Calvin Schnure

Many analysts have noted that increasing construction and high prices on commercial properties often presage a downturn in the sector, and have asked whether this cycle may be approaching the 9^th inning. NAREIT research economists have examined data from several sources to shed further light on the risks that the sector may be approaching a correction.

Commercial mortgages are to the real estate market like rainfall is to a farmer. Too little rain and the crops dry up, but too much and floods can destroy the fields. In commercial real estate, too little credit and business is stifled, but too much debt can lead to speculation, overbuilding and defaults.

REITs delivered solid gains in operating results in 2015:Q4. Funds From Operations (FFO) of All Listed U.S. Equity REITs rose nearly 10% from a year ago, to $12.2 billion, and Net Operating Income (NOI) increased 13.2% over this period. Dividends paid by All Listed U.S. Equity REITs and Mortgage REITs increased 5.1% over 2014:Q4. Total dividends paid for the year as a whole increased to nearly $45 billion.

Strong and growing demand for commercial real estate in 2015 carried into the new year. Commercial property transactions totaled $139 billion in January, up 15.3% over January 2015. Indeed, the CRE market appears to have gained momentum recently, as total sales over the past three months were 22.2% above the prior three months.

The outlook for REITs and commercial real estate depends critically on sustained improvements in economic fundamentals. What are the risks that a recession is on the horizon?

The total return on listed Equity REITs since stock market volatility spiked higher last August is 500 bps higher than the total return on the S&P 500. Moreover, REITs performed better than seven of the 10 headline Sectors according to the S&P/MSCI Global Industry Classification System (GICS®)

Economic fundamentals for REITs and real estate continue to improve. GDP growth slowed in late 2015, but mainly reflecting a decline in energy exploration and in export markets; domestic sectors supporting real estate remain firm. 

The outlook for equity REITs’ operating performance in 2016 depends in many ways on the impact of rising interest rates. How much will higher interest payments affect earnings? How solid are REIT balance sheet positions? Will higher short-term rates cause any difficulties covering interest payments?

Total nonfarm employment rose 211,000 in November, following an upward-revised increase of 298,000 in October, showing a strengthening economy heading towards the end of the year. Labor market slack is much diminished from two or three years ago, with the unemployment rate unchanged at 5%.

The holiday shopping season is officially underway, with Black Friday for in-store sales and Cyber Monday for online purchases.  Sales during the holiday season are a critical factor in the outlook for the retail property sector. There are crosswinds in the outlook for retail properties, however, with continued but uneven macroeconomic growth, the near certainty of a rise in short-term interest rates and, especially, the growing share of e-commerce at the expense of bricks & mortar sales.