U.S. Macro Forecast: Measured Optimism Still on the Menu

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The FINANCIAL — Despite an intense domestic political environment, the U.S. economy and property markets will continue to perform well overall, but growing supply will cross paths this year with slowing demand for most asset classes, according to Cushman & Wakefield’s  latest U.S. Macro Forecast report.

The property markets track reasonably well with the broader economy. According to Cushman & Wakefield’s report, U.S. real GDP is already showing signs of accelerating in Q2 2017, and is expected to grow by 2.1% for all of 2017 and by 2.3% in 2018 – a marked improvement from the 1.6% growth rate registered in 2016. Global growth is also improving, and U.S. exports are at their strongest level in five years. Thus, macroeconomic conditions continue to remain highly favorable for the CRE sector. 

However, Cushman & Wakefield’s report also points out that fiscal policy is a significant wild card and continues to cloud the outlook. The Trump Administration has spotlighted several priorities that affect economic/CRE forecasts directly, including tax reform and/or cuts, deregulation, spending increases in certain areas such as defense and infrastructure and renegotiating trade agreements, 

“Given the current political atmosphere, predicting the future has seldom been more difficult,” said Kevin Thorpe, Cushman & Wakefield Global Chief Economist. “Fortunately the U.S. economy has significant tailwinds at its back right now. Consumer and business confidence remain high, job growth remains steadfast and healthy and wage growth is finally accelerating to the point where the virtuous cycle is within reach. Stakes are high, but our current assumption looks for policymakers to deliver just enough fiscal stimulus to keep the markets satisfied and the economy growing at a healthy clip.”

Cushman & Wakefield’s also provides forecasts for various commercial real estate sectors out to 2018.

U.S. Office Sector 

Developers of office product have remained quite disciplined throughout this cycle. Completions are roughly 25% lower than in the run-up to the Great Financial Crisis and 50% lower than after the Dotcom Crash. The office supply cycle will peak in 2017, and most new deliveries are in markets that need the space.

“Whether because of memories of the pain endured during the previous recession or because of a tighter lending environment, construction volumes, in the aggregate, have been much lower than in previous cycles,” Thorpe said. “Even factoring in the latest density trends, the U.S. is generally not overbuilding office product.  But there are certain spots that are overdoing it.”

Nearly 50% of the new office buildings are being developed in the top-10 construction markets. The bulk of new space is being added in the largest cities/metros (the Bay Area, New York and Dallas, for example) that arguably need it the most. Nevertheless, this wave of new space will challenge leasing fundamentals as it delivers at a time when broader job growth is decelerating.

“Certain pockets of Manhattan, for example, are already seeing concessions and TI’s push higher to help lease  available space,” Thorpe said. “But by and large, the Sunbelt markets and most other secondary/ tertiary markets are seeing measured construction levels, and in many cases, are under-building relative to job creation.”

U.S. Industrial Sector

Since 2013, more than 1 billion square feet of industrial inventory has been absorbed, averaging more than 250 million square feet (MSF) per year. As the structural shift towards 21st century spending habits persists, so, too, will demand for modern distribution product. Since 2000, eCommerce’s share of the retail pie has expanded from 0.8% in 2000 to 7.2% in 2016. It is expected to gain more share over the next five years, hitting 8.5% by 2021.

“In mapping the warehouse sector to the expected growth in online sales, the industrial sector will see one-fifth of newly generated absorption link directly to  eCommerce for the next several years,” said Rebecca Rockey, Cushman & Wakefield Head of Americas Forecasting. “Policy risks aside, the U.S. industrial sector is nearly a lock to continue to register very robust leasing fundamentals.”

U.S. Retail Sector

For retail, the translation of increased consumer spending into demand for mall and shopping center space has been frustratingly difficult. Neighborhood/community centers remain slightly immune to some of the downsizing or outright store closure that some major retailers are undergoing. The vacancy rate for this class has fallen by 40 bps over the last four quarters—from 8.4% in 2016Q1 to 8.0% in 2017Q1. Over the next two years, the overall vacancy rate for neighborhood/community centers is expected to rise from 8.0% in 2017 to 8.1% in 2018, but with both years combined only totaling 17.3 MSF of absorption.

Given the space coming available due to store closures, Cushman & Wakefield now anticipates average neighborhood/community asking rents to fall 5.4% this year, to $19.26 from $20.36 in 2016, and by 3.2% in 2018, to $18.64, before rebounding into positive territory in 2019.

“Despite some of the strong rhetoric classifying retail as dead, certain property types, and most assets with a viable location, are performing well enough,” said Garrick Brown, Cushman & Wakefield’s Retail Research Director. “It does appear that the shake-up in retail will be felt across most asset types, with malls feeling the greatest impact. Power Centers will be impacted by consolidation from the office-supplies and sporting-goods categories, but they have a strong tenant pool for space that is being given back thanks to the continued strong growth of off-price apparel players.”

Capital Markets

For U.S. capital markets, sales will register more than $449.1 billion in 2017, down roughly 10% from the $494.1 billion posted in 2016. Transaction volumes will decelerate further in 2018 to $437.0 billion with substantial interest remaining from foreign investors. Coming off of a two-year streak with more than half a trillion dollars in trades in both 2015 and 2016, this deceleration is partially a function of fewer assets being positioned for sale. In 2016, investment activity was 2.7% of nominal GDP, and this is expected to moderate as the cycle continues.

“Investing in a maturing cycle is always difficult, but the engines suggest there is still plenty of activity ahead,” Thorpe said. “Reflecting continued investor demand for CRE allocations, dry powder at closed-end funds targeting CRE assets is at an all-time high, supporting our outlook for healthy deal activity, but it will be slower.”

Bouts of uncertainty—both abroad and domestically—have not led to a capitulation on pricing, though growth in CRE values has tempered substantially. The broadest measure of CRE asset prices is the RCA/Moody’s CPPI Price Index for all property types, which grew at a 7.1% year-over-year rate in 2016, roughly half of its 2015 14.1% growth rate. This Index is forecast to rise by 6.6% in 2017 and by 2.3% in 2018. Of course, the outlook for prices is one reason why returns also are moderating over the next few years.

“The broad deceleration in returns hides considerable variation,” Rockey said. “Secondary markets have recently outperformed core markets on a price-return basis, closing some of the historically wide gap that accumulated during the cycle. Similarly, suburban office returns have accelerated and are beginning to close the gap relative to other asset classes.” 

“Industrial and retail assets continue to be impacted by the divergent effects of eCommerce, driving total retail returns lower while sustaining industrial returns – primarily through continued strong income, albeit decelerating from recent years’ trend resulting from extraordinary rent growth in many markets,” Rockey continued.

Concluded Thorpe, “All and all, upside risks more than offset the downside risks to our outlook. As we assess the future trajectory of the property markets, the positives comfortably outweigh the negatives. We may be entering into the final stage of the U.S. expansion, but that doesn’t mean the final stage can’t go for a lot longer.”


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