CBRE’s Chris Ludeman doesn’t foresee meaningful cap rate compression in the next few years, regardless of how strong GDP growth proves to be.
The road ahead could lead to robust economic growth or to a slowdown, each with broad implications for commercial real estate values. In either case, investors should not look to asset appreciation as a given when calibrating their near-term strategies, CBRE’s Chris Ludeman tells GlobeSt.com.
Partly this is due to the age of the current cycle, in keeping with historical norms. “As we get longer in the cycle, where there’s less cap rate compression, investors rely more on property performance to drive value,” says Ludeman, global president, capital markets at CBRE. ‘And that’s what has happened.” The increasingly small share that price appreciation has had in the NCREIF Property Index’s quarterly returns lately is a case in point.
Accordingly, although cap rates and pricing may vary widely across local markets, on a national basis CBRE’s 2018 US Real Estate Market Outlook advises that “the steady income returns that CRE is likely to generate over the period provide a solid basis” for investment strategies “as investors simply wait out the asset value fluctuations.” That holds true regardless of how the broader economy performs over the next few years.
There are three plausible scenarios for the economy’s trajectory, CBRE says in its outlook report. In one, GDP growth slows down next year, followed by a return to growth in 2020 and an increase in cap rates of anywhere from 30 to 120 basis points by 2023, depending on the market and property type.
The second scenario forecasts annual GDP growth reaching a robust 3.3% by the middle of this year and then moderating to 1.5% over the next three years, with real estate NOI following a similar path. Here as well, cap rates will begin to increase, although the timing would be different and apartment properties would generally be immune to the increases.
Lastly, there’s a possibility of 0% to 1% annual GDP growth over the next five years, with cap rates rising anywhere from three to 50 bps over the period. Of these three scenarios, Ludeman sees the robust-growth track as most likely.
“Given the changes to the tax code, there is a better case to be made for continued economic expansion,” he says. “And with economic expansion, real estate equities will perform well.
“That being said, while there’s a higher probability that the economic expansion will continue, it is not my view that cap rates will compress in any material way,” continues Ludeman. “It is more likely that they will remain very near current levels.”
Along with cap rates maintaining the status quo, Ludeman also expects transaction volumes to remain healthy. He points out that although sales have returned to levels that were seen prior to the recent 2015 peak, “by historical standards, those are terrific.” The perception that sales are in a slump is “a little bit jaundiced.”
Even as investors look more toward property performance and less toward value appreciation, Ludeman doesn’t anticipate a meaningful lengthening of hold periods as a result. “My guess is that hold periods will continue to align with how the capital was formed,” he says. “If you’ve got a value-add fund, it’s going to be a three- to seven-year hold. It’s all aligned with the strategy you have: value-add, opportunistic or core, each with different characteristics.
“When I’m talking to capital, I don’t sense that capital is going to hold assets longer,” Ludeman adds. “What is of note is that as we get longer in the cycle, investors are going to be more careful about how much noise they want in a rent roll in the next couple of years. A lot of volatility in a rent roll may lead to more caution for some investors.”
By: Paul Bubny (GlobeSt)
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