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Principal Real Estate Investors Releases 2015 U.S. Commercial Real Estate Outlook

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Principal Real Estate Investors, one of the largest institutional real estate managers in the United States, released its annual strategy outlook for commercial real estate. The report details the key themes expected to drive the U.S. commercial real estate market in 2015, including stronger economic growth in the United States and continued accommodative monetary policy.

From the report: “Our base-case economic outlook is for the U.S. economy to finally achieve a cyclical period of moderate escape velocity with the forecast for real gross domestic product to expand by close to 3 percent in 2015. This will be a welcome relief after nearly five years of sluggish growth following the end of the global financial crisis.”

The report goes on to detail the following areas of interest for commercial real estate investors in 2015:

  • Capital markets enter “extra innings”: Commercial real estate investors may enjoy “extra innings” of capital market tailwinds with a flatter yield curve supportive of current cap rates, especially given that the long end of the Treasury yield curve may likely remain somewhat range bound. If space market fundamentals remain strong, cap rates should stay stable or even modestly compress in some markets/property types. Risk-premia expectations from commercial real estate should also remain stable.
  • Modest up-weight to risk strategies: A relatively benign economic and capital markets environment supports a modest increase in risk. Preferred strategies include value added/opportunistic in private real estate, high-yield debt in non-gateway markets, and legacy issue in commercial mortgage backed securities.
  • Net operating income growth for “offense” and “defense”: Investors should focus on increasing same-store rent growth, even if the capital markets environment turns out to be more favorable. Investors can then either take advantage of improving economic conditions, or be defensive in case cap rates start to rise to reduce any drawdown in value.
  • Recommended four quadrant strategy: Under our base case economic scenario, our four quadrant strategy is modestly biased towards value-add private real estate equity (focused on stronger job growth markets) and subordinate debt (focused on markets still in early stages of recovery) as a proxy for “growth.” By property type we favor office and industrial as well as luxury or high-end oriented retail to deliver above-average net operating income growth. Moderately leveraged core real estate should also perform reasonably well given the likelihood of limited upward pressure on cap rates and low interest rates.

The report concludes: “After nearly five years since the end of the global financial crisis, the U.S. economy appears to be heading towards a modest period of escape velocity growth in 2015. The winding down of quantitative easing by the Fed also suggests its growing comfort with the economic outlook. For real estate investors this likely means that a remarkable period of central bank aided performance is coming to an end, with the baton of growth transferring from the capital markets to the space markets. The timing for such a transition could work out well, with demand firming and expected to accelerate across most property types, and a capital market environment that is still expected to remain supportive.”

About Principal Real Estate Investors
Principal Real Estate Investors manages or sub-advises $54.3 billion in commercial real estate assets1. The firm’s real estate capabilities include both public and private equity and debt investment alternatives. Principal Real Estate Investors is the dedicated real estate group of Principal Global Investors, a diversified asset management organization and a member of the Principal Financial Group(R).

1 As of Sept. 30, 2014.

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