There are conflicting predictions out there for a certain sector of real estate right now, and it’s important for our investment strategies that we get to the bottom of it.
According to the National Association of Realtor’s quarterly commercial real estate forecast, the commercial market is going to be strong in 2017. In fact, that group is predicting that GDP growth in the commercial sector will be “around 2.4 percent,” citing higher wages and increased spending as the foundation for this expansion.
NAR’s Chief Economist, Lawrence Yun said, “Renewed corporate optimism leading to a focus on investment and a desperately needed boost in residential construction should pave the way for modest expansion this year of around 2.4 percent in GDP growth.” He added that “Steady hiring and low local unemployment levels are finally supporting higher wages and increased spending, which in turn bodes well for sustained demand for all commercial property types.”
But last month, the Federal Reserve said that commercial property prices are presently a “growing concern.” They based this on data showing that $90 billion dollars in commercial loans are expected to reset this year. These are loans that originated in 2007 when lending guidelines were lax and a lot of “newbie” real estate investors took on huge amounts of commercial debt because they believed that the commercial market couldn’t fail.
According to Morningstar data, half of that $90 billion may face refinancing roadblocks., which means there could be a commercial real estate tsunami waiting in the wings.
If you are invested in commercial real estate and have a balloon payment coming due, be aware of this issue. It would be prudent to start looking at your options and develop multiple backup plans. And… if you are looking for commercial investments, then there could some opportunities coming later this year…
But let’s get back to this discrepency between what the National Association of Realtors predicts and what the Federal Reserve fears.
Commercial real estate actually includes a number of diverse types of properties. There’s office space, which is rented by businesses and depends a great deal on businesses expanding or upgrading their offices. Retail space, which is rented by stores and restaurants and depends heavily on consumer spending. Industrial space which is often used for warehouses, and multifamily space, which generally is apartment complexes of 5 units and more.
Medical and healthcare developments are sometimes lumped in with retail and sometimes with office, but they’re such big players in the commercial market today that they really should really have their own separate label.
So when we hear “commercial real estate will be strong,” the very first question we should be asking is, “Which part?” One sector could easily thrive while another does not due to different economic factors.
For example, multi-family properties boomed in the wake of the housing meltdown as people who lost their homes to foreclosure and moved back into apartments. But retail suffered as fewer people were able to spend money.
While NAR predicted that the commercial sector would be strong, they actually broke it down like this:
They predict office and retail vacancies will drop, and they expect multifamily to remain unchanged at 6.5%. Their “biggest concern” is inventory shortages, which would drive prices and rents up.
Not surprisingly, Marcus and Millichap report that private capital is increasingly interested in medical offices, driving cap rates down for those assets. However, the company said, “on-campus medical office buildings command premium cap rates, trading at sub-6% initial yields for single-tenant properties, while multi-tenant buildings draw first-year returns in the mid-6 to low-7% range.”
So to summarize, real estate is multi-faceted. There are many types of residential properties and many types of commercial properties. One sector may thrive while another nosedives.
As investors, we need to pay close attention to demographic shifts, economic trends, migration patterns and city redevelopment plans. All of these changes will affect real estate values in both commercial and residential real estate.
The main difference between these two sectors today is that residential loans have been solid over the past decade, while commercial loans are just now showing some signs of weakness.
With every challenge comes opportunity. In this case, investors who know how to capitalize on bad debt can profit – especially when the underlying asset is valuable. This is exactly how we were able to pick up some incredible land deals back in 2010.
We expect to see similar type bargains coming soon – but in the commercial property sector. If you’d like to be among the first to know about those, join the network to get on the VIP investor list.
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