Commercial Real Estate: Amid economic uncertainty, Situs RERC data show increase in CRE yield spreads

We are now a decade past the Global Financial Crisis (GFC). With the economy on sure footing, the record-long expansion is forging ahead into uncharted territory.

The unemployment rate remains near a 50-year low and inflation is under control. The 10-year Treasury rate dipped below 2% at the beginning of July, but has since increased by about 10 bps. However, the 10-year rate is still about 80 bps lower than it was a year ago. Global uncertainty is the main culprit; the uncertainty has led the Fed to signal that it may cut the federal funds rate later this month. But despite some worries about a recession within the next year, CRE investors appear somewhat optimistic compared to other types of investments.

The decreasing Treasury rate in 2Q 2019 has resulted in a widening of the spread between the real estate yield over the bond yield. With the average real estate yield increasing from 1Q 2019 to 2Q 2019 and both Moody’s Baa and Moody’s Aaa decreasing over the same time period, the spreads between real estate yields and corporate yields have also widened.

Amid these developments, Situs RERC released its 2Q 2019 edition of the Situs RERC Flash Report in early July. The report provides a preliminary look at institutional investment conditions, required cap and yield rates and other investment criteria based on survey data received by Situs RERC as of June 17.

According to the survey data, required internal rates of return (IRRs; also known as pre-tax yield rates) rose among all the property types except industrial R&D. On average, the overall yield for all property types increased 10 bps from last quarter, and industrial flex had the largest increase – 30 bps.

The average overall CRE required going-in and terminal rates were unchanged from 1Q 2019 to 2Q 2019. For the fourth consecutive quarter, apartment registered the lowest going-in cap rate of all property types; it also experienced the lowest terminal cap rate in preliminary 2Q 2019 results.

Investment conditions improved for many property types from 1Q 2019 to 2Q 2019. The industrial warehouse subtype continued to garner, by far, the highest rating in investment conditions among all property types, according to Situs RERC’s preliminary 2Q 2019 survey data. However, investment conditions decreased for both of industrial’s other subtypes, R&D and flex. Industrial R&D recorded the largest decrease in investment conditions.

The largest increases in investment conditions were in neighborhood and community centers, suburban office and power centers. Preliminary data also show an increase in the hotel investment conditions rating in 2Q 2019. Respondents gave hotel a rating behind only warehouse and apartment. Regional mall had the second largest decline and continues to hold the lowest rating among all subtypes surveyed.

As additional investment survey data continue to come in, they will be integrated with current data and reported in the full 2Q 2019 Situs RERC Real Estate Report, set for release at the end of August. Our report is the nation’s longest-running real estate research report offering investment criteria and investor insights on all the major markets and property types.

To purchase your copy of the complete Flash Report or to subscribe to the Situs RERC Real Estate Report, visit store.rerc.com or call 319-352-1500.

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