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Commercial real estate performance holds steady
Research - APRIL 26, 2018

Commercial real estate performance holds steady

by Andrea Zander

The NCREIF Property Index reflects investment performance for 7,553 commercial properties, totaling $567 billion of market value, according to National Council of Real Estate Investment Fiduciaries’ first quarter 2018 results.

The total return was 1.70 percent in the first quarter, down slightly from 1.80 percent last quarter. For the current and previous three quarters, the total return was just slightly over 7 percent — a slight improvement over the four quarters of 2017. This is an unleveraged return for what is primarily “core” real estate held by institutional investors throughout the United States.

The average quarterly return over the past five years was 2.43 percent or 10.08 percent annualized. Although the current quarter’s return of 1.70 percent or 6.98 percent annualized is down from the torrid pace during the previous five years, the downward drop in returns witnessed for several years stopped at the beginning of 2017 and returns have held remarkably steady since then.

The first quarter 2018 total return consisted of a 1.12 percent income return and 0.58 percent capital appreciation. Over the past four quarters, both components of the total return have been relatively stable with the quarterly income return ranging from 1.12 percent –to 1.15 percent and appreciation in the 0.56 percent –to 0.63 percent range.

Industrial properties, which are primarily warehouses, continue to be the stellar performer with a return of 3.25 percent for the quarter. Office followed at 1.80 percent and then apartment at 1.5 percent. Retail was only 0.72 percent for the quarter.

The spread between industrial and retail returns is a “tale of two sectors” with online shopping creating increased demand for last-mile warehouse space and hurting many traditional retailers.

The returns between industrial and retail space are now a positive 2 percent Occupancy for NCREIF-tracked properties remains close to its 16-year high, at 93.50 percent, which is down just slightly from 93.55 percent last quarter. The highest occupancy was for industrial properties at 96.34 percent, just slightly lower than the 96.37 percent reached the prior quarter. The second highest was retail at 93.09 percent, which was slightly higher than the 93.05 percent the prior quarter.

Rental rates actually declined by 3.27 percent for the quarter, and NOI growth was a negative 2.47 percent. Industrial and retail properties had positive growth but the other sectors were negative with office a negative 7.8 percent and apartments a negative 2.47 percent. If rent and NOI growth continue to be negative, this could ultimately put pressure on returns — especially if cap rates increase. Cap rates declined slightly for the quarter from about 5 percent to 4.86 percent, but there could be upward pressure as interest rates start to rise.

The NPI represents unleveraged property performance. However, about half of the properties in the NPI utilize leverage, which can provide an opportunity for higher returns given the low interest rate environment. For the 3,615 NPI properties utilizing leverage, the leveraged total return was 1.96 percent in the first quarter 2018 or an annualized return of 8.07 percent. Thus, leverage continues to be favorable with the unleveraged return exceeding the interest rate on the debt financing used by the properties in the index. But this is an extremely modest amount of leverage.  For properties that have leverage, the average loan to value ratio is 42 percent and the average annual interest rate being paid is just under 4 percent.

 

 

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