Global Economic Briefing, The NAI Global Quarterly Review of The Economy

Part I

In June the U.S. economy entered its 96th month of economic expansion, the third longest in U.S. history since 1854. Odds are favorable that this period of growth will surpass #2, which took place during the turbulent 1960s (1961-1969), yet calling the takeover of the 120-month economic expansion and #1 “tech boom version 1A” from 1991 to 2001 is too early to say.

That was one of the takeaways from a recent Global Economic Briefing sponsored by NAI Global in a live webcast presented to NAI professionals and guests in mid-June by Dr. Mark J. Eppli, Professor of Finance and Bell Chair in Real Estate at Marquette University. Once a quarter, NAI Global hosts an economic outlook call featuring domestic and international experts on the economy and other business trends.

Highlights from the webcast included:

4.3 percent current unemployment is the lowest in 16 years

Low unemployment is creating more competition for talent and pushing wages up

Inflation is expected to rise as wages increase

15.7 million net-new jobs is the largest job growth in a U.S. expansion (total employment is currently about 146 million)

College-educated worker pool is fully employed


Yet there are long-term limits on economic growth due to weak employment growth and low labor productivity. As such, the U.S. economy is expected to continue its modest annual growth of just over 2 percent. However, from an historical perspective, modest growth is far more common than the rapid productivity growth of post-World War II, according to Dr. Eppli.


Even so, with the economy expected to grow +/-2.75 percent through 2018 and inflation rising, commercial mortgage interest rates are likely to increase 50-75 basis points in the next 18 months.

Market Size as a Proxy for Growth (liquidity)

Dr. Eppli reviewed the seven-year holding period returns by city tier from 1987-2016, with Tier 1 being the big six of Boston, New York, DC, Chicago, LA and San Francisco. Tier 2 has Dallas, Houston, Phoenix, Austin, Las Vegas, Miami and Orlando, while Tier 3 has Seattle, Denver, San Antonio, Charlotte, Raleigh, Nashville, Tampa, Salt Lake, Portland and San Diego. The list of Tier 4 cities is much longer but includes cities such as San Jose, Indianapolis, Jacksonville, Kansas City and Detroit. Only institutional-grade investments were included in this batch of data, with NCREIF as the lead source of information. The data was crunched by Dr. Eppli and a colleague from the University of San Diego.

Not surprisingly, Tier 1 came out on top with 9.63 percent return for apartments, 8.54 percent return for industrial, 7.75 percent for office and 9.14 percent for retail. Interestingly, Tier 3 outperformed Tier 2, with 9.62, 8.74, 6.43 and 9.00 percent, respectively, by product category.  We suspect that is because many of the Tier 3 cities have moved into ULI’s list of thriving “18-hour” cities in recent years and largely driven by technology company expansions in those markets.

Cap rate compression has been widely covered by the commercial real estate trade media, and Dr. Eppli provided 10 and 20-year perspectives on the topic. In the last 10 years, cap rates have declined in all four city tiers (between 0.95 percent and 0.80 percent) while during the recent 20 years, cap rates compressed 2.07 percent in Tier 1 cities, 1.77 percent in Tier 2 cities, 1.92 percent in Tier 3 cities and 1.90 percent in Tier 4 cities.

In summary, real estate investments averaged a 7.9 percent return during seven-year holding periods, which matched pension obligations. Even at current low cap rates, real estate returns are appropriate relative to other investment vehicles. In terms of forecasting, Dr. Eppli expects cap rates to stabilize and expand slightly by about 25 basis points over the year.

Check back next week for the rest of Dr. Eppli’s economic forecast to NAI Global in which capital flows, supply/demand conditions and other aspects of the real estate economy will be reviewed.

Part II

The second half summary of Dr. Mark Eppli from the real estate program of Marquette University began with a study of capital flows to U.S. property markets in the first four months of 2017, with the finding that investors of all types reduced real estate acquisitions (by total volume) 17 percent compared with the January-April period of 2016. However, he attributed that to the uncertainty of a new administration and expects volume to pick up the rest of this year.


With transaction volume moderating, concerns that we are entering an investment bubble are abating.

One of the most interesting segments of the presentation reviewed the CPPI/RCA Apartment Walkability Price Index, and not surprisingly, “highly walkable CBD” outperformed “highly walkable suburban” apartments by 50 basis points while “somewhat walkable suburban” and “car-dependent suburban” lagged behind. “Infill development in walkable neighborhoods is an interesting trend and one that will continue,” he said.

Supply is in line with Demand

Dr. Eppli does not see evidence of an over-supply bubble forming. He showed three slides with the first being construction put in place through 2016, and beginning in 1993. Apartments, office, retail, industrial, medical office and hotels were included in the slides. The average annual investment in this period was $188 billion, but it was not adjusted for inflation or population growth. Last year topped the chart, with $300 billion invested in commercial real estate development. 2008 was second, at around $280 billion.

Though once inflation was accounted for (the cost of goods and services has increased approximately 50 percent since 1993), U.S. developers put more money into real estate development in 2008 in that 24-year span, and 2007 was on par with 2016, according to Eppli (he used U.S. Census data for some of this).

Once he factored in population growth – with the U.S. growing its employment based 34 percent from 1993 to 2016, then 2000 was the biggest year for construction put in place with an inflation-adjusted $360 billion (in today’s dollars), followed closed by 1999, 2007 and 2008, at around $350 billion. At $300 billion, 2016 lagged eight other years for the level of completed construction projects in the U.S after inflation and population growth were considered.

During the Q&A period, NAI Global President Jay Olshonsky asked Dr. Eppli how GDP might get to the 4 percent level that the administration is targeting as part of its budget planning, and the answer was, perhaps if we engage some of the potential workforce currently unemployed, and if tax reform takes place and puts more money in consumers’ pockets that would be recirculated into the economy. However, Eppli said “even getting to 3 percent seems like a stretch to me.”

A second question focused on the potential tax reform of the 1031 exchange clause of the IRS, in which investors would no longer be able to defer capital gains taxes from profits made in real estate investments. Eppli was contrarian to most commercial real estate market watchers and analysts, saying that “other than single-asset NNN sales like Walgreens properties, and perhaps, overall transaction volume, the change would have an almost unnoticeable impact on real estate investing.”

Lastly, and again on the topic of tax reform, Eppli noted the enormous amount of cash that tech titans Apple, Google and others have overseas, for fear of bringing it back and having it taxed at current U.S. corporate tax rates. While stating that some of the administration’s policy proposals could include separate accommodations for repatriating that money, “if I worked in Washington, I would narrow the focus on achieving that and less so on the bigger tax picture….the level of potential investment these tech companies could make is nothing short of incredible and would have a positive impact on the economy,” he said.