FLASH REPORT. valuation rates and metrics

Transcription

1 4Q 2017 FLASH REPORT valuation rates and metrics

2 LETTER FROM THE PRESIDENT January 2018 Happy New Year! What a wild ride 2017 has been! Despite one political brouhaha after another, the financial and capital markets remained strong. The Dow continued its historic rise that began in the first part of February Though nowhere close to historical averages, the 10-year Treasury shrugged off its 2016 malaise, posting some of the highest rates in the past three years. Despite the rising interest rates, spreads between Situs RERC required pre-tax yield rates and the 10-year Treasury exhibited low volatility over 2017 (near historical averages), signifying the relative stability of CRE as an asset class. In addition, the widening spreads between the real estate yield and corporate bonds demonstrates the strength of CRE relative to similar securities, as seen in this report. But it appears that our predictions about the end of cap rate compression may be finally coming to fruition. As seen in this report, our preliminary Situs RERC required going-in and terminal cap rates increased slightly for most property types compared to our 3Q 2017 rates. The slight increase in overall rates makes sense; the strength of the economy and anticipated inflation, the likelihood of increasing short- and long-term interest rates and the historical low cap rate environment are likely serving as a catalyst for the cap rate increases. You will notice a new and improved look to our 4Q 2017 Situs RERC Flash Report. However, this report still contains the same trusted data and insight on which you have come to rely. As always, we note that Situs RERC Flash Report presents only a preliminary look at our fourth-quarter institutional investment survey data and reflects only the information drawn from surveys received to date. As additional investment survey data continue to come in, they will be integrated with current data and reported in the 4Q 2017 Situs RERC Real Estate Report. We want to send a special thank you to our survey respondents, without whom this research would not be possible. We appreciate your time and effort in trying to make CRE market data as transparent as possible. We wish everyone a happy new year as we eagerly await what 2018 has in store. Sincerely, Ken Riggs President Situs RERC riggs@rerc.com

3 SITUS RERC REQUIRED REAL ESTATE YIELDS VIS-A-VIS CAPITAL MARKET RETURNS Preliminary data show that real estate yields increased slightly in 4Q Conversely, Moody s Baa and Aaa corporate bond yields declined compared to the last quarter, leading to increasing yield spreads. The 10-year Treasury increased 20 bps on a quarterly basis, lowering the spread between the real estate yield and the Treasury yield. While corporate profits increased in the recent quarter, corporate credit quality has been trending downward as corporations have taken advantage of low interest rates and have increased their leverage. The widening spreads between the real estate yield and corporate bonds demonstrates the strength of CRE relative to similar securities. 4Q Q Q Q Q Q 2013 Real Estate Yield (%) Moody's Baa Corporate (%) Moody's Aaa Corporate (%) Year Treasurys (%) Yield Spread ( Percentage Points) Moody's Baa Corporate (%) Moody's Aaa Corporate (%) Year Treasurys (%) Sources Situs RERC Investment Survey, Federal Reserve, Moody's, 4Q Percent Sources Situs RERC Investment Survey, Federal Reserve, Moody's, 4Q SITUS RERC 10-YEAR TREASURY FORECAST The Fed is expected to raise rates two or three times in 2018 to try to stay ahead of any inflation that a tight labor market and rising wages might generate. While long-term rates typically escalate following short-term rate hikes, this has been tempered by persistently low inflation. Over the next two years, however, Situs RERC is forecasting a moderate increase in the 10-year Treasury rate, due to a pickup in inflation and an expected deficit increase that will accompany the recently enacted tax cuts. Our base case scenario has the Treasury rate reaching nearly 3% by the end of 2018, compared to 2.4% in 4Q Percent Readings displayed are quarterly averages. Shaded area indicates forecast. Sources Federal Reserve, compiled and forecast by Situs RERC,4Q 2017.

