Is the Runway Running Out? by Kenneth McBride, McBride Capital
At a recent conference in Los Angeles, we sat down with some of the nation’s largest lenders and investors in commercial real estate. Not surprisingly, everyone wanted to discuss the seemingly never-ending economic recovery, and how much time remains in the current cycle. The length of the current cycle has many worried that the glory days may be coming to an end, but their worries are primarily based on the cycle length, and not the fundamentals of the market.
Demand is outpacing supply
It gets worn out, but real estate may be the best example of the relationship between supply and demand. It was estimated that 350,000 new units need to be delivered nationally each year to satisfy demand. This year roughly 300,000 units will enter the market, leaving a 50,000 shortfall. There are many causes for the lack of equilibrium. However, much of it can be attributed to the labor shortage. Hardest hit were markets such as Houston where natural disasters occurred earlier this year. Additionally, developers are having a harder time making proformas work with the increased cost of labor, supplies, SDC charges, and bearing the impact of rent control. The lack of supply will keep an upward pressure on rents for non-rent controlled units.
Low Interest Rates & Low Inflation
Another sign that would point to an economic slowdown would be the rise of interest rates and inflation. We entered 2017 with the 10-year treasury at 2.45% after an abrupt increase in November due to the election. The Fed has raised the benchmark interest rate twice, unemployment is hitting all-time lows, the 10year treasury has settled at 2.30% and everyone is left wondering when inflation will join the party? For now, a low interest rate environment and low inflation will keep things moving in the right direction.
Migration patterns will help Portland
Institutional investors are shifting their market strategy. Current trends show significant domestic out-migration from the six largest metropolitan areas, which has investors slightly more bearish in these markets. They are much more bullish on the next 30 largest MSA’s, which
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are experiencing the largest domestic in-migration. These markets boast diversified economies, strong job growth and more favorable cap rates. If we can house the newcomers, they should continue to look to Portland for the foreseeable future, keeping gas in the tank for multifamily real estate.
Returns will be tempered
Over the past seven years we’ve experienced a significant increase in rents, coupled with depressed cap rates. The resulting returns have made this one of the strongest cycles of all time. While there is no cliff in sight, many investors are preparing for the slowdown that will inevitably come. The trend on the institutional side is to secure properties with lower leverage to take advantage of better pricing and shield their assets from potential vacancy over the next five years as the onslaught of new product comes on-line.
Consensus
The consensus among investors and lenders is that rents and valuations will continue to increase, but at a decreasing rate over the next two to three years. While all those who survived the last downturn may already be bracing themselves, the next downturn is expected to be shallower with a quicker recovery. We are always available to discuss options available for your property that take advantage of opportunities to reduce the interest rate and/or provide advantageous terms. Ken McBride is the President and CEO of McBride Capital and can be reached by phone at (503) 624-5800 or via e-mail at ken@mcbridecapital.com.