Chinese investors are dumping their commercial real estate investments, under pressure from the Chinese government as a result of the escalating trade war between the U.S. and China. According to an article in the Wall Street Journal, Chinese investors sold $1.29 billion of U.S. CRE in the second quarter of 2018, while purchasing less than 1/10th of that amount. This is the first time the Chinese have been net sellers in 10 years. Just as heavy Chinese investment activity previously boosted prices for U.S. commercial properties, a massive sell-off will likely put downward pressure on them.
The University of San Diego‘s latest economic forecast showed the second monthly decline in a row, raising concerns about a slowdown in the local economy. The Burnham-Moores Center for Real Estate’s Index of Leading Economic Indicators for San Diego County, released last week, fell 0.2 percent in May following a decline of equal magnitude in April. A decrease in help-wanted advertising, higher initial claims for unemployment insurance and a decline in residential building permits pushed the index down. “Economists usually look for three moves in the same direction for a leading index to indicate a turning point in the economy,” wrote Professor Alan Gin in his report Thursday. “This hasn’t happened yet, so the outlook for the local economy remains positive for now,” he noted. However, he added, any number of things could adversely affect San Diego’s economy, “including rising gas prices, rising interest rates, high housing prices making it difficult for companies to attract and retain workers, a trade war leading to barriers against San Diego companies, local government budget problems, increased taxes on some San Diegans due to the 2017 tax reforms, and turmoil in the health care markets as elements of the Affordable Care Act are eliminated.” The San Diego Regional Chamber of Commerce earlier reported that business optimism in the region had declined to a five-month low.
Under new tax laws, investors can defer tax on any prior real estate gains until December 31, 2026, so long as the gain is reinvested in a Qualified Opportunity Fund, an investment vehicle organized to make investments in Qualified Opportunity Zones. In addition, if the investor holds the investment in the Opportunity Fund for at least ten years, the investor would be eligible for a step up in basis equal to the fair market value of the investment on the date it is sold.
The Opportunity Zones program offers three tax benefits for investing in low-income communities:
- A temporary deferral of inclusion in taxable income for capital gains reinvested in an Opportunity Fund, until the earlier of the date on which the opportunity zone investment is sold or December 31, 2026.
- A step up in basis for capital gains reinvested in an Opportunity Fund, in the amount of 10% if the investment in the Opportunity Fund is held by the taxpayer for at least 5 years, and by an additional 5% if held for at least 7 years — thereby excluding up to 15% of the original gain from taxation.
- A permanent exclusion from taxable income of capital gains from the sale or exchange of an investment in an Opportunity Fund if the investment is held for at least 10 years. (This exclusion applies to gains accrued after an investment in an Opportunity Fund.)
Treasury and the IRS still plan to address the certification of Opportunity Funds, which are required to have at least 90 percent of fund assets invested in Opportunity Zones. For more information or a map of Qualified Opportunity Zones, contact Regal Properties and consult your tax adviser.
Of the 29 states having approved medical marijuana sales, only 3 have approved sales for recreational use. State and federal laws still clash, because all marijuana sales are still illegal under federal law. Hence, marijuana is still an all-cash business because credit cards and bank accounts are federally controlled. Given cash caps on real estate transactions, commercial property owners and managers risk running afoul of federal money-laundering laws by accepting cash rents. Although Trump and Congress have shown support for relaxation of laws, and federal legalization seems inevitable, Attorney General Jeff Sessions remains vehemently opposed to legalization; so property owners and managers should understand the risks involved in the interim.
Commercial real estate investors can expect property prices to trend downward soon, according to Green Street Advisors, a real estate research firm headquartered in Newport Beach, California. “Value appreciation has practically stopped in aggregate,” said Joi Mar, senior analyst at Green Street. However, sectors vary. Industrial—especially last-mile industrial—has seen rising values, and malls have seen big losses, she noted. Prices on industrial assets recorded an 11% gain year-over-year, while mall valuations have dropped by 15%, resulting in a 25% spread between them over the past 12 months. “That’s pretty unprecedented,” Mar said.
