Cap Rate Forecast 2017 (Compression or Expansion?)

At times we are so consumed in our daily grind of work that we have to remind ourselves to stop take a breath and pop our heads up and look at the macro view of the market. These times allow us to take the micro data we are exposed to in our local markets and activity and see how that translates into the global macro view of the future. As real estate moves at a much more glacial pace than say the equities market, we can help to identify macro trends that may cause minor course corrections to help us be better fiduciaries and deliver the best returns possible.

When we look at a macro view of the US real estate market, we are taking into account several factors. Those factors are GDP, US Treasury interest rates, Job creations, population (births and immigration), wage growth, CAP rates and foreign investments.

When we sit down and shift through this data, we are making analysis and forecast for the near future. Although, our crystal balls are quite fuzzy we have learned that there are some identifiers with economic factors before they become boom and bust cycles (bubble and burst). One of the key takeaways has been the current CAP rate compression in the Big 6 (Boston, Chicago, LA, NYC, SF and DC) and the other core markets. So a quick recap, if CAP rates are compressing that, means the real estate values are going up. So, CAP rate down (compression), asset values up. Currently, we now have real estate values in some of those core markets at new all-time highs. The question across the industry is with new all-time highs are we priming for a new correction and down market.

Given this macro look at the market and the current global environment here is my take on the data and forecast for cap rates and values in 2017. As we are fresh off the rumblings of the “Brexit”, we have to understand this, and other global factors are hamstringing the fed and their ability to make any additional rate increases for the near future.

We then take into account the foreign investment money that is looking for a safe harbor (Sovereign Wealth Funds, Foreign Insurance Companies, international blue chip corporations and PE firms with foreign investment capital). When we make those analyses and the fact that most of the global markets are sitting in a negative interest climate we understand that the spread of negative interest to those compressed CAP rates (high values) of core markets still seem quite attractive to a foreign investor. This, in my opinion, will drive more foreign capital investments into core markets and sustained or further CAP rate compression.

What does this mean for us if core markets continue to see a compressed cap rates (increase in values)? It is my prediction is that when those assets sell in SF, LA, NYC etc that capital will need to be reallocated and reinvested. I believe that most of those domestic fund will choose to reinvest back into the US. However, the fact that the capital is based in the US they will look reinvest into markets that they can make a safe return. This will lead to the spillover effect of more domestic capital into secondary and tertiary markets. Some of those secondary and tertiary markets are Denver, Dallas, Austin, Charlotte, Atlanta, Seattle, San Antonio, Phoenix, etc. That increase of capital will lead to an increase of values and further CAP rate compression for those markets as well. So the macro view of the US real estate market for 2017 is that we will see a very steady eddy status quo moving forward. This is not to say that the US economy or RE markets are doing anything spectacular it is just that we are currently the tallest midget in the global economy.

Have a cool and blessed rest of summer.