Commercial Real Estate Could Deliver Double-Digit Total Returns in 2021

Commercial real estate (CRE) transaction volume and total returns appear set to move higher by the end of 2021, according to the latest survey of institutional investors and forecast by SitusAMC Insights. Senior Director Peter Muoio, PhD, and Jennifer Rasmussen, PhD, Vice President and Head of Thought Leadership and Publications, discussed those developments, as well as trends in the economy, capital markets and asset classes, at the Quarterly Valuation Trends webinar on September 21. Here are the highlights:

Institutional investors are favoring commercial real estate. The second quarter of 2021 saw a notable uptick in the preference for CRE relative to alternatives, hitting a five-year high. “What's really impressive about this rating is it even beat out stocks, which have been on this absolute tear since the beginning of the year, though they've retreated somewhat over the past month,” Rasmussen said. “But that's a really striking finding and supports this theme of commercial real estate showing resilience.”

Total returns appear likely to rise. Commercial real estate posted a 3.3 percent total return in the second quarter, based on the SitusAMC Insights analysis of NCREIF data. “For the year we see that ticking up, potentially into the double digits,” Rasmussen said. “Our higher-case scenario seems to be getting more and more probable.” 

Transactional activity may be set to spike. SitusAMC Insight’s survey asks investors whether they're likely to recommend selling, holding or buying CRE. The rating to “hold” declined quarter over quarter to the lowest rating since the firm began collecting data back in the mid-1990s, while the recommendation to sell rose. “I think we're going to see a lot more activity moving forward,” Rasmussen said. “We do see differences by property type. Industrial is one where people are saying this might be the time to sell, while for suburban office, investors are saying it’s a better time to buy.”

Risk premiums are returning to levels near their long-term averages after the spike from COVID-19. Typically, long-term averages for pre-tax yield rates over the 10-year Treasury run about 580 or so, and are now back at 600. 

Investor concerns about risk in the hotel sector appear to be abating. The survey found institutional investors’ perceptions of risk-adjusted returns for lodging rose in the second quarter from the previous quarter. “Hotel fundamentals actually had a pretty stellar quarter,” Rasmussen said. “People have been returning to vacations as we’re coming out of COVID. Room rates and occupancy are near pre-pandemic highs.” 

Meanwhile, the Biden Administration this week announced plans to ease travel restrictions for fully vaccinated foreign visitors. “This could be another boost to the hospitality segment, especially in gateway markets,” Muoio said. “The leisure side of the business is definitely coming back faster and stronger. The international piece could be beneficial on the business side; there's a lot of international business that's just not been able to have been done over the course of the travel ban.”

The hot industrial sector shows no signs of cooling off. Through the first half of the year, vacancies have declined and are about to dip into single-digit territory, while rent growth is accelerating and property prices are rising. As for capital flows, the industrial share of deal volume over the last 18 months has increased significantly. “Investors are responding to fundamentally positive factors affecting the industrial segment, including e-retail, logistics, last-mile, and cloud computing,” Muoio said. “We’re on pace for just an amazing increase in industrial returns, driven by the huge increase in prices due to the appreciation piece.” 

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