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Wells Fargo: Commercial Real Estate Chartbook: Q4

Wells Fargo Economics Group Special Commentary

17 February 2016

As the Commercial Real Estate Cycle Turns:  With domestic demand projected to remain fairly healthy, CRE fundamentals should also continue to advance.

  • CRE Operating Fundamentals
  • Supply still Growing
  • Valuations Still Elevated
  • Risk Premium Still Favorable

Outperforming Sectors are still Growing, but Shift is Imminent

  • For commercial real estate, sectors that have outperformed in the cycle, like apartments and hotels, continued to post gains in 2015

CRE Property Pricing & Fundamentals

  • Operating fundamentals for CRE continued to advance in Q4 2015, with transaction volume surging during the quarter.
  • Excluding hotels, cap rates trended lower in Q4.
  • Foreign buyers were very active in 2015, with cross-border activity swelling to $90.2 billion.

Apartments

  • The national vacancy rate of apartments increased to 4.4 percent in Q4 as rising supply outpaced demand.
  • Effective rent growth remained robust in Q4 with national year-ago gains increasing 4.7 percent.

Office

  • Office fundamentals continued to improve at a steady pace in Q4 as labor market conditions improved with demand for office space picking up and the vacancy rate falling to 16.3 percent.
  • Class A and B/C office vacancy rates in major markets continued to decline in 2015 and are currently below the national average.
  • Office effective revenue growth continues to surge in technology-intensive markets like San Diego, Seattle and Chicago, with the quarterly annualized rate suggesting an accelerating pattern.

Retail

  • Retail fundamentals continue to lag in the cycle compared to other property types, but the recovery has been mixed.
  • Growing e-commerce has also slowed the overall pace of activity as retailers downsize floor plans and reduce the number of stores; however, some online retailers are starting to set up physical locations.
  • Retail effective revenue growth continues to improve, with secondary markets, like Miami, Raleigh-Durham and Suburban Virginia, seeing some of the strongest gains over the past year.

Industrial

  • Industrial demand remained robust throughout 2015, continuing to outstrip completions; thus, overall effective revenue growth rose 5.9 percent over the past year.
  • Cross-border activity also surged in 2015, with Singapore making the largest investment in the U.S. industrial space.
  • Over the next three years, completions as a percent of stock in the Inland Empire and Atlanta are projected to far outpace the national average of almost 5 percent, reaching 15.2 and 10.0 percent, respectively.

Hotel

  • Overall hotel performance metrics remain solid, but are beginning to decelerate from their cycle high.
  • The pipeline of new hotel construction continues to increase with almost 500,000 rooms in development.

Houston Market Overview

  • Although Houston’s economy is more diverse than in previous cycles, concerns continue to grow around the health of office fundamentals.
  • By submarket, Class A office space in North/FM 1960 and Class B/C in the CBD and North Belt saw the largest vacancy rate percentage point increase last year.
  • Supply is also increasing with Reis projecting completions as a percent of stock to peak this year; however, office operating fundamentals will likely get worse before they get better.

Read the complete commentary here:  cre-chartbook-4q2015-20160216 

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