MARKET INSIGHTS
February 21, 2017

By Andrew Little

If current capital markets exuberance for the new administration is any indication, 2017 could be huge for commercial real estate.

While 2016 was a terrific year, it didn’t quite live up to 2015’s amazing standards.

Despite a spike in interest rates during the last few months of 2016, 2017 is starting off with great promise as inflation is the word around Wall Street and real estate is viewed as a good hedge.

Several themes emerge when reviewing 2016 and looking into 2017.

According to data from Real Capital Analytics, a New York­based real estate research firm, sales volume for 2016 through November is down about 10 percent from 2015 on all sales across the country.

A subset of data from RCA related to the Richmond area shows sales volume locally is down even greater than the U.S. trend. Preliminary data show sales volumes were down $420 million — or about 25 percent — in 2016 from 2015.
Digging into the Richmond­area numbers reveals the 25 percent dip relates to several blockbuster deals that occurred in 2015 that skewed the numbers a bit.

For instance, the biggest volume decline was in the sale of flex and industrial properties, which came in at about $159 million in 2016 compared with $377 million in 2015.

Sales were bolstered in 2015 by the sale of two local Amazon distribution centers — in Chesterfield and Dinwiddie counties — that sold for $138 million and the sale of First Potomac Realty Trust’s portfolio of 19 buildings in six business parks throughout the region that sold for $60 million.

In 2015, two large downtown office buildings — the two 20­story Riverfront Plaza towers and the 18­story Gateway Plaza — traded for a combined $249 million, which was more than 60 percent of the $410.95 million total sales recorded in 2015.

In 2016, three downtown office towers traded as well — the sale of 24­story Bank of America Center and the 15­story Williams Mullen building as well as the recapitalization of the 24­story SunTrust Center by Parmenter in a $40.2 million joint venture with Partners Group. The proceeds from the combined transactions only accounted for $160.2 million, or about 43 percent of the $371.8 million in total office sales.

In the region’s suburban markets, Brandywine Realty Trust’s entered into a joint venture for its office and office­warehouse portfolio while the sale was completed on the medical office building in the Towne Center West development in Henrico County occupied by VCU Health.

The trend toward higher suburban office sales also was experienced nationwide. According to RCA data through November, sales of suburban office were up slightly from the same period in 2015, whereas volume was down 10 percent in the central business district’s office sector from 2015 to 2016.

The other trend in 2016 nationwide was the continuation of apartments as the darling of the commercial real estate investment world.

Fannie Mae and Freddie Mac both eclipsed 2015 loan volumes in 2016 and set another record for originations. This helped apartments become the top selling asset class nationwide through the 11 months ended Nov. 30.

In the Richmond region, apartment sales volume was down about $110 million in 2016 compared with 2015.

The trend was for investors to purchase older, cheaper, suburban complexes in 2016 to fix them up and push rents, whereas 2015 was dominated by the sale of luxury complexes such as The Flats at West Broad Village and the Retreat at West Creek in Goochland County.

Interest rates went on a wild ride in 2016 and ended the year right about where they started. The 10­year U.S. Treasury started the year at 2.27 percent and ended the year at 2.45 percent. In between, the 10­year yield fluctuated from a low of 1.37 percent on July 5 to a high of 2.6 percent on Dec. 16.

Commercial mortgage rates also moved wildly. According to the John B. Levy National Mortgage Survey, rates are currently in the 3.75 percent to 4.2 percent range for 5­ and 10­year mortgages.

Conduit rates are higher, averaging close to 5 percent, but the commercial mortgage backed security market is in the middle of absorbing a regulatory change that is forcing what many lenders are calling price discovery.

In 2016, conduit lending across the country was down from 2015 by about $25 billion with total volume finishing at about $76 billion domestically, down from $101 billion domestically in 2015.

The difficulty in the conduit market was felt early in the year, and the market never fully recovered. Turmoil and low volume in the industry created a shake out to narrow the once growing field of over 40 CMBS lenders down to less than 30 in 2016 (and shrinking).

2017 is starting off with great promise. Growing employment and production in the U.S. is good for commercial real estate.

Real estate is generally a good hedge against inflation — which is expected to pick up with the prospect of greater government spending and a tight employment market.

The one drag is higher interest rates, but the rise in interest rates is not significant when compared to the beginning of the year and rates remain extremely low from an historical perspective.