Real Estate Capital Scoreboard® – February, 2019

Chicago, Illinois, February 1, 2019 – With the government shutdown temporarily settled, the capital markets refocus on trade wars and economic growth for gauging interest rate control by the Fed.  In the first meeting of this year, the Fed agreed to exercise caution, keeping rates unchanged and causing overall indices to drop to the same levels as the end of last year.  The Fed policy may change course should GDP growth approach year’s three-percent level.

The net result of the Fed’s actions may be a five-percent-benchmark mortgage rate as the new low-rate norm – treading levels not seen in over a decade.  These rates will dampen home-ownership affordability, but should help sustain demand for rental housing and related commercial real estate property types.

Even as rates moved upwards during the past two years, mortgage pricing still stays historically attractive as compared to the most recent recession.  Nevertheless, investors absorb less favorable debt and leverage, ultimately trickling down to lower property values. Owners, now more than ever, feel the pressure to maximize cash flow in the face of such market factors as follows:

Limited Income Growth:  Most CRE sectors are operating at peak performance levels based upon nearly a decade of growth.  Not much room for upside, as new supply saturates inventory in select areas and property sectors.  Owners compete by offering “more for less”.  Expect capitalization rate to move upward by as much as fifty basis points, and prime overall yields to rise to the double-digit range for all but the highest-quality institutional assets.

Climbing Expenses:  Expenses are catching up to income.  Rising rents and values of the past few years, definitely have not escaped notice of governmental taxing bodies.  Municipalities are raising real estate taxes to record levels.  Additionally, rapidly escalating property insurance rates follow close behind due to mounting losses from recent catastrophes (e.g., California wildfires).  Rising management and employee costs also surface, as owners desperately seek [and try to retain] talent in a fiercely competitive job market.  Alternatively, “smart” building designs dampen rising expenses through efficient energy management.

The Real Estate Capital Institute’s® director, John Oharenko, suggests, “Finally, the tide is turning from a strong seller’s market to more ‘normal’ equilibrium.  Cash flow is king.  Owners with extremely strong management and operations teams should win big in this volatile market.”

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