ObamaCare and Federal Budget Wrangling Effect on Commercial Real Estate

Date: 09/26/2013

Several years after the recession has ended, the commercial real estate recovery remains varied, with multifamily soaring and retail still the lagging sector. Meanwhile, uncertainties over the federal budget and the implementation of the new federal healthcare reform law, known as Obamacare, could slow the economy and the commercial real estate industry recovery as well.

Those were several of the points made during a recent episode of the “Commercial Real Estate Show,” in which my guest Ryan Severino, senior economist at Reis, provided an enlightening view of the state of the commercial real estate markets. Our topics included the performance of the individual property sectors, investment sales, new construction, and the potential impacts of Obamacare, rising interest rates and tapering of quantitative easing.

Star Student

With a national vacancy rate of just 4.3 percent, the multifamily sector remains “the star performer” of commercial real estate, Severino said. A looming uptick in new construction, however, could cool off the white-hot sector just a bit, he cautioned.

“You aren’t going to see demand pull back significantly, but you are going to see greater competition from new supply in the next six to 18 months,” Severino said. “That is not going to cause vacancy to explode, but we’ll probably drift higher in the next four to five years.”

This year, for the first time in a while, multifamily construction will be on par with the 15-year historical average, Severino said. “Outside of apartments, though, you’re still seeing a very benign construction environment,” he added.

Cap rates on apartment sales have a national average of about 5 to 6 percent, but in some markets, such as New York City, those rates can be as low as 2 percent. As I told Severino during the show, I once asked a New York City investor where the upside was in such an expensive acquisition. The investor told me, “Michael, there’s a limited supply of apartments there. These rents are going to increase, and that’s where we’re going to get our big return.”

Retail, Office & Industrial

On the opposite end of the spectrum, the retail market continues to sputter overall, but it’s not without its positives. “If you look at those high-quality, Class A malls with anchors like Nordstrom and Neiman Marcus and in-line tenants like Armani and Polo, those centers have held up pretty well,” Severino said. “If you get away from those sectors to the Class B+ and lower-caliber malls, we haven’t seen demand bounce back because most consumers have been a little more circumspect about their discretionary spending.”

The office market continues to be hampered by sluggish job growth, but that could change starting next year, Severino noted. “Give it a year or two,” he said. “With economic growth accelerating, I think you’ll see stronger demand on the part of users of office space.”

The trend toward using less office space is holding the sector back as well, my guest added. While fitting more people into less space does enable tenants to cut back on real estate expenses, the drawbacks include lack of privacy afforded to employees and the difficulty in concentrating due to the noise of fellow co-workers.

Meanwhile, the industrial sector “has a Goldilocks temperature to it right now,” Severino said. “It’s not as hot as the apartment market, and it’s not as cold as retail.” The national vacancy rate for the warehouse/distribution subsector is 11.8 percent and 13.8 percent for the flex/R&D subsector, he added.

Important Factors

Questions about the implementation of Obamacare are one of several economic factors impacting property performance in the coming months, Severino said, as business owners will remain hesitant to make real estate and personnel decisions until the dust settles.

“Whether you like Obamacare or you don’t like Obamacare, what I would really like to see them do is just settle on everything so that the market knows where it stands, and [business owners] can make decisions,” Severino said. “Even if you hate the law and you don’t like what it’s going to do to your business, at least you can make decisions about the future once you know for certain where you stand.”

A government shutdown or another series of budget crises will have major effects on the economy and by extension commercial real estate. “Any time you get any kind of disagreement about [the federal budget], it could create problems,” Severino said. “If [Congress] can’t raise the debt ceiling, and they have to decide what doesn’t get paid, that will ripple through the economy.”

Severino added: “It would be nice if everybody in Washington played a little bit nicer in the sandbox, but it’s really hard to envision them coming to some kind of compromise unless they’re almost forced to do so.”

The entire episode on REIS’ view of real estate is available for download at www.CREshow.com.