U.S. INVESTMENT OUTLOOK

Transcription

1 Econometric Advisors U.S. INVESTMENT OUTLOOK Q U.S. INVESTMENT

2 REMAINING IMPACT OF FISCAL BOOST TO KEEP 2019 OUTLOOK STRONG JOB GAINS TO MODERATE AND WAGES TO GAIN AS LABOR MARKET TIGHTENS STRONG CONSUMER AND GOVERNMENT SPENDING DROVE GDP GROWTH IN Q3; OCTOBER JOB GAINS BEAT EXPECTATIONS WHILE WAGE GAINS SURPASSED 3% Consumer spending continues to be the primary driver of the current economic expansion. A spurt of government spending also fueled growth during the quarter. However, Q3 also bore the negative imprint of President Trump s trade wars, with exports dropping sharply as imports surged despite higher tariffs. Also, corporate investment s contribution has waned over the course of 2018, the tax reform notwithstanding. The October jobs report showed solid gains across all economic sectors. Average monthly job gains for 2018 stood at a solid 213,000. The unemployment rate remains at its lowest levels in nearly two generations. The tax reform will continue to act as a stimulus, but job growth will likely moderate, as the economy is operating near capacity. Wage growth stepped up to 3.1% in October its fastest pace of increase since April, Although this was significantly improved over earlier periods of the expansion, wage gains are still not historically commensurate with the current level of unemployment, nor have they kept pace with consumer spending over the past three quarters. A HEALTHY ECONOMIC OUTLOOK FOR 2019, WITH A SLOWDOWN BY MID-2020 Our baseline GDP outlook for 2018, 2019 and 2020 has been revised upward. The remaining impact of the fiscal boost, the capital spending cycle, early signs of wage growth and high consumer confidence will drive a more moderate growth in 2019 than they did in Rising interest rates will weigh on business and consumer activity by late By H2 2020, we expect the economy to slow in reaction to higher interest rates, equity market corrections and credit market problems, with some shrinkage in employment. The slowdown will be relatively mild and short. We expect one additional rate hike this year, with the possibility of three in 2019, if wage growth and inflation surge. 2 Q U.S. INVESTMENT OUTLOOK

3 Q BASELINE SCENARIO* SOLID GDP GROWTH IN 2018 AND 2019 AND A MILD RECESSION BEGINNING AT THE END OF 2020 In 2018, a tight labor market and fiscal stimulus raise inflationary pressure; inflation reaches 2.3% by the end of The Federal Reserve approaches inflation hawkishly, steadily raising the Federal Funds Rate. Long-term interest rates adjust to the Fed s rate hikes and the 10-year Treasury yield settles around 3.1% by the end of Rising interest rates choke economic growth, causing GDP to decline in The Federal Reserve uses moderate easing, causing the 10-year Treasury to decline to 2.1% by GDP growth resumes in 2022 and Treasury yields begin to increase, reaching 2.5% by 2022 and slowly trending up to 2.9% by * Our two scenarios are designed to capture a range of possible outcomes for the U.S. economy and CRE investment performance. We do not assign specific probabilities to either scenario. Scenarios serve as a guide to (rather than a formal predictor of) the possible outcomes for investment performance in CRE. 3 Q U.S. INVESTMENT OUTLOOK

4 Q HIGH INTEREST RATES SCENARIO* WELL-IMPLEMENTED TAX REFORM AND FISCAL STIMULUS BOOST THE U.S. ECONOMY, EXTENDING THE CURRENT EXPANSION GDP growth reaches 3.4% at the end of Resurgent economic activity stimulates inflation, which reaches 3.1% by Economic activity increases demand for CRE and boosts NOI growth. The Federal Reserve engages in monetary tightening; the 10-year Treasury reaches 4.3% by 2019 and moderates to 3.1% by the end of 2020 as economic growth slows. GDP growth declines to 1.8% by the end of The 10-Year Treasury reaches 2.9% by 2025 and remains around 3.0% over the long term. * Our two scenarios are designed to capture a range of possible outcomes for the U.S. economy and CRE investment performance. We do not assign specific probabilities to either scenario. Scenarios serve as a guide to (rather than a formal predictor of) the possible outcomes for investment performance in CRE. 4 Q U.S. INVESTMENT OUTLOOK

5 END OF CAP RATE COMPRESSION NCREIF NPI Cap Rates: Baseline (solid) vs. High Interest Rates (dashed) NCREIF Cap Rate, Treasury Yield (%) Forecast Retail Apartment Industrial Office 10 Yr T-Bond Sources: NCREIF, CBRE Econometric Advisors, Q Baseline As we have experienced over the past two years, a rising interest rate environment puts upward pressure on cap rates as the cost of capital rises. So far, however, this pressure has been negated by decline in cap rate-to-interest rate spreads. As risk premiums spike during the economic slowdown we forecast for H2 2020, cap rates should increase accordingly. High Interest Rates Cap rate compression for offices and apartments continues until Meanwhile, retail and industrial cap rates are flat, despite bond yield increases. In 2021, cap rates trend upward as NOI growth starts to slow. 5 Q U.S. INVESTMENT OUTLOOK

