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Minnesota Commercial Real Estate Outlook Shows More Signs of Optimism

Spring 2019 – Minnesota Commercial Real Estate Outlook Shows More Signs of Optimism for the Upcoming Two Years

The May 2019 University of St. Thomas / Minnesota Commercial Real Estate Survey is continuing to show to show changes in the sentiment of our panelists as they look out over the next two years. The biannual survey projects a two-year ahead outlook for Minnesota’s commercial real estate industry and forecasts potential opportunities and challenges affecting all commercial real estate sectors.

As was done with all sixteen of our previous surveys, the same group of 50 commercial real estate industry leaders involved in development, finance, and investment were polled regarding their expectations of near-term future commercial real estate activity. The decisions that these industry leaders are making today will determine what the CRE markets will look like two years from now.

Spring 2019 Results

Observations from May 2019 have recorded several notable changes in the panel’s expectations when compared to the previous survey conducted in Fall 2018. “There is still some concern that we are near the top of the cycle and that overbuilding and increased vacancies may occur in some product types and submarkets.” says Herb Tousley, Director of the Real Estate Programs at the University of St Thomas. “While our composite index for late 2021 remains slightly pessimistic, there are some bright spots worth noting. There is no expectation of a major downturn in the commercial real estate market in the Twin Cities within the next two years. The increase in online shopping, low interest rates, changes in housing trends and the continued redefinition of the office environment will remain major factors in the performance of commercial real estate in the coming two years.”

The panelists are very concerned about the expected increase in the cost of land and building materials and its expected impact on values and expected returns for developers and investors. There was a big change in the index for investor’s return expectations. It increased 9 points moving from a pessimistic level moving to slightly optimistic territory. This is a big change in sentiment since our last survey. It appears that our panel now expects interest rates to remain stable at current low rates. While our respondents are not expecting a major downturn, they are more somewhat concerned about where we are in the market cycle.

Index values greater than 50 represent a more optimistic view of the market over the next two years, with values of less than 50 indicating a more pessimistic view. More detailed information about each of the individual indices may be found below.

The individual indexes are detailed below:

Rent Expectations

The outlook for rental rates is essentially unchanged from our last survey. Market conditions expected in early 2021 are best described by the price for space (rental rates) and the supply of space (occupancy levels). The index for rental rates was 63 compared to 62 six months ago. This means the panel continues to be strongly optimistic in its expection of continued rent growth. The panel’s sentiment is that the economy will continue to grow and that business conditions will continue improve creating more competition for commercial space.

 Occupancy

The outlook for occupancy levels continues to be moderately pessimistic moving from 43 to a slightly less pessimistic 45. This indicates the panelist’s belief that occupancy levels and space absorption may not remain at current levels during the next two years. As a great deal of new product continues to be delivered, the panel is beginning to be concerned about the market’s ability to absorb the new space. This is especially noticeable in the multi-family and certain office and industrial segments. It is a continuation of a general trend that began 4 ½ years ago. Businesses expect to continue to grow but they are concentrating on reducing their cost of occupancy by doing more with less space.

Land Price Expectations

The rate of increase in land prices is expected to accelerate. The land price index has decreased (become more pessimistic) in the current survey moving from 46 last December to 40 this spring. Although, the lowest point for the index was recorded at 31 in the fall 2013 survey, a score of 40 for this index indicates increasing concern about the rapid rise of land prices. Since land prices are a major component of project costs, any increase has a great deal of impact. Higher land prices are a hindrance to new development, making it more difficult to obtain financing and adequate returns for investors.

Building Material Price Expectations

There is a continued expectation that increases in the price of building materials will continue to increase. The index for the price of building supplies remains strongly negative, moving from 26 in December 2018 to 32 in May 2019. The panel believes that commodity prices for lumber, concrete, steel and many of the other materials used in construction will continue to increase due to shortages and newly imposed tariffs. Since building materials are a major cost component of any development project any increases in prices will make it difficult to provide adequate returns on future developments.

Return on Investment Expectations

Our panel expects that investors return on investment expectations will remain constant. The index for investor’s return expectations made a big move, increasing from a pessimistic 42 to a slightly optimistic 51. This indicates that investors will be expecting to maintain their expected returns. The consensus among survey respondents indicates that investors will not be seeking higher returns in the next two years due to their expectation of stable interest rates. The panel’s concern remains about market fundamentals over the next two years. Investors will continue to seek out quality investments, but they will be much more diligent about how they price risk, evaluate projects and developer/sponsors when they evaluate potential return when considering their investment options.

