Commercial Investment Real Estate July/August 2018 | Page 28

regulatory relief. The index was under 100 for four straight
years until President Donald Trump was elected, and has
remained in a bullish 103-107 range through 1H2018.
Looking Ahead
So, what could go wrong? Although everything appears
copasetic and like the Lego movie (Everything is Awe-
some), some bearish concerns are in the market. Positive
momentum could be subject to disruption due to uncer-
tainty surrounding potential Black Swan events that
include:
• Threatened tariffs and a resulting trade war with Asia
and Europe;
• November midterm Congressional elections;
• A volatile Mideast with unresolved nuclear and
chemical weapons threats from Syria and Iran; and
• Federal monetary policy (interest rate hikes and selling
down its balance sheet and extracting liquidity) along
with market impacts from the rise in the yield for the
10-year Treasury Bond.
If Democrats regain control of the House, Senate, or
both, in the upcoming midterm elections, they could undo
the tax bill and undo much of the regulatory relief occurring
under the Trump administration. Likewise, the economic
stimulus that we are starting to see kick in could be undone,
Treasury already has started moving higher. At the end of
April, the 10-year Treasury hit 3 percent for the first time
in more than four years.
The Federal Reserve raised the short-term bank lending
rate 25 basis points in February (its sixth increase in two
years), and I expect the Fed to raise interest rates three more
times this year. The next 25-basis-point increase likely will
come in the June meeting, followed by additional increases
in September and December, for a total of 100 basis points,
or a full 1 percent increase this year.
In commercial real estate, cap rates have compressed, and
values have gone up due to historically low interest rates.
That gig is up. Now the way property values are going to go
up is through increasing net operating income. Commercial
real estate brokers and CCIMs will have to be much more
tuned into NOI, lease maturities, and the potential to raise
rents, to see if a particular property or market can absorb
higher interest rates without the property declining in value
as cap rates rise in response to higher interest rates.
Industrial Engine Remains
Strong
Despite a potential trade war, the bulls are continuing
to run in the industrial sector. E-commerce is fueling
unprecedented demand for distribution and warehouse
space handling virtually everything that people
consume, from produce to paper products. All are
being bought online in bigger and bigger quanti-
ties. In the U.S., e-commerce sales now account
for about 9.1 percent of total retail sales. And that
percentage is much higher — upwards of 20 per-
cent — when excluding sales from autos, gasoline,
restaurant, and food categories.
The next two big disruptors in online sales that
will further benefit industrial are grocery and
autos. Giants such as Amazon and Walmart are
putting more competitive pressure on their peers as they
continue to improve on e-commerce platforms and rapid
delivery. Auto sales also are shifting to online sales, replac-
ing the traditional model of showrooms and acres of park-
ing on prime real estate. Today, consumers don’t walk acres
of inventory in search of a new car; rather they click their
way through online inventory stored in warehouses ready to
be instantly financed/purchased and delivered overnight in
much the same way as apparel is consumed today.
A potential trade war would have a dampening effect
on industrial, with tariffs that make imports and exports
more expensive. Less shipping activity translates into
reduced demand for warehouse space. However, trade
wars are relatively short-lived, because they are not effec-
tive. A trade war could disrupt the market for 12 to 18
months, but no one is interested in creating a prolonged,
expensive trade war.
THE 10-YEAR TREASURY
ALREADY HAS STARTED MOVING
HIGHER. AT THE END OF APRIL,
THE 10-YEAR TREASURY HIT 3
PERCENT FOR THE FIRST TIME
IN MORE THAN FOUR YEARS.
which is why we are seeing a reintroduction of stock market
volatility. Any or all of these Black Swan events quickly
could reverse small business and consumer optimism and
send us back to a sub-2 percent economy.
Rising Interest Rate
Environment
We have been waiting for the economy to be strong enough
to sustain wage and price growth, and the consequence of
that is interest rates moving higher. The big focus for com-
mercial real estate in the near term will be how to function
in a rising interest rate environment.
Interest rates have been incredibly low for the past decade.
People have grown so accustomed to almost free money and
low interest rates that they may not know how to function in
a rising interest rate environment. Investors in commercial
real estate need to adjust to those higher rates. The 10-year
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July | August 2018
COMMERCIAL INVESTMENT REAL ESTATE