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The Raub Report- Too Much of a Good Thing

March 15, 2018

Mae West once said, “Too much of a good thing can be wonderful!” That may be where commercial real estate is at this time in history. CRE has appreciated greatly over the past 8 years and all sectors are pretty fully valued at this point in the economic cycle.  So much so, that the few people who may want to sell are asking very high prices – and getting them with multiple offers. Example:  a new, very well located 15,000 SF retail center in San Antonio, 100% leased to high quality tenants went on the market and received 75 indications of interest.  It is selling at a cap rate just over 7%. Multi-family is selling in the mid-5’s cap rates. Many are concerned that the rise in interest rates will reduce values, as the cost of debt eats into cash flow, but so far that is not the case.  So, if you have investable cash, or are going to have it from a sale of property – what are you gonna do with your money? Put it in the stock market? That’s pretty risky, because it, too, is very highly priced and volatile. Right now there is just a lot of money chasing fewer deals. Ten years ago the markets cratered because of excessive, risky debt. Now, is there too much equity chasing deals?

For now, though, the outlook remains sunny. Many had forecast that 2017 would be the beginning of the next downturn, yours truly included.  The dramatic change of attitudes with the election of Donald Trump has moved that expectation of a downturn into 2019 or 2020.  RCLCO is a nationally respected real estate consulting firm.  Their commentary on where we are in the current economic cycle is as follows: Almost half of RCLCO Sentiment Survey respondents believe that the current expansionary phase of the cycle is likely to last for at least another two years. Most product types exhibited little cycle movement since six months ago, remaining in the stable phases of the real estate cycle.  Nearly half of respondents believe that retail is already in downturn, and almost half predict that multifamily will be in downturn within the next 12 months. However, these predictions have changed very little from the midyear 2017 survey. RCLCO’s outlook for generally positive though moderating, operating and investment performance through 2018 is consistent with the majority of survey respondents. We continue to have limited reason to fear an impending or sharp downturn in real estate performance, though there are some signs of moderate distress in certain property types and geographies.

This is all to say both nationally and locally, we are apparently in a time of equilibrium, where the increase in supply of property space is roughly matching the increase in demand for space; that is, there is presently no gross over-building.  We are undoubtedly very far along in this very long economic cycle, but that doesn’t mean a downturn is imminent. Indeed, this cycle could last through the latter part of 2019. San Antonio is rated as being in equilibrium in every commercial property sector, with only apartment supply slightly ahead in the cycle and office slightly under-supplied in the development cycle.

Industrial is now the most sought after property type, and there are a lot of new projects being planned in San Antonio, with up to 1,000,000 square feet of spec space being considered.  However, it is quite possible that not all of this will actually find investment capital and get built.

Retail remains in flux because of the effects of “e-tailing” ,and e-commerce may have become too much of a good thing causing retail businesses to struggle. Nevertheless, most businesses have made their adjustments and life will go on (or not).  Construction has been adequate to meet the new demand as new homes are built at the edges of the metropolitan area, and older space in mature neighborhoods is still getting backfilled.  This means that occupancy rates and rents are remaining strong, as the “busted” retailers’ spaces are being backfilled by successful new ventures.

New constructed luxury apartments have gotten a little ahead of themselves, and rent concessions are common but occupancies still remain good and are in the 93%’s; however, new permits are slowing down.  The problem here is that new construction has gotten very expensive and rents are not increasing fast enough to make the numbers work.

Construction overall is becoming much more expensive in every category, from home building to high rise offices.  The major components are all under price pressure because of the robust economy.  Labor shortages are a great concern, as older highly skilled workers retire, and new entrants into the marketplace lack the skills and maturity of those they replace.  And wages go up.  Materials are in high demand, especially when we consider the rebuilding needed in Texas after Hurricane Harvey last year.  And prices are going up.  And land values continue to rise, and property taxes are going through the roof, with 20% per year increases.

Job growth is always the key to a healthy commercial real estate market and that is projected to remain very positive.  The Dallas Federal Reserve Bank economists forecast that Texas employment will grow at a 3.3% rate this year, raising their previous estimate of 2.8%. Last year Texas added 240,500 workers, a pretty good year, but this year the forecast is 407,900.  That would mean about 33,000 net new jobs in San Antonio, where we already enjoy an ultra-low unemployment rate of 3.4%, compared to the national average of 4.1%.

So, in summary, we are in a good place now, and perhaps, too much of a good thing will, indeed, be wonderful.