Commercial real estate in all major sectors will continue to improve but the prospect of short-term interest rates going up as the Federal Reserve seeks to tighten credit could complicate market growth in the year ahead.
NAR Chief Economist Lawrence Yun told Realtors® at the commercial real estate outlook yesterday at the 2015 Realtors® Conference & Expo in San Diego. He said that vacancy rates in the major commercial market sectors—office, retail, manufacturing, hotel, and multifamily housing—are likely to continuing declining in 2016, even as new projects come on line to expand capacity.
He’s forecasting vacancy rates in the office sector to drop to 15.6 percent this year from 16 percent last year, and to further improve to 15 percent in 2016. In the industrial sector, vacancies will end the year at 11.7 percent, down from 12 percent, and drop further to 8.8 percent in 2016. In retail, vacancies will end 2015 at 13.2 percent, compared to 13.8 percent last year, and will drop to 12 percent next year. And in the multifamily sector, which has seen big growth in the last several years as tight credit conditions make it hard for young households to buy, vacancies are expected to stabilize at 7.1 percent, this year and next year
Action by the Federal Reserve to tighten monetary policy by raising short-term interest rates, either in December or January, and then to continue tightening throughout 2016, creates unknowns for commercial markets. But Yun pointed out that higher financing rates won’t necessarily follow the Fed tightening, because many factors other than what happens to short-term rates can influence the direction of interest rates.
Against continued strengthening of the commercial sector, some analysts are asking about the formation of an asset bubble gaining strength similar to the one that brought down markets half a dozen years earlier. But that is unlikely, said Jim Costello, senior vice president of Real Capital Analytics, who also spoke at the forum.
Among other things, properties today are far more conservatively underwritten then they were before the last downturn and there remains a confortable spread between cap rates and financing costs, he said.
One potential threat to commercial markets could come out of Washington, and that’s the curbing or elimination of 1031 tax-deferred exchanges to help reduce the federal budget deficit. Although it’s only informal talk at this point, NAR would be concerned if proposals were to be taken up in legislation next year, because the tax provision plays an important role in many commercial transactions, including small transactions that are the bread-and-butter of NAR’s commercial members.