Commercial real estate outlook

Midyear 2019: Coasting at the speed limit

Solid fundamentals supporting the CRE market are driving price growth – but at a slower pace than in years past.

Download the complete outlook
July 31, 2019 | 16 minute read

Executive summary

The commercial real estate (CRE) market has continued cruising along in 2019, albeit at a slower pace, with U.S. economic outperformance providing a steadying force to the space. Consumers have been driving much of the growth during this expansion, and they continue to feel confident despite financial market volatility at last year’s end. However, heightened uncertainty driven by trade tensions, as well as decelerating global growth, could introduce more volatility in the second half of the year.

Transaction volume in 2019 has generally fallen short of 2018 levels, a sign that investors may be starting to feel more uncertain. Price gains have moderated over the past two years, though a 7.1% year-over-year gain is certainly still a solid pace.¹ Cap rates have largely remained flat since the end of 2017, which has left rent growth as the primary contributor to valuation increases. While still comfortably positive, rent growth has fallen across all sectors except industrial since 2015.²


Coasting at the speed limit

During most of this cycle, CRE debt markets have been characterized by strong coverage metrics, which measure the ability of properties to service their debt through net operating income (NOI). This strength stems from a combination of lower interest rates and more-conservative underwriting driven by enhanced post-crisis regulation. The 10-year U.S. Treasury yield has fallen more than 100 bps since October 2018,³ pushing commercial mortgage rates down and debt coverage up close to a cycle high at 1.85x.¹ The market is now pricing in at least two rate cuts for the rest of 2019, which should continue to hold rates low and keep debt as an attractive source of financing.³

The industrial sector continues to outpace the rest of the CRE market, with year-over-year price growth of 11.7%. Vacancy rates have fallen to decade lows as the e-commerce boom has consistently driven absorption that has outpaced new construction. The retail sector, seen as the laggard of the CRE market for much of this cycle, continued to post the lowest price gains. However, a strong and confident consumer should continue to help buoy retail despite less favorable fundamentals.1

Our outlook for the rest of 2019 is for a continuation of gradual price growth moderation as economic uncertainty and a tight labor market squeeze returns from both the demand and supply sides. Low rates will likely keep debt financing attractive and cap rates stable. The top risk to the space remains the possibility that the economic growth slowdown starts to impact transaction volume as well as consumer sentiment, which could pressure rent growth at a time when it is an increasingly vital driver of price growth.

  • Real Capital Analytics, as of May 31, 2019.

  • Reis, as of March 31, 2019.

  • Bloomberg, as of May 31, 2019.

This information is educational in nature and does not constitute a financial promotion, investment advice or an inducement or incitement to participate in any product, offering or investment. FS Investments is not adopting, making a recommendation for or endorsing any investment strategy or particular security. All views, opinions and positions expressed herein are that of the author and do not necessarily reflect the views, opinions or positions of FS Investments. All opinions are subject to change without notice, and you should always obtain current information and perform due diligence before participating in any investment. FS Investments does not provide legal or tax advice and the information herein should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact any investment result. FS Investments cannot guarantee that the information herein is accurate, complete, or timely. FS Investments makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information.

Any projections, forecasts and estimates contained herein are based upon certain assumptions that the author considers reasonable. Projections are necessarily speculative in nature, and it can be expected that some or all of the assumptions underlying the projections will not materialize or will vary significantly from actual results. The inclusion of projections herein should not be regarded as a representation or guarantee regarding the reliability, accuracy or completeness of the information contained herein, and neither FS Investments nor the author are under any obligation to update or keep current such information.

All investing is subject to risk, including the possible loss of the money you invest.

Search our site