Amidst Continued Political Uncertainty, North America Real Estate Remains Stable
CHICAGO (July 19, 2017) – Real estate market fundamentals in North America performed in line with expectations during the first half of 2017, with a few variations – primarily in the U.S. – stemming from the pace of change within the retail sector, the sharper-than-expected slowdown in transaction volume, along with the sustained political turbulence and slower-than-expected progress on key policy initiatives. According to LaSalle Investment Management’s (“LaSalle”) Mid-Year Investment Strategy Annual (“Mid-Year ISA”) 2017, the U.S. and Canadian real estate markets continue to attract investor interest despite these trends.
The Mid-Year ISA also reinforces the case for adding environmental factors to the DTU (demographics, technology and urbanization) secular drivers of real estate demand. LaSalle does not see the U.S. pull-out from the Paris climate treaty affecting the long-term importance of these “E-factors.”
LaSalle clients can view the full report at: http://www.lasalle.com/research/reports/2017-investment-strategy-annual-mid-year-update
In the U.S., several factors such as below-trend economic growth, slowing rent growth and a decrease in transaction volume have caused U.S. real estate values and returns to moderate. While the US real estate market remains healthy, this trend is a reversal from the strong growth of the past six years.
Investor appetite for Canadian real estate continues to grow driven by a strengthening Canadian economy, strong fundamentals in gateway markets and a low Canadian dollar. However, high average household debt levels nationally and frothy housing markets in Toronto and Vancouver remain risks, while ambiguity still looms concerning the renegotiation of the North American Free Trade Agreement (“NAFTA”) which is slated to occur later this year.
Bill Maher, Head of Americas Research & Strategy for LaSalle, said: “In an environment of political change that has caused increased political and regulatory uncertainty, the financial and economic sectors (including real estate) in North America have remained remarkably steady. Perhaps the biggest surprise is the lack of meaningful legislative changes enacted by the Republican–controlled U.S. Congress. Two initiatives that could have a significant impact on real estate – tax reform and trade policy – may not move forward in 2017, and the final form of these changes have a wide variety of outcomes. At this point in time, we believe Canada remains a bright spot with heightened transaction activity due to broad-based strength across several sectors. How the Trump administration moves forward with renegotiating NAFTA will impact the market’s future outlook.”
The Mid-Year ISA shows that capital flows to U.S. real estate are above long term levels but decelerating. Trading volumes are down 15-20% through April; however full year 2017 volumes are likely to be down less. Activity has fallen the most in major markets, as investors have shifted to secondary markets searching for higher yields. Conversely, Canada continues to experience record levels of real estate transaction volume. Of note, Q1 2017 transaction volume in Canada reached $9.1 billion – a five-year quarterly high – with foreign capital accounting for $1.7 billion or 19% of the total.
Rich Kleinman, Managing Director of Research and Strategy in the U.S. for LaSalle, said: “For the U.S. real estate market, our base case economic scenario calls for several more years of moderate growth and real estate returns consistent with long term trends – 4-5% in real terms. However, we acknowledge and continue to plan for a potential recession or slow-down prior to 2020.”
Select North American property sector insights from the Mid-Year ISA, include:
Apartments: Suburban markets in the U.S. lacking recent construction continue to outperform downtowns on rent growth. As predicted, the slowdown in new supply due to tightened bank lending for new construction is directionally correct. However, the decline in new permits year to date has been less than anticipated. In LaSalle’s 2017 ISA, Canadian build-to-core was a recommendation and the sector continues to remain attractive. Recently implemented rent controls in Ontario, Canada will limit income growth; however a slowdown in new supply and continued favorable demographics should keep multifamily occupancy levels high.
Retail: Despite generally favorable economic data in the U.S. markets, an unusually high number of retailers filed for bankruptcy or announced store closings in the first half of 2017 after reviewing their long term “brick and mortar” strategies. Retail REITs – especially mall REITs – significantly underperformed during the first half of the year. While retail vacancy rates remain at cyclical lows, net absorption is expected to slow in the coming year as planned closings take place. The recent announcement that Amazon intends to buy Whole Foods indicates that the supermarket sector is not immune to changing models of delivery and consumption. However, neighborhood centers with top performing grocers (including Whole Foods) should continue to stay full and provide steady income. In Canada, urban retail and mixed use with retail remain attractive.
Warehouse/Industrial/Logistics: In the U.S., the industrial sector continues to be the strongest performing property type with an availability rate of 8.0% – the lowest level in 16 years – and should generate the strongest rent growth of all property types over the next several years. Construction is ramping up quickly - 2017 will likely be the first year, since the recovery began, that the availability rate will rise. However, tenant demand is very strong and build-to-core industrial remains very attractive. In Canada, warehouse remains the strongest sector, particularly in the gateway markets of Toronto and Vancouver. For higher return strategies, warehouse and small bay lease-up remains a recommended strategy, buoyed by all-time low availability in the aforementioned submarkets.
Office: The U.S. office market got off to a slow start in 2017 given net absorption that was seasonally slow and below expectations. Tech-driven office markets should see a correction in the medium term, when a reversal in demand will team with new supply to spike vacancy rates. Medical office continues to offer a low risk option to invest in the office sector, despite the threat of a possible “repeal and replace” of the Affordable Care Act. As investors begin to recognize the long-term challenges of office investment, a price-driven opportunity should develop for investors willing to take on moderate risk in exchange for a modest return premium. In Canada, the Alberta office markets (Calgary and Edmonton) are likely to continue to struggle with high vacancy and limited demand in late 2017 and beyond. While prices remain low, they have stabilized compared to the past two years.
About LaSalle Investment Management
LaSalle Investment Management, Inc. (together with its global investment advisory affiliates, “LaSalle”) is one of the world’s leading real estate investment managers. LaSalle on a global basis manages approximately $57.6 billion of private and public equity and private debt investments. LaSalle’s diverse client base includes public and private pension funds, insurance companies, governments, corporations, endowments and private individuals from across the globe. LaSalle sponsors a complete range of investment vehicles including separate accounts, open- and closed-end funds, public securities and entity-level investments. LaSalle is a wholly-owned, operationally independent subsidiary of Jones Lang LaSalle Incorporated (NYSE: JLL), one of the world’s largest real estate companies. For more information please visit www.lasalle.com.
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