Lending Expectations

Equity and loan to value requirements are not expected to increase. The index for the amount of equity required by lenders remained unchanged from our last survey at 41. That recorded level is somewhat pessimistic but, now that appears interest rates have moderated and are expected to stay that way, the panel’s belief that is even if interest rates were to increase moderately credit will still be available for good projects. However, they expect lenders will continue be more risk adverse by tightening their underwriting criteria in the coming two years.

 

 

 

 

 

Appraisal, Commercial Lending, Commercial Real Estate, Commercial Real Estate Index, Development, Industry News, Twin Cities Real Estate

Minnesota Commercial Real Estate Outlook Showing Increased Signs Of Pessimism

 

The October 2018 University of St. Thomas / Minnesota Commercial Real Estate Survey is continuing to show to show changes in the sentiment of our panelists as they look out over the next two years. The biannual survey projects a two-year ahead outlook for Minnesota’s commercial real estate industry and forecasts potential opportunities and challenges affecting all commercial real estate sectors.

As was done with all fifteen of our previous surveys, the same group of 50 commercial real estate industry leaders involved in development, finance, and investment were polled regarding their expectations of near-term, future commercial real estate activity. The decisions that these industry leaders are making today will determine what the CRE markets will look like two years from now.

Fall 2018 Results

Observations from October 2018 have recorded several notable changes in the panel’s expectations that were observed in the last survey conducted in December 2017. “There is some concern that we are near the top of the cycle and that overbuilding and increased vacancies may occur in some product types and submarkets.” says Herb Tousley, Director of the Real Estate Programs at the University of St Thomas. “While the forecast for 2020 has become slightly less optimistic, there is no expectation of a major downturn in the commercial real estate market in the Twin Cities. The increase in online shopping, higher interest rates, changes in housing trends and the continued redefinition of the office environment will remain major factors in the performance of commercial real estate in the coming two years.”

Our panelists seem to be most concerned about the expected increase in the cost of building materials and the impact of rising interest rates on values and expected returns for developers and investors. The panel has changed to a more pessimistic outlook on all categories (see the chart at the end of the report). While our respondents are not expecting a major downturn, they are more concerned about future prospects than they have been in our previous surveys.

The composite index of all the other indices the survey continues to indicate a slightly less than neutral expectation looking ahead two years to late 2020. The composite index was recorded at 42. This is slightly less optimistic than the 43 that was recorded a year ago. Index values greater than 50 represent a more optimistic view of the market over the next two years, with values of less than 50 indicating a more pessimistic view. More detailed information about each of the individual indices may be found below.

The individual indexes are detailed below:

Rent Expectations

The outlook for rental rates has become less optimistic. Market conditions expected in late 2020 are best described by the price for space (rental rates) and the supply of space (occupancy levels). The index for rental rates was 62 compared to 67 one year ago. This means the panel now has a lower expectation of the rate rents will increase for all property types over the next two years. The panel’s sentiment is that the economy will continue to grow and that business conditions will continue improve at slower pace, creating less competition for commercial space.

Occupancy

The outlook for occupancy levels has changed significantly moving from slightly optimistic 52 to more pessimistic 43. This indicates the panelist’s belief that occupancy levels and space absorption may not remain at current levels during the next two years. As a great deal of new product has been delivered the panel is beginning to be concerned about the market’s ability to absorb the new space. This is especially noticeable in the multi-family, office and industrial segments. It is a continuation of a general trend that began 4 years ago. Businesses will continue to grow but they are concentrating on reducing their cost of occupancy by doing more with less space.

Land Price Expectations

The rate of increase in land prices is expected moderate. The land price index has increased (become less pessimistic) in the current survey moving from 38 last in December 2107 to 46 this fall. The lowest point for the index was recorded at 31 in the fall 2013 survey. This index has become somewhat less pessimistic. Although land prices are expected to continue to increase during the next two years, any moderation in the rate of increase would help to keep total project costs in check. Higher land prices are a hindrance to new development, making it more difficult to obtain financing and adequate returns for investors.

Building Material Price Expectations

There is a continued expectation that increases in the price of building materials will continue to accelerate. The index for the price of building supplies remains strongly negative, moving from 24 in December 2017 to 27 in October 2018. The panel believes that commodity prices for lumber, concrete, steel and many of the other materials used in construction will continue to increase due to shortages and newly imposed tariffs. Since building materials are a major cost component of any development project any increases in prices will make it difficult to provide adequate returns on future developments.

