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Real estate ‘sweet spot’

by Larry Gray

The U.S. real estate market is entering a “sweet spot” in its current cycle that could last for the next several years, and risk levels remain generally low, according to a recent report from MetLife Real Estate Investors.

The firm estimates the U.S. economy will expand by 2.6 percent this year, producing solid job growth and buoying consumer confidence and spending. The report notes that most property markets in 2015 will be characterized by space demand that is stronger than supply, which will help fuel net operating income growth of between 4 percent and 6 percent, as rents continue to grow and leases signed at the bottom of the market roll to higher market rates.

“We believe that the U.S. real estate market is entering a sweet spot that could last for the next several years given the momentum seen in the economy and real estate markets. Demand should continue to outpace supply across most property types in 2015 leading to a continued fall in vacancy rates and rising rents,” says Melissa Reagen, associate director of research for MetLife Real Estate Investors and author of the report.

The outlook for growth will support healthy real estate fundamentals for the next several years as vacancy rates decline and rental rates rise. In addition, most property types will see solid value growth, supported by firming fundamentals and rising investor demand for real estate assets.

One investment theme emphasized in the report is that markets with expanding STEM (science, technology, engineering and math) job bases will outperform in the coming years and generate above average NOI growth. MetLife’s forecasts indicate that office markets with a high concentration of highly paid knowledge workers and urbanization have the strongest outlook for rent growth. Cities with high concentrations of STEM jobs that are also performing well from a real estate standpoint include Austin, Boston, New York, San Francisco and Seattle.

“Our investment recommendations take advantage of the structural changes taking place in the U.S. from the rise of urbanization to increasing Internet retail sales to the rising importance and dominance of the ‘knowledge worker’ or those employed in the expanding Science, Technology, Engineering and Mathematics [STEM] industries,” says Reagen. “These industries generate well-paying jobs, helping drive demand for institutional-quality real estate.”

The MetLife report also notes that investors will need to monitor potential risks as the U.S. economic and real estate recoveries continue to mature. Key cyclical indicators to watch include supply and demand, pricing vs. fundamentals, the spread between cap rates and the U.S. Treasury yield, capital flows, and underwriting standards.

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