By George Ratiu, Managing Director of Housing & Commercial Research, NAR
We find ourselves in the ninth year of economic expansion, with most indices pointing in an upward direction. According to the Expectations & Market Realities in Real Estate 2018 report, published by Deloitte, the National Association of REALTORS® and Situs RERC, most global economies toiled under sunnier skies over the past year, with about 75 percent of countries experiencing gains.
In the U.S., gross domestic product has been expanding steadily, boosted by a combination of higher consumer spending, rising business investments, and solid export activity. For consumers, the pace of job creation and wage growth spurred increased optimism, which led to higher spending. Employers added 2.2 million new jobs to payrolls during 2017, bringing the 2010-17 total number of new jobs to 17.8 million. The unemployment rate declined from 4.8 percent in January of 2017 to 4.1 percent by January of 2018. For perspective, the unemployment rate clocked at 9.8 percent in January 2010, not far from the Great Recession-high of 10.0 percent. Just as importantly, employment gains over this period have been broad-based, across most sectors.
The pace of economic gains was also reflected in the Federal Reserve’s monetary policy actions. The Federal Open Market Committee voted for three rate hikes during 2017, citing the low unemployment rate and signs of upward pressures on inflation. The Consumer Price Index (CPI) moved in a narrow range most of the year, around 2.0 percent, according to the Bureau of Labor Statistics. However, the cost of housing — both rent and owners’ equivalent rent, which comprise about a third of the CPI—advanced at a faster clip during 2017, averaging close to 3.5 percent. In addition, the Fed also moved toward further monetary tightening, when it announced in October of 2017 that it would commence divesting some of its $4.5 trillion in assets starting in 2018, by allowing maturing bonds to roll off its balance sheet without reinvesting the payments.
Commercial real estate matures
For commercial real estate fundamentals, the economic gains translated into solid demand for space. While the performance of each property sector offered more nuances in 2017, on balance, commercial markets recorded rising rents, placing cash flows at the center of shifting investor expectations.
This shift in investor expectations was a defining characteristic of the commercial real estate landscape in 2017. While the bifurcation in investment trends continued along valuation lines, with pricing reaching new highs and interest rates moving higher, investors refocused their strategies away from returns based on appreciation gains and cap rate compression, and toward cash-flow-centered returns.
The refocus was evident in transaction volumes and pricing. Investment volume in the large cap space closed 2017 with $463.9 billion in transactions, a seven percent decline from 2016, according to Real Capital Analytics (RCA). This marked the second year of sales declines. Sales volume declined in each of the four quarters, with the last one posting a 13 percent drop.
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