US real estate: growing optimism
Second-tier cities look most attractive as economic and real estate conditions continue to strengthen and credit become easier.
- Economic indicators improving.
- Real estate occupier market strengthening.
- Real estate debt market recovering.
- Real estate looks attractively priced relative to most income-producing asset classes.
- Retail and office sectors in second-tier cities look most attractive on risk adjusted basis.
US economic growth has been impressive. Growth was faster-than-expected in the third quarter, at 4.1% on an annualised basis.1 We expect the economy to expand by around 3% in 20142, driven by increased consumer spending, as a rebound in house prices and booming stock markets boost household wealth. In response to the improved economic outlook, the Federal Reserve (Fed) began scaling back its monthly bond purchases in December, which financial markets have taken in their stride.
Rental markets improving across the board
As the economy has improved, so has the real estate market. The rental market is strengthening and vacancy rates have fallen steadily since 2010. The third quarter of 2013 saw further falls in vacancy levels across every sector, apart from apartments. But vacancy rates are lowest in this sector at just 5.8%3. The recovery has also reached the retail sector having delivered its third consecutive quarter of positive rental growth.
Investment market conditions continue to look robust, with US commercial property returning 2.6% in the third quarter of 2013 according to the National Council of Real Estate Investment Fiduciaries (NCREIF). The NCREIF index also shows capital values have risen 25% since the first quarter of 2010 after a 32% decline from the previous peak.
According to figures from JLL4, commercial real estate volumes in the US in 2013 reached $240bn, up 18% from the previous year. Investment volumes are expected to continue growing this year on the back of stronger economic growth and improving liquidity via debt and equity markets.
Marked improvement in credit conditions
Credit conditions are easing and the real estate debt market has improved markedly over the past year. The October 2013 Fed’s Senior Loan Officer Opinion Survey showed domestic banks had eased lending standards and experienced increased demand for commercial real estate loans.
A sign of increased willingness to lend is evident in the commercial mortgage-backed security (CMBS) market. Issuance in the first 11 months of the year was $84.4bn, according to data specialists Dealogic.
Although down significantly from the 2007 peak, CMBS issuance in 2013 is set to have roughly doubled from the previous year and we believe CMBS lending will accelerate further in 2014. Furthermore, the delinquency rate for US commercial real estate loans that comprise CMBSs has fallen to 7.66%, 268 basis points below the mid-2012 peak.
Despite a sharp rise in government bond yields during 2013, real estate still looks attractively priced relative to most income producing asset classes including government and corporate bonds.
The scope for yields to fall further in gateway cities – such as New York, San Francisco and Chicago – appears limited. Although there will still be some attractive assets in these locations, we believe second-tier cities such as Dallas, Miami, San Diego and Seattle provide more attractive opportunities, particularly in the retail and office sectors.
1. Source: US Bureau of Economic Analysis December 2012
2. The forecast figure is based on Aviva Investors estimates which may or may not be achieved. It is provided for information purposes only and it is not to be relied upon for the purpose of making investment decisions.
3. Source: PPR Q4 2013
4. As at January 2014