Cap rates have been inching up over the past year for all sectors except industrial, according to Mar. The bid-ask spread has widened, investors in general have been more cautious and hesitant, operating fundamentals have softened a bit, and there is a fear of rising interest rates. Transaction volume is also down, but would be even lower if debt capital was not so widely available.
Today, investors can expect returns of around 6%, on average, for assets in most core sectors, and a little bit higher returns for niche sectors, said Andy McCulloch, managing director at Green Street, noting that the firm’s return forecasts focus on un-levered returns for long-term holds.
An Austin-based company plans to change the home buying market by making houses more universally accessible and sustainable. According to its website, ICON debuted the first permitted 3-D printed home in Austin on March 12, 2018, built using a prototype of a mobile printer that will have the ability to produce “a single-story, 600 to 800 square foot home in under 24 hours for less than $4,000.” The founders of the company partnered with New Story, a non-profit charity that works to transform slums into functional, sustainable communities, to address housing shortages around the world. The prototype model has a living room, bedroom, bathroom and a porch. The company’s plan is to finish tweaking and testing the design to get a community of up to 100 homes built in El Salvador in 2019.
Trump’s imposition of steep tariffs on steel and aluminum imports has sparked dire warnings from architects, contractors, REITs and real estate associations, who say the tariffs will put more pressure on already rising building costs — causing developers and investors to postpone or cancel new developments. Despite a carve-out for North American trading partners Canada and Mexico, Trump’s signed proclamations formalize 25% and 10% tariffs on imported steel and aluminum that will take effect in 15 days. “The bottom line is that any short-term gains for the domestic steel and aluminum industries will likely be offset by the lower demand that will come for their products as our economy suffers the impacts of these new tariffs and the trade war they encourage,” AGC chief executive Stephen Sandherr said.
U.S. Chamber President and CEO Thomas J. Donohue also issued a statement Wednesday saying “We urge the administration to take this risk seriously and specifically to refrain from imposing new worldwide tariffs, which would harm American manufacturers, provoke widespread retaliation from U.S. trading partners, and leave the true problem of Chinese steel and aluminum overcapacity virtually untouched.”
According to an estimate this week by Trade Partnership Worldwide, an international trade and economic consulting firm, while the plan will increase U.S. iron and steel, aluminum and other non-ferrous metals employment by about 33,450 jobs, the tariffs will eliminate 179,334 jobs throughout the rest of the economy for a net loss of nearly 146,000 jobs, including more than 28,000 construction positions.
White House Chief Economic Adviser, Gary Cohn, who opposed the tariffs, resigned this week.
New data and commentary from federal financial regulators are pointing to signs of increased risks in CRE lending. Notably, the amount of delinquent multifamily and owner-occupied property loans on the books of U.S. banks increased in the 4th quarter of 2017, according to statistics released this week by the Federal Deposit Insurance Corp. The FDIC data follows the Federal Reserve’s latest Monetary Policy Report that noted growing vulnerability in the commercial real estate sector. “By many measures, stocks, bonds, and real estate are richly priced. Stock price-to-earnings ratios are at high levels, traditionally a cautionary sign to investors of a potential market correction,” Gruenberg noted in the FDIC’s recent 2017 annual report. “Bond maturities have lengthened, making their values more sensitive to a change in interest rates. As measured by capitalization rates, prices for commercial real estate are at high levels relative to the revenues the properties generate, again suggesting greater vulnerability to a correction.”
Meanwhile, the total amount of commercial real estate loans held by U.S. banks and savings and loans has continued to swell. The $2.13 trillion year-end 2017 total CRE loans outstanding compares to $1.63 trillion at the last peak of the CRE markets at the end of June 2007.
In CBRE’s Second Half 2017 Cap Rate Survey, key U.S. takeaways include:
- Commercial real estate pricing was broadly unchanged, with the exception of some retail segments.
- Industrial cap rates fell by 13 basis points to 6.52%.
- Multifamily infill cap rates fell to 5.23% on average from 5.27%. Stabilized suburban assets also declined to 5.59% from 5.66%.
- Office and hotel sector cap rates were generally stable.
- Retail cap rates increased, with power centers moving to 7.98% from 7.54%. Neighborhood and high-street retail cap rates increased slightly by 7 and 9 bps, respectively.