6 SPREAD CONTINUE TO TREND DOWN Spread over 10-Year Treasury Yield, NCREIF NPI Cap Rates: Baseline (solid) vs. High Interest Rates (dashed) Spreads (%) (1) Retail Apartment Industrial Office Sources: NCREIF, CBRE Econometric Advisors, Q Forecast Spreads between cap rates and the 10-year Treasury yield have been trending down since Baseline Spreads are expected continue narrowing until mid 2020, and then to widen significantly in the end of 2020 due to the anticipated economic downturn. As the economy subsequently recovers, spreads trend upward toward their long-run equilibria. High Interest Rates Expectations for strong growth pressure cap rates downward to pre-recessionary levels until As growth slows, spreads trend toward their long-run average. 6 Q U.S. INVESTMENT OUTLOOK

7 SLOW NOI GROWTH AND RISE OF CAP RATES IMPACT VALUES NCREIF NPI Appreciation Returns: Baseline (solid) vs. High Interest Rates (dashed) (5) (10) (15) (20) (25) (30) NCREIF Appreciation Return, % YoY Forecast Baseline Slower growth in NOI and higher cap rates lead to decline in asset value growth. As the economy returns to growth ( ), interest rates are expected to rise, putting upward pressure on cap rates. This creates potential for asset value decline over the next 3-4 years. High Interest Rates Asset value growth is higher than under the baseline scenario due to higher economic growth, but also begins a downward trend in Retail Apartment Industrial Office Asset value growth (appreciation returns) may dip into negative territory, due to economic slowdown. Sources: NCREIF, CBRE Econometric Advisors, Q Q U.S. INVESTMENT OUTLOOK

8 ASSET VALUE DYNAMICS DOMINATE TOTAL RETURNS NCREIF NPI Total Returns: Baseline (solid) vs. High Interest Rates (dashed) NCREIF Total Return, % YoY Forecast Total returns follow dynamics generally similar to those of appreciation returns, with income returns providing some moderation under both scenarios. Baseline 0 (10) (20) Total returns stay positive, dropping to zero (APT, RTL) or to slightly negative levels (OFC, IND) during (longer for OFC), as negative appreciation returns adversely affect total returns. High Interest Rates (30) Retail Apartment Industrial Office Following a period of robust performance, total returns trend down with office, industrial and retail turning negative in 2022, mainly due to negative appreciation returns. Sources: NCREIF, CBRE Econometric Advisors, Q Q U.S. INVESTMENT OUTLOOK

9 INVESTMENT OUTLOOK In 2019, cap rates are most likely to remain stable; some markets may start to see slight increase during the year, while many others continue to enjoy historically low levels. Rising bond yields and cyclical high corporate debt levels add complexity for real estate investment, as investors expect to reevaluate their portfolios return-to-risk. Rising cap rates temporarily halt asset value growth until the economy gets back on firm footing. Negative dynamics in appreciation returns lower total returns. Under both scenarios, asset values eventually stabilize and return to growth. Even with the temporary adjustment in value, CRE is poised to generate solid income returns, making it an attractive investment. Anticipated by investors, cap rates upward movement in the coming years may cause more caution; however, commercial real estate has so far shown its resilience, and the sheer volume of debt and equity capital available for real estate transactions should mitigate the impact. 9 Q U.S. INVESTMENT OUTLOOK

10 Jing Ren Economist Alex Krasikov Economist Copyright (C) 2018, CBRE Econometric Advisors (CBRE EA). All rights reserved. Metropolitan employment forecasts are copyrighted by Moody s Economy.com. Sources of information utilized in this report include CBRE, CoStar, Moody s Economy.com, and CBRE EA. The information presented has been obtained from sources believed to be reliable but its accuracy, and that of the opinions and forecasts based thereon, is not guaranteed. All opinions, assumptions and estimates constitute CBRE EA s judgment as of the date of the release and are subject to change without notice. The information and material contained within this product is for informational purposes only and is not intended as an offer or solicitation for the purchase or sale of a security or real estate assets. This product does not take into account the investment objectives or financial situation of any particular person or institution. CBRE EA holds all right, title and interest in this product and the proprietary information contained therein. This product is licensed to the Licensee for use in the ordinary course of the Licensee s ordinary business, subject to the restrictions set forth herein. Unless otherwise agreed to in writing by CBRE EA, Licensee shall not provide this product to, or permit their use by or for, any third party, including, without limitation, any parent, subsidiary, affiliated entity or franchisee of Licensee. Licensee agrees to hold this product and all proprietary information contained therein in strict confidence and further agrees not to sell, sublease or disseminate this product including, but not limited to, computer readable data files, either in whole or in part, without the prior written consent of CBRE EA. Licensee agrees to acknowledge CBRE EA in any reports, presentations or any other materials produced by Licensee using this product as the source of the data in which such report, representation or other material is based. CBRE EA hereby represents that it will use commercially reasonable efforts to deliver the scope of services free from any defects in design, materials and workmanship, and free of viruses as such terms are understood in the computer industry.