Key Factors in Commercial Property Pricing

Key Factors in Commercial Property Pricing

Commercial property prices are affected by many things. Some are obvious, like construction costs; others not so obvious, like the state of global trade.

How do rising costs affect home ownership? Are they positive for the rental market?

Rising costs have contributed to rising home prices in the U.S. over the past several years, helping make buying a home less affordable and boosting rental demand at the same time. Indeed, the U.S. homeownership rate remains near its 50-year low at 64.2% and fell a whopping 60 basis points (bps) in Q1 2019. After some steady, recent improvement, this was a significant decline. Industrywide, a huge overall recovery in the for-sale housing market is not anticipated in the near future.

Nearly 50% of all U.S. renters are cost-burdened (approximately 20 million people), spending 30% or more of their income on housing. Furthermore, the widening discrepancy between housing appreciation and income growth certainly will continue to be a positive to rental apartments, along with mounting student debt loads, which are now at $1.6 trillion nationally, largely impacting the Millennial and Gen Z generations. Housing experts anticipate another 500,000 new rental households per annum through 2025.

Could rising costs also impact the supply of commercial property and support prices?

U.S. construction costs are at a historic high due to a surge in labor costs and key commodity prices. New development and renovations may be somewhat restricted in the coming years, especially with the recent tariffs imposed on iron, steel, and other commercial materials from China.

Over the past five years, U.S. construction costs have escalated almost 30%, rising 2-3 times faster than the inflation rate. It has become a significant challenge for developers to make new development projects feasible, which can be a hedge for potential oversupply. On the positive side, higher replacement costs will add additional rent margins compared to the existing commercial buildings, increasing appreciation potential going forward.

Could stricter capital controls blunt demand for residential and commercial property?

In 2018, cross-border investment in U.S. commercial real estate climbed 64.4% year-over-year to $89.2 billion, the second highest level on record. This increase was impressive despite Chinese capital controls in 2017-2018. There is tremendous interest in U.S. commercial real estate investments due to relatively higher yields, appreciation potential, fewer perceived risks, and greater transparency. Overall, the U.S. remains a top pick and a haven for most global investors.

Another major development in this market cycle is the record level of global debt bearing negative interest rates. Clearly, investors are searching for yield and attractive investment opportunities. On a relative basis, U.S. commercial real estate is supported by sustained demand drivers; currently offers favorable, high yields; and has an attractive return track record. We believe that we will likely see continued strong capital flows into U.S. commercial real estate investment.

Because of Chinese capital controls, demand for for-sale residential real estate in certain U.S. cities, especially on the West Coast, could be negatively impacted. Nonetheless, the overall U.S. for-sale residential market is enormous and primarily driven by domestic supply and demand dynamics, pricing affordability, and interest rates. We have not heard of any capital controls from Europe yet.

Will developers be able to procure building and remodelling materials domestically?

Yes, a shift is currently underway. More building materials will be sourced from the U.S., as well as Mexico, Canada, and other Asian countries. In fact, the cost of labor is already lower in Mexico, India, and several Southeast Asian countries than in China. Many logistics managers are evaluating global logistics chains and may shift some low-cost manufacturing production away from China. However, at the same time, China may move up in the value chain and produce higher-value goods and services to make up for any shortfalls in GDP growth.

Are there any long-term implications (positive and/or negative) for U.S. real estate if there are protracted trade negotiations?

In the near term, a protracted trade negotiation between the U.S. and China would result in increased uncertainty and delayed decision-making among business investors, leading to weaker GDP growth in the U.S. and globally. This would be a negative for commercial real estate demand.

Over the long term, demand for U.S. commercial real estate space is primarily driven by domestic demand. While trade patterns might shift to near-shore (increasing manufacturing production in Mexico or Southeast Asian countries) or onshore (increasing manufacturing production within the U.S.), aggregate consumer demand is expected to continue to increase over time.


Investment in real estate entails significant risks and is suitable only for certain investors as part of an overall diversified investment strategy and only for investors able to withstand a total loss of investment.

Definitions:

Gross Domestic Product (“GDP”) is an economic statistic which measures the market value of all final goods and services produced within a country in a given period of time.

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