While the US economy seems on its way to reaching a record 10 years of expansion, more signs are pointing to a possible downturn in the next year or so.
That’s according to economic data and investor sentiment revealed in a survey conducted 1Q 2019 by Situs RERC, which released its Flash Report in early April. The report provides a preliminary look at institutional investment conditions, required cap and yield rates and other investment criteria based on the survey results.
While the average real estate yield was unchanged from 4Q 2018, both Moody’s Baa and Moody’s Aaa decreased from 4Q 2018 to 1Q 2019, causing the spreads between real estate yields and corporate yields to widen. As of February 2019, the 10-year Treasury rate was 2.7%, down from the 4Q 2018 average of 3.0%. That continued the downward trend that began in October 2018; the February 2019 rate was the lowest monthly average since January 2018.
More subtypes showed a decline in investment conditions than an increase from 4Q 2018 to 1Q 2019. Investors seem to be becoming more hesitant amid fears that the nearly record-long economic expansion will end soon. The industrial warehouse subtype continued to garner the highest rating in investment conditions among all property types by far. Investment conditions improved in both of industrial’s other subtypes (R&D and flex) from last quarter as well.
CBD office recorded the largest decrease from 4Q 2018 to 1Q 2019 and was the only subtype that moved from above average to below average investment conditions. Regional mall continued to hold the lowest rating among all subtypes surveyed, driven by the continued trepidation in this sector.
Preliminary data show a surge in the hotel investment conditions rating in 1Q 2019. Respondents gave hotel a rating that surpassed apartment, and came in second only to warehouse. The largest increases were seen in hotel and all the industrial subtypes, while a small increase was noted in student housing.
Although the required internal rate of return (IRR) shifted among the property types, the overall average yield for all property types was unchanged compared to last quarter. Experts agreed that hotel and R&D IRRs experienced the largest declines from 4Q 2018 to 1Q 2018 – 40 basis points (bps) and 30 bps, respectively. CBD office had the largest increase from 4Q 2018 to 1Q 2019, rising 30 bps.
Cap rate sentiment continues to be mixed among the property types; however, on average, the overall CRE going-in rate increased only 10 bps, and the overall terminal rate remained unchanged from 4Q 2018 to 1Q 2019. Apartment registered the lowest going-in cap rate of all property types for the third consecutive quarter, while also experiencing the lowest terminal cap rate in preliminary 1Q 2019 results, indicating continued investor enthusiasm in the sector. Average expense growth was steady from 4Q 2018 levels.
The trends noted in the survey come amid further signs of overall economic weakness. These signs include a reduction in the projected growth rate in the US gross domestic product in 2019 from 2.3% to 2.1%; inflation remaining below the Fed’s target rate of 2.0%; and fears the emergence of emergence of inverted yield curves, which in the past has been an accurate predictor of a recession within 18 months. After raising short-term interest rates four times in 2018, the Fed is taking a dovish stance, signaling that it won’t raise rates this year and is planning only one increase in 2020. The Fed also said it would end its balance-sheet runoff by September.
Our final data will be published in the upcoming 1Q 2019 Situs RERC Real Estate Report, set for release at the end of May. Our report is the nation’s longest-running real estate research report offering investment criteria and investor insights on all the major markets and property types.
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