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1Q18 United States Capital Markets Report

May 2018
NKF Capital Markets presents the First Quarter 2018 United States Capital Markets Report. The statistics and in-depth market perspective contained in the report illustrate current trends with a focus on national investment sales.

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Despite market volatility related to foreign policy decisions and interest rate uncertainty emanating from the Federal Reserve, 2018 promises to see global economic growth touch 4.0% annually, with the US hitting 3% annual growth. Correspondingly, real estate saw year-over-year growth, managing over $110 billion in total sales volume.

Geographically, larger supply constrained metropolitan areas which make up a notable portion of core and trophy assets have stabilized over the past 12 months ending in Q1 2018, after investment sales dipped in early 2016. Not all asset classes have felt pressure evenly – industrial pricing for example has managed a 9.4% year- over-year increase in the primary markets, with last mile warehouses achieving similar gains. Industrial assets in major metros are benefiting from a shortage of usable land within reach of the metro population and simultaneous increased demand from ecommerce firms, who are pushing the limits of volume and speed with an emphasis on next-day, same-day and even two-hour delivery for a wide basket of goods.

Secondary markets (as well as suburban markets surrounding major metros) have seen continued steady demand – in order to achieve yield targets, funds have been eager to place capital in value-add and opportunistic properties that offer superior returns, without severely impacting the risk profile. Multihousing, which had the strongest sales volume performance of any asset class in 2018, exemplifies this trend. Secondary markets typically make up over half of the total multihousing sales volume, with investors focusing on cities in the West, Southwest and Southeast, which have benefited from strong population, job, and rental growth (thereby reducing the risk of taking on capital intensive investments).

Investors have also looked outside of the conventional asset classes, toward student housing, senior housing, self storage and medical office properties. Student and senior housing investments in particular are being purchased for their anti-cyclical characteristics, and for their ability to protect against inflation. Diversification of real estate asset investments then appears to be sustaining the cycle and making the financial system more balanced as a whole, decreasing the risks associated with a setback in any one asset class.

The pursuit of yield also has seen its limits – investors and lenders alike have overwhelmingly favored security of capital, over pure returns. Underwriting requirements have not loosened, and LTVs have not reverted back to the mean (in the mid 70s), even in the strongest of markets in asset classes such as multihousing. Many institutional investors who have traditionally been on the equity side, now see opportunities in debt – international groups in primary markets have increasingly looked to financing, to stay involved in commercial real estate, without taking on the risks of investing later into the cycle.

On the macroeconomic policy level, interest rate uncertainty has been on the minds of all investors and fund managers. Yet generic commercial real estate capitalization rates have held steady, staying within 5 basis points of last quarter. A look at the yield curve reveals that there hasn’t been a significant change in 10 year treasury rate (40 basis points, or 17% increase) since last year, which is the basis for most lenders. Therefore costs of borrowing have been kept in check. The largest changes have been seen on the debt fundraising side, with REITS in particular raising the most debt capital ever in 2017, in anticipation for higher future rates. Bond issuance has continued into 2018, outpacing net selling activity on the equity side.

Stable growth in the post 2008 real estate cycle should keep high levels of capital in the financial system. Yet in recent years, increased availability capital and the consequent increase in the amount of funds has also contributed to a high level of dry powder. The perpetual lack of core trophy assets in primary markets, which have been targets for institutional investors, and near record high pricing across all core product, have slowed transaction velocity. Sellers in these markets also played a role, particularly those that bought at higher prices later in the cycle. In order to hold on to properties longer, many have refinanced and have extended their ownership period with the expectation that prices will rise again in the future.

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