Forecasters remain optimistic about US property despite a sluggish backdrop, according to PREA's latest Consensus Forecast, presented here by Greg MacKinnon
In early June, the Pension Real Estate Association (PREA) released the second quarter results of its Consensus Forecast Survey. Each quarter, PREA surveys its investment manager, adviser, consultant and research company members about their forecasts for the NCREIF Property Index (NPI), the most widely followed index of US commercial real estate. The PREA Consensus Forecast reports the average of the submitted forecasts. Many IP Real Estate readers may be more familiar with the Consensus Forecast reports issued by the IPF for the UK and Europe. PREA believed a similar endeavour could provide value in the US markets and therefore began its series of consensus forecasts in the second quarter of 2010.
Despite continued labour market weakness, and recent indicators showing an anaemic economic recovery, this quarter's survey showed that forecasters, on average, remain optimistic about prospects for the US commercial property markets, albeit with expected returns down somewhat from the bounce in 2010 and slowing slightly.
Given an average forecast of a 10.6% total return on the NPI for full-year 2011, and a strong first-quarter realised return of 3.36%, the implied return forecast over the remainder of the year is 7%, or an average of 2.3% per quarter. Market returns are therefore expected to remain quite healthy, although down somewhat from the recent past when there was significant price appreciation in US core properties, especially in major coastal markets. This same theme can be seen looking at forecasts over longer horizons, with total returns expected to decline slightly to 9.8% in 2012 and 9.5% in 2013. For comparison purposes, the long-term average compound rate of return on the NPI has been just under 9%. Hence, while overall returns are expected to decrease slowly they are expected to remain somewhat above the long-term average.
Looking at how expectations for 2011 have developed over time, it is interesting to note that the average forecast for 2011 returns in this quarter's survey is 20 basis points higher than that seen three months ago. In fact, among the respondents the outlook for 2011 for the US market overall has improved steadily over the past year. It would appear that the strength of the market and the speed of its rebound following the global financial crisis continue to surprise.
Looking at expectations by property type, multi-family is expected to again lead the pack in 2011 with a consensus forecast total return of 11.4%, based on continued healthy income and capital appreciation forecast at close to 6% for the year. Following an excellent 2010 in which the NPI multi-family index returned over 18%, it would appear that the average forecaster believes there are still good returns to be had in that sector. A move from single-family homes to apartments because of the continuing problems in the US mortgage market, longer-term demographic trends, and limited construction have combined to make the fundamentals appealing in this sector. In fact, expectations for multi-family return in 2011 have been increasing at a greater pace than for the market overall; only a year ago forecasters were predicting returns of under 8% for apartment in 2011.
Retail is expected to be the second-best performing sector, with an average expected 2011 return 20bps behind multi-family. However, single-number forecasts such as this do not always tell the whole story. While the average forecast is relatively high, there might be more disagreement among forecasters on retail returns relative to the other property types; the spread between first- and third-quartile forecasts is greatest for retail among the sectors.
Office has an average forecast return of 10.3% for 2011, ranking it third for 2011, 110bps behind apartments. Expectations for 2011 office returns actually decreased slightly from last quarter's survey, perhaps indicating that some of the cap rate compression already seen for high-quality, primary market office properties has eaten into forecaster expectations for the sector. That said, the distribution of forecasts for office is negatively skewed; the bulk of forecasts are higher than the average, but a few more conservative forecasts pull the average down, so expected prospects for this sector may be somewhat better than the average would indicate.
Following a 2010 in which industrial properties had the lowest returns across property types, industrial is again expected to be the worst performer (although still with healthy expected returns) with a 2011 forecast return of 9.6%. The expected underperformance of industrial is fairly widespread among our forecasters; 38% of this quarter's respondents ranked industrial last in expected return for 2011. In fact, if compared with the distribution of forecasts for the other property types, the average forecast for industrial would fall in the bottom quarter of forecasts in each of the other sectors.
It is important to note, however, that over a longer horizon there is much less difference in expected performance across the property type sectors. Over the five-year period from 2011 to 2015, apartments and office have the highest expected average annual return at 9.7%, but industrial and retail are only 20bps behind at 9.5%. Hence, while there appears to be a spread in expectations for property-type performance in the short run, over a longer-run horizon of relevance to most investors the differences in the stops and starts of gradual recovery across sectors are expected to largely cancel out.
Overall, the strength of the institutional-grade commercial property market has continued to surprise, and forecasters are quite optimistic about prospects. Only time will tell how accurate these forecasts will turn out to be, and if opinions will change as more information on the strength of the underlying US economy becomes available.
Greg MacKinnon is director of research at PREA