By Rebecca Rockey, Economist
Most every point in the economic recovery and subsequent expansion faced some sort of macroeconomic hurdle, whether generated by factors in the U.S. or abroad. Clearly, 2016 is no different, and, similarly, we expect another robust year for the U.S. economy and commercial real estate (CRE) markets, as we discuss in our report, U.S. Macro Forecast: A Correction or a U.S. Recession?
First, let’s look at the economy and recent volatility.
Worries about China’s economy and oil prices’ continued slide caused stock markets around the world to stumble and pushed the Dow and S&P 500 both down 9% to 10% in January since the start of December last year. While China’s issues are a global concern, analysis shows that China’s GDP growth, currently 6.8%, would have to fall below 3% to cause a recession in the U.S. Additionally, China has enormous fiscal resources ($3.3 trillion in reserves) available to stabilize its economy. Current assumptions suggest that China’s economy will continue to decelerate amidst structural rebalance. That will cause some choppiness for the global economy, but no hard landing is imminent.
Declining oil prices pose a more significant threat to our baseline outlook. Energy sector layoffs totaled 59,000 in the U.S., and an estimated 1.5% to 3.5% of commercial bank loans are tied to the energy industry. Still, every penny decline in retail gas prices adds more than $1 billion to consumer spending over the course of the year, according to Moody’s Analytics. Lower oil prices spur increased business and consumer consumption, which benefits most U.S. CRE markets to the tune of 23.8 million square feet (MSF) of additional office and industrial demand.
While the American consumer is a complicated species to understand, overall, consumers are doing well. Job openings are at a 15-year high. We’re coming off two of the strongest years for job growth since the late 1990s and expect 2.3 million non-farm jobs to be created in 2016 and 2017, respectively. Both wage and total compensation growth rose by more than 2% last year, the first time since 2008 that both measures grew more than 2% simultaneously. And, despite disturbing global headlines to start the year, consumer confidence rose to 98 in January, from 96 in December, which is critical. American consumers are expected to be the dominant GDP driver going forward.
So, what does it mean for U.S. CRE?
The U.S. will continue to be a global safe haven for investors seeking both stability and expected returns, which averaged over 13% on an annualized basis last year. A significant amount of capital, especially from foreign investors, is waiting to be deployed, and we expect strong capital markets activity and further compression in cap rates in 2016 and 2017, even as the Fed tests moving forward with raising the federal funds rate. That said, credit spreads have widened in concert with greater uncertainty in CMBS markets, allowing banks and life insurance lenders to increase debt pricing recently.
For U.S. office markets, continued job growth is the most important factor. Office-using job growth will decelerate in 2016 (713,000 new office-using jobs) and 2017 (666,000 new office-using jobs), which does translate to slower aggregate demand for office space. We estimate annual net absorption in the 75-85 MSF range over the next two years, but new development continues to lag. We estimate that 140 MSF of office product will deliver over the next two years versus the nearly 160 MSF that will be absorbed. As a result, office vacancy will continue to decline, falling from 14.2% in 2015 to 13% in 2017, and rent growth will accelerate to 4% in 2016 and 4.5% in 2017. In 2018, new development should catch up with decelerating demand.
U.S. industrial markets will see decelerating demand, but that’s compared to record setting years in 2014 and 2015, when absorption totaled 247 MSF and 234 MSF, respectively. We expect 220 MSF of demand this year and vacancy to tighten by 500 basis points to 7%. Brisk leasing velocity and tenant requirements suggest rent growth will average 5% throughout 2016 and 2017. The growth of e-commerce, expanding demand in the residential sector and consumer spending will continue to drive the tightest conditions ever observed in the industrial sector.
Higher consumer spending driven by wage growth and lower gas prices will drive retail real estate, too, but retail paints a more bifurcated picture. With continued, increasing e-commerce sales, retailers started 2016 with further evaluation of real estate portfolios toward a more omni-channel strategy. This will result in more store closures, and malls and lifestyle centers will feel the pain – though trophy centers in prime locations will be minimally impacted. Neighborhood/community and power/regional centers will experience little e-commerce fallout and will continue to see occupancy growth. We expect net absorption to maintain 2015 levels (40 MSF) for the next two years, with demand largely focused on Class A product and/or new space. Higher-end development will see strong rent growth, but the overall average for the U.S. retail sector will be between 2% and 3% in 2016 and 2017.
For now, ignore the Dow, and focus on fundamentals. Early year stock market jitters are nothing new. Could a prolonged downturn in equity markets seep into the broader U.S. economy? Sure. Is that probable? No. U.S. economic fundamentals and property markets remain on solid footing.
What’s your outlook for the U.S. economy and CRE in 2016 and beyond?
Becky joined Cushman & Wakefield in January 2014 as the U.S. Economist. Before joining Cushman & Wakefield, she worked as a consultant at a finance and economics consulting firm in the DC area, primarily working on loss forecasts for a national housing finance company’s single-family, fixed income portfolio. Prior to that, she was a junior economist at the Congressional Budget Office in the Financial Analysis Division.