PREA's latest consensus forecast shows that prospects for US real estate remain upbeat - so far, at least, writes Greg MacKinnon
In the second quarter of 2012, GDP in the US grew at a rather anaemic rate of 1.5%. This was a slowdown from the 2% growth experienced in Q1, and a long fall from the 4.1% of Q4. This has raised fears that the economy could stall and that the long-awaited economic recovery is again moving farther into the future.
Over the last two years the US economy has had its ups and downs. At the beginning of 2011 the economy appeared to be gaining momentum and economic forecasts were upbeat. Then came the summer, the return of the euro crisis, and the US debt downgrade and budget fiasco. These combined to increase risk aversion and the economic momentum was cut short. By the end of 2011 and going into 2012 things again started to look up; the euro crisis seemed to have stabilised and the US economy was gaining traction. Once again, however, summer proved to be the cruellest of all economic seasons as the euro crisis entered its most dangerous phase yet and the US economy again slowed.
The ups and downs of the last two years are shown in figure 1, which illustrates the change in non-farm employment alongside the ISM Purchasing Managers index (PMI). From early 2011 both series declined during mid-2011, regained ground in late 2011 and early 2012, and are now again on a downward path.
Through all of this, however, returns to US institutional quality property have remained robust. From the start of 2011 through Q2 2012, the NCREIF Property index has returned over 20% (13.1% annualised). While property values remain 19% below their 2008 peak, on a total-return basis (including income), NCREIF properties have already surpassed the peak. Of course, the recovery in US property has not been uniform; the NCREIF index is based on institutionally held properties and tends to be concentrated in major markets and core properties. It is this sector of the market that has benefitted the most from the flight to safety and historically low interest rates. Recent numbers from Real Capital Analytics, however, show that transaction volume is starting to pick up in secondary and tertiary markets.
But what of the future? Will US property continue to perform, given the macroeconomic challenges? The most recent consensus forecast of the NCREIF Property index, conducted by the Pension Real Estate Association (PREA), can help shed light on the expectations for the future of major market players. Conducted in May 2012, the Q2 consensus forecast shows the average forecaster expecting good returns for full-year 2012, but with a slowing over the next two years due to reduced rates of appreciation in 2013 and 2014.
The average Q2 forecasts for the NCREIF index imply a growth rate in net operating income (NOI) running above 3.7% through 2013, a rate well above current inflation. Keep in mind, of course, that this version of the consensus survey was conducted before the release of recent bad news concerning the macroeconomy, so it remains to be seen whether the perception of healthy NOI growth will hold into the future.
How the perceptions of the US property market have changed with economic conditions can be seen in figure 2, which shows how the average forecast for 2012 returns has evolved over time as the quarterly surveys were conducted. As with the economic data, expectations for 2012 declined through 2011 and reached a nadir in Q4 2011, after which expectations for this year began to pick up as the economy showed stronger signs of growth. We must wait for the Q3 consensus forecast to see if forecaster's optimism remains intact following the slowdown.
Looking at return expectations by property type, multi-family is expected to continue its recent outperformance and be the top returning sector in both 2012 and 2013. Demand for multi-family, based on demographics and declining homeownership, remains. According to a report from Axiometrics, new supply is below historical norms, although it appears that the first wave of supply in the development cycle is hitting the market. Pramerica Real Estate Investors forecasts that new supply will only come online at above average rates beginning late in 2013. At least in the short term it appears that fundamentals remain strong for multi-family; longer-term prospects depend on the economy and the sector's ability to absorb new units as they are built.
Perhaps the biggest surprise from the consensus survey is the average forecast predicts industrial will be the second best performing sector in 2012 through 2014. While previous quarters' surveys have generally seen industrial as the laggard of the sectors, this has changed significantly. Forecast appreciation in industrial is modest at 3.1%, 1.9% and 1.4% in 2012, 2013, and 2014 respectively; NOI growth implied by the forecasts sits at 1.5% for 2012, expanding to 3.5% in 2013. The key to industrial's expected performance is income return; at a projected 6.3% for both 2012 and over a five-year horizon, industrial's forecast income is tied for highest (with retail) among the sectors. It would appear that industrial's new-found attractiveness is therefore due to pricing. After several quarters of being outshone by other sectors, pricing for industrial is beginning look tempting.
The economy appears even weaker now than at the time the consensus forecast survey was conducted. Perhaps this weakness will prove brief and have little long-term effect on property fundamentals; or perhaps the deterioration in the economy will begin to eat into real estate expectations. As of Q2, forecasters remained fairly upbeat about prospects for US property returns ahead - we wait for the Q3 survey to see if that is still the case.
Greg MacKinnon is director of research at the Pension Real Estate Association