase. Average national apartment rent growth was flat in 4Q18 but national average rents increased 3.1% year-over-year.

Note: The 10-largest apartment markets make up 50% of the total square footage of multifamily space we monitor. Thus, the 10-largest apartment markets are in bold italic type to help distinguish how the weighted national average is affected.

Markets that have moved since the previous quarter are now shown with a + or – symbol next to the market name and the number of positions the market has moved is also shown, i.e., +1, +2 or -1, -2. Markets do not always go through smooth forward-cycle movements and can regress or move backward in their cycle position when occupancy levels reverse their usual direction. This can happen when the marginal rate of change in demand increases (or declines) faster than originally estimated or if supply growth is stronger (or weaker) than originally estimated.

Retail

Retail occupancies increased 0.1% in 4Q18 and were up 0.1% year-over-year. Retail demand continues to grow at a very moderate rate with older formats (department and general merchandise stores mainly) being replaced by experience retail (escape rooms, brew pubs and restaurants). In addition, a great deal of old retail space is being converted to office and apartment use, and a rapid retail space loss coming from conversions to “last mile” industrial warehouse storage use, (if local municipalities will allow the usage change). This means the amount of available retail space is declining, which allows surviving retail space to absorb what new demand comes along. National average retail rents increased 0.1% in 4Q18 and increased 1.5% year-over-year.






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