Chicago, Illinois, January 1, 2020 – Last year closed as a milestone period for the US economy. The stock market hit new record highs, experiencing the best gains since 2013. The Fed dropped interest rates three times during the year and decided to keep rates unchanged at the most recent meeting. Furthermore, unemployment levels witnessed fifty-year lows. Most investors’ biggest fears rest upon worrying about how long economic conditions continue into the new year and beyond.
All worries aside, pundits find many signs of optimism for 2020, with real estate capital markets sharing the euphoria characterized by a low-rate investment environment facing ongoing yield compression.
More Low Rates: The downward rate trend continues, despite trade wars, labor shortages, and inflationary pressures. Far too much capital chases too few goods. Very limited investment options force both real estate debt and equity investors to tolerate low yields. Also, more global capital floods the US, both for safety and yield. For example, during the past month five-year, and ten-year Treasury notes barely nudged higher less than ten basis points.
Yield Compression: Core, core-plus, value-add, and opportunistic investment real estate returns endure yield compression. Two hundred basis points represent typical yield differentials between various investment categories. Core investments in gateway markets attract pricing below 5%, while core-plus ventures experience mid-single-digit returns. Value-add projects target lower-teen returns. Only opportunistic deals offer any substantial yield premiums, as new-construction and substantial redevelopment ventures require higher-priced risk capital, especially so late in the economic cycle. And for Class-A properties in prime urban versus suburban locations, narrower pricing differentials exist, in some cases only fifty basis points (e.g., multifamily). Lower funding costs combined with rising construction and operating costs pinch profitability. Scarce new supply barely disturbs property supply-demand equilibrium in most markets.
Mr. John Oharenko of The Real Estate Capital Institute, adds, “the new decade brings in the enduring prosperity of the previous decade, with no immediate end in sight.”