Return on Investment Expectations

Our panel expects that investors return on investment expectations will increase. The index for investor’s return expectations has become more pessimistic moving from 42 to 39. This indicates that investors will be expecting to achieve higher returns. The consensus among survey respondents indicates that investors will be seeking higher returns due to their expectation of increasing interest rates and concern about market fundamentals over the next two years. Investors will continue to seek out quality investments but they will be much more diligent about how they price risk and evaluate return when considering their investment options.

Lending Expectations

Equity and loan to value requirements are expected to remain essentially unchanged. The index for the amount of equity required by lenders has decreased slightly, moving from 42 to 41 in December 2017 to 42 in October 2018. Although interest rates have increased somewhat since our last survey, the panel’s belief that is even if interest rates continue to increase moderately credit will still be available for good projects. However, they expect lenders will continue be more risk adverse by tightening their underwriting criteria in the coming two years.

 

 

 

 

 

 

Commercial Real Estate, Commercial Real Estate Index, Economics, Industry News, Office Real Estate, Real Estate Trends, Retail Real Estate, Twin Cities Real Estate

Minnesota Commercial Real Estate Outlook Showing Few Changes Following Election, says University of St Thomas Minnesota Commercial Real Estate Survey

The December 2016 University of St. Thomas/Minnesota Commercial Real Estate Survey, taken entirely after the November 8th election, shows few changes in commercial real estate leaders outlook. The biannual survey projects a two-year-ahead outlook for Minnesota’s commercial real estate industry and forecasts potential opportunities and challenges affecting all commercial real estate sectors.

In all 12 surveys the same group of 50 industry leaders have been polled on their expectations for future commercial real estate activity in six categories: rents, occupancy levels, land prices, cost of building materials, rate of return, and equity requirements. Their responses are used to create index scores that can be compared over time. Scores higher than 50 represent a more optimistic view of the market over the next two years; scores less than 50 represent a more pessimistic view.

The panel is expecting to see a continuation of the favorable market conditions for commercial real estate that we have been experiencing for the last two to three years. The results of the November 8th presidential election does not appear to have significantly changed their outlook for the next two years

Observations from 2016 have recorded few major changes in expectations from before the election compared to after the election. “The natural cycle in commercial real estate appears to be running its course somewhat independent of the presidential contest” says Herb Tousley, Director of the Real Estate Programs at the University of St Thomas. “While the forecast for 2017 still looks good, the increase in online shopping, higher interest rates, and the continued redefinition of the office environment will remain major factors in the performance of commercial real estate in 2017.”

Here is a look at the panel’s responses for each of the questions.

Rent Expectations

An outlook that rents will continue to increase at current rates. The index for rental rates has increased from a highly optimistic 60 to a slightly more optimistic 61. This is an indication of an expectation of continued rent growth over the next two years and that the economy will continue to grow and that business conditions will continue improve.

Occupancy Expectations

A moderately positive outlook on expected occupancy levels. The index for occupancy levels increased moderately from 52 to 54. This indicates the panelists continue in their belief that occupancy levels will increase slightly over the next two years. This is a continuation of a trend that began 1 ½ years ago that reflects their expectation that business will continue to expand and will need more space.

Land Price Expectations

Increases in land prices are expected to moderate. The panel’s outlook for land prices reveals an expectation that land prices will increase at a slower rate between now and fall 2018. The land price index has increased (become less pessimistic) for the fourth consecutive survey moving from 40 last spring to 46 this fall.

Building Material Price Expectations

Increases in the price of building materials are expected accelerate.  The index for the price of building supplies took a sharp turn downward, moving from a strongly negative 32 to an even more negative 29. This reflects the panel’s strong belief that rate of increase in building material prices will accelerate over the next two years.

Return on Investment Expectations

Investors return expectations are expected to increase slightly over the next two years. The index for investor’s return expectations has decreased slightly moving from 48 to 46. This slight decline indicates that investors will be looking for higher returns. The consensus among survey respondents indicates that investors will be seeking higher returns due to their expectation of increasing interest rates over the next two years.

Lending Expectations

More equity is expected to be required.  The index for the amount of equity required by lenders decreased significantly, falling from 42 in to 36. This indicates the panel’s strong belief that credit will be available for good projects but lenders will be more risk adverse by increasing their equity requirements in the coming two years.

 More Information

Additional details can be found on the Shenehon Center’s website: http://www.stthomas.edu/business/centers/shenehon/research/default.html.

Commercial Real Estate, Commercial Real Estate Index, Development, Economics, Industrial Real Estate, Industry News, Investment Real Estate, Office Real Estate, Real Estate Trends, Retail Real Estate, Twin Cities Real Estate

Semiannual Survey of the Twin Cities Commercial Real Estate Experts Predicts Continued Favorable Market Conditions

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Leaders in the field of Minnesota commercial real estate expect to see a continuation of the favorable market conditions for commercial real estate that we have been experiencing for the past two to three years.