4 RETURN VS. RISK AND VALUE VS. PRICE RATINGS 4Q 2017 Return vs. risk ratings declined for a second consecutive quarter as survey respondents indicated that risk is now exceeding returns in the overall CRE market. Hotel was perceived as the riskiest sector (relative to returns) in the fourth quarter. Because the hotel sector is closely tied to economic performance, the sector suffered from the effects of hurricanes and political turmoil in 4Q The sector is also working through a large amount of supply, which is driving down returns. Value vs. price ratings also declined for overall CRE, with 4Q 2017 ratings signifying the CRE market is overpriced. The industrial sector was the only property type in which prices were supported by values; all other sectors were considered overpriced. Industrial was also the only sector in which investors believed returns outweighed risk. This is not surprising as e-commerce continues to be a boon to the sector. Reflective of headwinds facing the retail sector, its value vs. price rating was the lowest since the Great Recession. Ratings are based on a scale of 1 to 10, with 10 suggesting that return greatly outweighs risk or value greatly outweighs price. Source Situs RERC Investment Survey, 4Q 2017, preliminary data. EXPECTED LEASING ASSUMPTIONS, MARKETING & HOLDING, AND INVESTMENT RECOMMENDATIONS 4Q 2017 Renewal Probability (%) Time to Release (months) Vacancy Loss 1 (%) Marketing Time (months) Holding Period (years) Buy (%) Sell (%) Hold (%) Office - CBD Office - Suburban Industrial - Warehouse Industrial - R&D Industrial - Flex Retail - Regional Mall Retail - Power Center Retail - Neighborhood Apartment Student Housing Hotel N/A N/A N/A All Types The retail sector remains the most volatile going into 2018, with high-street retail and groceryanchored centers continuing to perform well, while traditional strip centers and some big-box retailers face strong headwinds. As mentioned previously, while some big-box retailers are thriving in the current retail landscape, many traditional strip centers and big-box retailers remain outdated. We also might see a future rent correction for high-street retail in expensive locations. Investors remain positive toward neighborhood and community centers; it was the only sector with no sell recommendations. Regional malls and power centers, on the other hand, had the highest sell recommendation among all property types. 1 Vacancy loss reflects a typical holding period, not the current level. Source Situs RERC Investment Survey, 4Q 2017, preliminary data.

5 CURRENT QUARTER INVESTMENT CONDITIONS AND CAPITALIZATION TECHNIQUES 4Q 2017 INVESTMENT CONDITIONS1 CAP RATE3 INCOME APPROACH2 4Q Q Q Q 2015 Direct Cap. DCF Before Reserves After Reserves Office - CBD % 22% Office - Suburban % 22% Industrial - Warehouse % 38% Industrial - R&D Industrial - Flex Retail - Regional Mall % 29% Retail - Power Center % 29% Retail - Neighborhood % 29% Apartment % 75% Student Housing % 86% Hotel % 67% Investment conditions improved for all property sectors compared to the previous quarter except for hotel. The industrial sector provided the strongest investment conditions as online retailers continued to demand more space for warehouses and implemented lastmile delivery strategies. Despite the negative news coverage about the retail sector, investors were more positive across all retail subtypes compared to last quarter. Investors may be more optimistic about investment conditions for retail because of the better-than-expected holiday sales recorded for brick-and-mortar stores. The largest improvement in retail investment conditions ratings was for power centers, which rebounded after a sharp drop in the third quarter. The rise in ratings for investment conditions may be reflective of the ongoing revolution that is affecting the retail merchandising industry as a whole. It is a Darwinian environment that has created winners and losers. For the power center sector, certain big-box retailers, faced with adapting their strategies or becoming obsolete, are adding more experiential and omnichannel retail or shedding unnecessary space. CBD office recorded one of the largest increases in investment conditions compared to other property types. CBD offices (compared to suburban offices) are more likely to have the state-of-the-art amenities and technology-driven open spaces that tenants demand. The increase for investment conditions for CBD office may also reflect the continued desire of millennials, and their employers, to be situated in easily walkable, urban areas. However, we note that if/when more millennials begin to start families, we could see a disruption in this trend Investment Conditions are rated on a scale of 1 to 10, with 10 being excellent. Income Approach is rated on a scale of 1 to 10, with 10 being most relevant. Percent of respondents who apply the cap rate before or after reserves. Source RERC Investment Survey, 4Q 2017, preliminary data. FPO

6 REQUIRED RETURN EXPECTATIONS 1 BY PROPERTY TYPE 4Q 2017 Pre-tax Yield (IRR) (%) OFFICE INDUSTRIAL RETAIL APT CBD SUB WHSE R&D FLEX RGNL MALL PWR CNTR NEIGH/ COMM STUDENT HOUSING HOTEL Range Average Change Going-In Cap Rate (%) Range Average Change Terminal Cap Rate (%) Range Average Change Rental Growth (%) Range Average Change Expense Growth (%) Range Average Change IRRs increased across most property types in the fourth quarter. This is a reversal from the third quarter when respondents believed IRRs for most property types were declining. With most experts agreeing that the CRE cycle is nearing its end, perceived risk in the market is likely driving required yield rates higher. Across most of the major property types, cap rates increased from last quarter. The 50 bps increase in overall retail going-in cap rates and the 40 bps increase in overall retail terminal cap rates continue to reflect investors hesitation in the retail sector. However, these rates could provide opportunity for investors, especially for neighborhood and community centers. Expense growth rates for most property sectors declined in the fourth quarter. General expenses for CRE may have declined due to lower energy costs stemming from competition among service providers. 1 This survey was conducted in October, November, and December 2017 and reflects expected return for fourth quarter 2017 investments. 2 Ranges and other data reflect the central tendencies of respondents: unusually high and low responses have been eliminated. 3 Change (+/-) in basis points () from quarter immediately preceding current rate. Source RERC Investment Survey, 4Q 2017, preliminary data.

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