Uncertain outlook: Commercial real estate market strong, but challenges loom

Rising interest rates. Labor supply uncertainty. A presidential campaign of bluff and bluster. Global economic uncertainty.

Those issues are raising questions about the future of the economy – and the impact on the commercial real estate industry.

But members of the local development community say they aren’t overly concerned.

It’s a good time to be in business in Charlotte, they insist.

Asked if new inventory from a commercial building boom will increase vacancy rates in Charlotte, Brian Leary, who runs commercial and mixed-use business for Crescent Communities, said at a recent real estate panel discussion, “Most everyone feels good about” 2016.

“November may freak everyone out,” Leary said. “Who knows what happens in Washington?”

But he added, “I think it’s really more the next two or three years.”

One concern among the Charlotte development community is labor.

Labor pains

Developers are watching for signals that the already tight labor market will get tighter, and they say one might come from any actions stemming from the U.S. immigration debate.

“Rising construction costs, overall, are a good problem to have,” said Jensie Teague, a principal at Selwyn Property Group. “That indicates that our economy is growing and that we’re in a robust place to try to develop.”

But labor is driving the majority of the increase in construction costs, he said, “and a fluid labor market is going to be very important to us.”

A very strong and reasonable immigration policy is critical, Teague said.

Meanwhile, closely watched national data aren’t sounding major alarms, economists say.

Construction spending was better than expected in January, said Anika R. Khan, a Wells Fargo senior economist in Charlotte, in a recent research report.

Besting consensus expectations, construction spending rose 1.5 percent in January, with increases in private and public spending. Private nonresidential construction rose 1 percent during the month, while residential was flat.

Construction spending is now up more than 10 percent relative to a year earlier. Public spending jumped 4.5 percent in January, while private spending grew a modest 0.5 percent on the back of a flat monthly reading in residential outlays, Khan said.

In the residential component, outlays for single-family units and home improvement both declined in January, while multifamily posted its third consecutive monthly gain.

“We are not surprised that residential construction spending tumbled during the month as housing starts and new home sales were also weak,” Khan said in her report. “We expect residential spending to strengthen in the coming months as we get some payback from the lower-than-expected January reading and warmer weather supports building.”

In contrast, private nonresidential outlays and public construction spending posted strong gains during the month. Following two consecutive monthly declines, private nonresidential construction spending rose a solid 1 percent in January on the back of strong monthly gains in manufacturing and power.

Rising costs

Mentions of higher rates on loans and more expensive financing are winding their way into conversations among local developers and property owners.

Yet,  the feeling is Charlotte remains an attractive market for office buildings, hotels and multifamily development.

Prospects for this year “should be fine,” Jim Merrifield, managing partner with MPV Properties, said at the forum at the Fillmore Theater in Charlotte.

“Certainly, clouds (are) on the horizon about the overall national and international economies and what growth is,” Merrifield said. “If the rest of the world has got a flu, we’re bound to at least have a cold.”

He added, “I feel really good about the long-term dynamics for Charlotte. We’re more diversified than we were in ‘08.

“But we’re certainly part of the bigger picture. You have to think there’ll be some slacking in the economy…in the next two to three years and that’ll impact the real estate role.”

2016 growth expected

Looking ahead, the American Institute of Architects’ Architecture Billings Index, which typically leads nonresidential construction spending by nine to 12 months, registered an average score of 51.6 in 2015, which is a slightly lower than the 52.2 reading posted in 2014, Khan said.

“That said, the level remains in expansion territory and continues to signal growth in nonresidential construction spending in 2016,” she said.

Other forward-looking indicators, including the Dodge Momentum Index and nonresidential construction starts, also advanced last year supporting the positive outlook, Khan said.

According to the AIA Consensus Construction Forecast Panel, outlays in the nonresidential sector are expected to increase nationally about 8 percent in 2016, and 7 percent in 2017, which is in line with Wells Fargo’s forecast, Khan said.

“We acknowledge there are downside risks to our forecast given continued uncertainty around global economic growth and financial market volatility,” the economist said.

That said, builders remain optimistic and strength in U.S. domestic demand suggests continued gains, according to Khan.

Solid market

Ken Riggs, president of Situs RERC, which provides valuation management and fiduciary services to some of the industry’s largest retirement funds, banks, life insurance companies, and investment managers, told The Mecklenburg Times that Charlotte ranked 24th among the top 48 markets for retail property investment.

That was behind Atlanta and Raleigh/Durham.

With population and job growth above the national averages, Charlotte has several good underlying dynamics, Riggs said.

But the ranking was based on the relative pricing paid versus what Situs RERC viewed as the underlying value, he said.

He also said in a recent report that given the lifting of short-term interest rates in the U.S. in December, the global economic slowdown, and volatility in the stock and bond markets, it isn’t surprising many investors have sought less-risky alternatives as they watch and wait.

With that, and “the destabilizing effect of the 2016 U.S. presidential election,” it appears the stage is set for continued uncertainty and heightened risk in the economy and the capital markets in the year ahead, Riggs said.

The commercial real estate asset class ended 2015 in a generally strong position compared to other investments, due in great part to its transparency, strong fundamentals, and rational returns, Riggs said.

However, “returns are leveling off,” he said.

“Although performance is expected to be relatively strong in 2016, returns are up against the wall and we do not expect much additional improvement,” he said.

In Charlotte, there is ample optimism about the direction of development, despite higher prices.

Chris Epstein, president of BECO South and BECO Midwest, said at the local real estate forum hosted by Bisnow, a digital media company, that his firm this month is celebrating its sixth anniversary in Charlotte.

“We’ve assembled a portfolio of just shy of 2.5 million feet and growing in the university market and also in the airport market here in Charlotte,” he said. “It’s been a fantastic experience.”