May 2016 Results

The semi-annual Minnesota Commercial Real Estate Survey conducted in May 2016 has produced some interesting results. Overall, the survey continues to indicate a slightly less than neutral expectation looking ahead two years to spring 2018 for commercial real estate. The composite index was recorded at 46. This is the sixth consecutive survey where the composite index has been in the 46 – 48 range. Index values greater than 50 represent a more optimistic view of the market over the next two years, with values of less than 50 indicating a more pessimistic view. Although the composite index level is similar to previous surveys the pattern of the individual indexes in the current survey is very different.

As was done with all ten of the previous surveys, the same group of 50 commercial real estate industry leaders involved in development, finance, and investment were polled regarding their expectations of near-term, future commercial real estate activity. One thing we have observed in the current survey is there is less variation in the responses and that has caused a more uniform response rate reflecting the panel’s increased certainty in their views. The individual indexes are detailed below:

Rent Expectations

Less optimistic outlook that rents will continue to increase at current rates. Market conditions expected in spring 2018 are best described by the price for space (rental rates) and the supply of space (occupancy levels). The index for rental rates has declined from a highly optimistic 66 to a somewhat less optimistic 60. This is an indication of an expectation of a moderation of rent growth over the next two years. Higher rents help to offset the increased costs of new construction. A slowdown in rent growth puts pressure on expected returns that will be achieved by developers and owners.

Occupancy Expectations

A continued neutral outlook on expected occupancy levels. The index for occupancy levels increased slightly from 50 to 52. Despite the increase, the panelists continue in their expectation that occupancy levels will remain steady at current levels. As new buildings have been completed it takes some time for the market to absorb the new space. Over the last 2 years the occupancy index has been drifting downward towards a neutral expectation concerning the demand for space.

Land Price Expectations

Increases in land prices are expected to moderate. The panel’s outlook for land prices reveals an expectation that land prices will increase at a slower rate between now and spring 2018. The land price index has increased (become less pessimistic) for the third consecutive survey moving from 37 last fall to 40 this fall this spring. The low point for the index was recorded at 31 in the fall 2013 survey. This sentiment while still in pessimistic territory indicates an expectation that land prices will moderate their rate of increase during the next two years. Increasing land prices increase total project costs and are a hindrance to new development, making it more difficult to obtain financing and adequate returns for investors.

Building Material Price Expectations

Increases in the price of building materials are also expected moderate.  The spring 2016 survey reveals that for the fourth consecutive survey our panel continues to become less pessimistic about the rate of increase in price of building materials. The building material index moved from a strongly negative 32 to a somewhat less negative 37, reflecting the panel’s opinion that building material price increases are expected to moderate. Since building materials are a major cost component of any development project any improvement in prices will be favorable for future development.

Return on Investment Expectations

Investors return expectations remain unchanged over the next two years. The index for investor’s return expectations has increased slightly for the third consecutive survey at 48. Although this index value is slightly pessimistic, it is essentially neutral.  The consensus among survey respondents continues to indicate that investors expected returns will not change significantly in the next two years. Investors will continue to seek out quality investments but they are being much more diligent about how they price risk and evaluate return when considering their investment options.

Lending Expectations

More equity is expected to be required.  The index for the amount of equity required by lenders decreased significantly, falling from 51 in to 42. This indicates the panel’s strong belief that credit will be available for good projects but lenders will increase their equity requirements in the coming two years. The good news is that more equity should result in better rates and terms; however, the bad news is that in many cases equity is harder to find and more expensive than debt.

 Summary

To summarize the panel is expecting to see a continuation of the favorable market conditions for commercial real estate that we have been experiencing for the last 2 to 3 years, however there will be some differences as to why this will happen. The panel has moved from a positive to a neutral position on occupancy. With all of the new product coming on line it is expected that given a little time the market will be able to absorb all of the new space but while this happens occupancy rates will be depressed in the short run. Additionally, the panel expects to see continued rent growth, however, that growth will be at a slower rate as new product comes on line and is absorbed. Development efforts will be helped by an expected moderation in the rate of increase in land prices and building materials. The panel is also expecting to see lenders tighten their lending standards somewhat. That results in lower loan amounts and higher equity requirements on development projects. Higher equity requirements makes development more difficult since equity dollars are more expensive and using less debt financing tends to reduce the rate of return on a project. Overall, our panelists see continuing activity at or near present levels in most categories of commercial real estate during the next two years.

May 2016 Commercial Survey