U.S. economic expansion nears 10 years, and real estate fundamentals remain healthy
The U.S. economy is at full employment and GDP growth accelerated in 2018, but many have begun to worry about a future recession, with consensus forecasts placing the downturn two years out.
“There’s no obvious sign that there’s an end to the cycle, but there’s a few warning signs,” said Mike Acton, head of research at AEW, at a research presentation in San Francisco on March 26.
But while the cycle may not be showing signs of a precipitous end, it is getting quite long, with 10 years of expansion. If that continues through June, this will be the longest expansion in U.S. history.
“We’re soon to be in uncharted territory,” said Acton.
Policy may affect the timing of any future downturn, with a trade war moving up the timetable, whereas an infrastructure spending bill could extend the cycle even longer. The Tax Cuts and Jobs Act at the end of 2017, along with a new federal budget last year that ended deep cuts from the 2013 budget sequestration, spurred accelerating growth in 2018.
Still, notes Acton, it is unclear whether such economic growth will be sustainable in 2019 and beyond. It is also unclear whether employment growth can be sustained, as the country is beginning to run out of people to put into the labor force, even as the labor market continues to be very dynamic.
One key element for real estate investors to watch: interest rates may not keep rising. At its meeting March 19–20, the Federal Open Market Committee did not increase the target federal funds rate, but maintained it at 2.25–2.5 percent. Now, expectations are that the Fed will stop its current trajectory at 3.0 percent or less in 2019.
At the same time, cap rates may be bottoming out. The real estate sector is seeing some of its lowest cap rates ever, noted Acton. Industrial and multifamily are trending lower, while retail cap rates moved up in the fourth quarter.
“Yields are not, in my opinion, going to go down any more,” added Acton.
At current cap rate levels, he forecast property buyers will need NOI growth of 2–3 percent per year over the next 10 years just to sustain current values. Meanwhile, the consensus forecast for NOI growth is 2–3 percent per year.
Acton also pointed to the fourth quarter 2018 PREA Consensus Survey on future real estate returns, which is forecasting a 5.4 percent total return from the NCREIF Property Index during the next five years. Most of those gains are likely to come from income, not appreciation.
One concerning sign: the widening spread between private market cap rates and public market cap rates for most property types.
On the other hand, real estate does not appear to be heading for an oversupplied situation. Construction deliveries are peaking in 2018 and 2019, with a drop-off after this year. Unlike in previous real estate expansions and contractions, it appears real estate developers and lenders have had more information and made decisions to adjust their pipeline sooner rather than later. Or rising construction costs made the decision for them. In addition, vacancy rates are flattening out, suggesting supply and demand are in equilibrium, noted Acton.
Overall, the property markets appear to be healthy and continue to demonstrate strong fundamentals.