February 17, 2017
A number of significant issues will have a direct effect on values and the sustainability of the expansion as we get into the later stages of this cycle. Chief among them is the prospect of higher interest rates for borrowers, which may put a damper on valuations, especially in light of how low absolute rates have been over the last four years. Total returns will be much more dependent on increases in net operating income than decreasing cap rates over the next two to three years, thereby providing more normalized returns of 6–8 percent annually. We will be watching closely, as cap rates have more pressure to move up than down heading into 2017. The flow of funds into U.S. real estate will also be an important factor in 2017, especially from foreign sources. A recent survey by the Association of Foreign Investors in Real Estate indicates that 60 percent of its members believe the U.S. provides the most stable and secure real estate investments, and that 95 percent of its members plan to maintain or increase their investment in U.S. real estate. Yet one third of respondents were not as optimistic as they were a year ago regarding overall opportunities. Finally, potential legislative changes could have consequences for owners’ income and property values. These include potential tax reform, depreciation changes, and perhaps a repeal of some of the Dodd-Frank Act.
A recent survey by the Association of Foreign Investors in Real Estate indicates that 60 percent of members believe the U.S. provides the most stable and secure real estate investments. Furthermore, 95 percent of foreign investors plan to maintain or increase their investment in U.S. real estate.
Source: Association of Foreign Investors in Real Estate, Guggenheim Investments. Data as of 12.31.2016.
The real estate market has now seen seven years of increasing values since the lows of late 2009 and early 2010. Overall values are 22.3 percent higher than they were at their pre-recession peak. Apartments lead by a wide margin, at 50 percent higher than pre-recession levels. Central business district office properties are up 45 percent, while all properties in non-major markets are only up 8.4 percent, indicating that not all markets have participated equally in the recovery.
In the short term, banks and life insurance companies will be the lenders of choice (other than the Agencies for multifamily) as they offer certainty of execution and the best pricing for borrowers. With short-term interest rates likely to increase by 75–100 basis points this year, we favor permanent mortgages with five- and sevenyear terms, and adding Libor-based products for shorter-term transactions as a hedge against rising rates, particularly the shorter terms. We still see value in the bridge/ traditional business as well as construction lending. Banks’ appetite for this type of lending has decreased, but this is due to their regulatory burden, not demand from borrowers.
The real estate market has been in a seven-year bull market. Apartment buildings and office space are leading the way.
Source: Real Capital Analytics, Moody’s, Guggenheim Investments. Data as of 11.30.2016.
—William Bennett, Managing Director; David Cacciapaglia, Managing Director
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