The incoming Trump administration could implement pro-growth policies that could benefit the commercial real estate market, potentially slowing down an anticipated correction. “If [President-elect] Trump can get pro-growth policies passed, it may forestall any market correction for quite a while and in fact will result in a better economic environment,” said Leslie Himmel, founder and managing partner at Himmel & Meringoff.
Market pros pointed to positive signs in the equity and debt markets, with the major indices rising and yields on 10-year Treasuries buoyed by expectations that the Trump administration will decrease taxes and increase fiscal stimulus through infrastructure spending.
Although market players told REFI they are generally more optimistic today than they were a year ago, some still warned against the exuberance displayed in the market over the last few weeks. “Our prediction for the end of the cycle is still between late 2018 and early 2019,” said Spencer Levy, Americas head of research at CBRE. “It has been accompanied by higher interest rates that push in the opposite direction of stimulus and bring other risks.”
With expectations of higher rates, market pros are taking a hard look at the impact on cap rates, which remain at historically low levels. “Cap rates will rise [if interest rates rise],” Himmel said. “Real estate capital stacks and internal rates of return are a function of the cost of equity and cost of debt. Pricing will reflect a more normal return on equity for real estate and also reflect the increasing lack of liquidity in the asset class. As large amounts of new inventory are added to New York’s office market, landlords with superior properties and long-term operating expertise will benefit.”
Some investors, however, don’t feel as though a direct correlation between cap rates and interest rates is a sure thing. “Historically, interest rates and cap rates have moved in lockstep, but if you look at the 10-year trend line, that relationship is decoupling,” said David Eyzenberg, founder and managing partner at Eyzenberg & Co. Others have declared it too early to assess the relationship. “The first 50 basis-point move was largely built in, but once the 10-year gets above 3%, we’ll see more cap rate expansion,” said Levy.
Market pros are also evaluating the effect of a stronger dollar on foreign investment in gateway cities, where non-U.S. investors typically tend to be most active. “There is an enormous amount of foreign wealth and institutional capital chasing real estate investments in the best city in the world and as the dollar gets stronger, it will get very expensive to keep buying here,” said Himmel. “If the dollar gets even stronger, [investors] may try to take advantage of the currency change and take their money back out by selling.”
While most market pros are in agreement that a strengthening dollar could discourage some foreign investment, some posited that a general feeling of uncertainty around the world could act as a draw to the U.S. “There’s been a little bit of a global look at turning right instead of left,” said Tino Korologos, managing director at Berkeley Research Group, referring to a swing of global populist decisions made by voters in recent months. “The question becomes: are investors going to keep investment capital in their home country, or will they continue to invest in the U.S. because of its perceived safety? In my opinion, global capital will continue to flow into the U.S. in both debt and equity [markets].” The U.S. is often viewed abroad as a safe haven rather than a place to make windfall returns, according to Mitch Wasterlain, founder and CEO of CAPFUNDR. “Foreign investors are looking to preserve capital rather than generate income, so they’ll stick to investing in gateway cities,” he added. “They aren’t as concerned about returns; they just want to get their capital to a safe place.”
While foreign investors will continue to focus on gateway city markets, there has been a push among domestic investors towards secondary markets. “I think there are going to be a lot of [domestic investors] who are looking to invest in markets that have higher cap rates and are not so dependent on value growth,” said Wasterlain. “Due to the run up in values in markets like New York and based on the supply coming on stream [in that market], we’re seeing growth in markets in the Midwest and Southeast.”
Many market players are still optimistic about where we are in the cycle and still see strong fundamentals going into 2017. “There’s still more capital chasing assets than there are to buy,” said one longtime executive. “We may see prices start to soften and for it to go the other way, but for now there’s plenty of capital that’s chasing anything that’s income producing.”