Is The Real Estate Trend Still Your Friend?

By August 10, 2017Blog

Is The Real Estate Trend Still Your Friend?

To say that the commercial real estate market in the United States has been on a tear over the past several years is putting things mildly.

Since 2011 the top six markets in the U.S., including Los Angeles, have seen:

  • Retail property prices increase by 52%
  • Industrial property prices increase by 63%
  • Apartment property prices increase by 90%
  • Office property prices in the central business district increase by 96%

The Federal Reserve’s low interest rate policy deserves much of the credit for these historically high prices, as does the amount of foreign investment capital flowing into the U.S.  Over the past five years annual foreign purchases of real estate priced at $2.5 million or more has more than tripled, from $25 billion in 2011 to over $80 billion just last year.

Real estate investors have found themselves in a negative interest rate environment, chasing positive yields while at the same time having to compete with foreign investment and global family office funds, pushing capitalization rates down to historic lows.

Through the first half of this year, Class A central business district office space investments yield 4% in Los Angeles and San Francisco, 4.5% in Orange County, and 5% in San Jose.  Factor in the officially reported inflation rate of 1.6% and the returns in Los Angeles are reduced by nearly half.

With high prices and low yields, sophisticated investors are beginning to question how long the trend is going to continue.

Will the Fed actually continue to increase interest rates?  So far there have been two small increases without a noticeable effect on commercial real estate yields.

What effect will immigration have on the commercial real estate market?  With President Trump’s most recent decision to focus on immigration visas only for highly skilled foreigners, fewer non-tech immigrants means fewer workers for construction, meaning that costs will increase and affordability will decrease.

As we mentioned in a recent article, both of these factors create uncertainty in the U.S. commercial real estate market going forward.  And unknown risk is something that investors will go to great lengths to avoid.

Add to this the amount of new inventory in the pipeline and the future for commercial real estate yields in this country becomes even more uncertain.

Even if the Fed is successful in incrementally increasing interest rates without stalling the economy, even if the politicians are able to get their act together and address the health care issue, reform the tax code, and begin funneling money into infrastructure projects – and all of these are big ‘ifs’ – many believe that the U.S. real estate market will remain in an era of mid-single digit returns and basically flat growth of property yields and net operating incomes.

With this in mind, commercial real estate investors in the United States are beginning to look north of the border to remove some of the risk and unknown that currently lurks in their investment portfolios, while aiming to profit from returns that quarter by quarter are becoming much more difficult to find elsewhere.

One Canadian market that TwinRock Partners has been analyzing for some time is Calgary, Alberta.  The sudden declined in oil prices has pushed the economy there into a recession, with projected GDP this year forecast at 2.1% and with employment growth anticipated to be less than 1%.

While real estate prices in Calgary have declined as well, we believe this to be temporary, because the real estate market there has seen both booms and busts before, similar to what the office market in Orange County went through not too long ago.

For the time being, Class A office property in Calgary offers a relatively low point of entry into the market before the next upward movement begins.

Investing in Canada also avoids the enormous political and economic uncertainty in the United States while at the same time leveraging the currently strong U.S. dollar against the weaker Canadian dollar.

As we posited in our most recent investor newsletter, would you rather continue to invest near the end of an economic expansion or at the beginning of one?