2019 COMMERCIAL REAL ESTATE TRENDS

Roy Legal Group

18 Commercial Real Estate Trends To Dominate In 2019 National December 11, 2018 Champaign Williams, National Editor Want to get a jump-start on upcoming deals? Meet the major players at one of our upcoming national events! Goodbye 2018, hello 2019! As the new year approaches, Bisnow spoke with several industry execs, researchers and economists to uncover the major trends expected to dominate the commercial real estate industry in the coming year. From the rise of opportunity zones to a slowdown in industrial absorption, these are 18 trends experts forecast for 2019. Pixabay 1. Opportunity Zones Craze To Persist As investors await finalized guidance from the Department of the Treasury and the IRS regarding the Opportunity Zone program, the hunt is on for assets and investment opportunities in these designated areas that present the strongest upside potential. Investors are lining up to pour billions into Opportunity Zone Funds, with a report from Real Capital Analytics stating there is more than $6 trillion in unrealized capital gains eligible to be deployed into opportunity zones. While the program was created through the passing of the Tax Cuts and Jobs Act last year to drive economic development in underserved communities in exchange for a hefty tax break, research reveals many of the census tracts classified as opportunity zones have already attracted a substantial amount of investment prior to the launch of the new federal program. Critics of the program worry it will accelerate investment in areas already experiencing a surge in development activity, leading to a convergence of investment into burgeoning neighborhoods already in high demand, and a lack of investment in otherwise blighted communities. 2. Industrial Boom To Continue Thanks To High Demand From E-Commerce Players, Though A Few Headwinds May Surface Industrial real estate demand soared to new heights this year, and CBRE Head of Industrial Research David Egan expects more of the same in 2019. “I think the market has outperformed this year, at least from user activity. There has been a general expectation for a number of years that this can’t continue, and it turns out that hasn’t been true. We have a massive amount of demand on the market for logistics properties of all types; obviously the Class-A big-bulk warehouses are what get most of the attention, but the demand is very broad-based and extending all the way down to secondary and tertiary markets,” he said. “My expectation in 2019 is that we should see more or less of the same dynamic.” Net absorption resulting from e-commerce growth is expected to average between 75M SF and 94M SF, same as this year, according to CBRE’s 2019 Outlook report, and a lack of new supply has driven vacancy levels down to 4.3%, a historic low. “Based on the demand that we’re seeing from the e-commerce sector — as well as from traditional brick-and-mortar retailers that are entering or expanding in the online space — we can fully expect that e-commerce will continue to drive the market next year,” Bridge Development Partners President Anthony Pricco said. “This is especially true for infill sites proximate to the major population centers. While the rising costs of land and construction could be viewed as emerging market headwinds, the upside of industrial development is still exceptionally strong, as rents have been appreciating at an even faster pace.” Egan told Bisnow he would not be surprised if net absorption tapered off in 2019 due to new supply not keeping pace with robust demand levels. “You can only absorb what’s available,” he said. “While we expect to see supply-demand relatively in check, those growth metrics will still be positive.” 3. Federal Reserve To Gradually Boost Interest Rates Due To The Strength Of The Economy With robust jobs growth continuing to increase at a healthy clip and the unemployment rate steady at 3.7%, a 50-year low, Fed officials hint that they will likely continue their course of action in 2019 to gradually boost short-term interest rates to temper inflation and maintain a stable economy. “Inflation exists above the Fed’s target of 2% to 2.5%, with more job openings than unemployed and more homebuyers than new housing inventory. The Fed sees inflation ahead first and foremost and will continue on a hike-pause-hike-pause pattern in 2019 as long as GDP remains above 2% and unemployment below 5%,” CCIM Institute Chief Economist K.C. Conway said. The Fed boosted rates three times this year to a range of 2% to 2.25%, and many expect central bankers to bump rates again in December. Big Wall Street banks polled by Reuters expect central bankers to boost rates another three times in 2019. “Although the most recent Fed guidance has seemed less definitive on its future course, the market and most analysts anticipate another hike this month and two to four next year, as both inflation and wage growth exceed their targets,” Colliers International U.S. Chief Economist Andrew Nelson said. “This will ultimately translate into declines in consumer and business borrowing and curb spending and investing.” 4. Online Retailers Will Continue To Open Brick-And-Mortar Stores, Further Validating That Physical Retail Is Far From Dead With the retail industry stabilizing in 2018, CBRE Head Of Global Retail Research Melina Cordero expects retailers to begin reinvesting in their physical footprints to achieve the perfect omnichannel shopping experience for consumers. In addition, digitally native (or e-commerce only) retailers will increasingly shift to open physical stores to grow their business and retain more customers, Cordero said. “In terms of retail and real estate, I think the retailers have finally sort of learned what to do. There’s a lot of investment, changes and closures that had to happen to adjust to omnichannel. Over 2018 a lot of those investments finally started to pay off. “What we think is going to happen over 2019 is a real return to the store. Retailers are finally starting to realize the value of their real estate — they can’t just close a store and rely on online, they really need the store for profit margins, customer attention, customer acquisition, for lots of reasons. I think we’re going to see a lot of reinvesting in the store and a lot of reinvesting in strategies to try to get people into the store,” Cordero said. 5. Industry To Continue Reading The Tea Leaves To Predict The Next Downturn Everyone is on the lookout for signs of the next recession, as the economy nears its 10th year of expansion — its longest period of expansion ever. “In the history of U.S. business cycles, downturns have typically occurred within one or two years after the economy has reached full employment,” JPMorgan Chase Commercial Banking Head Economist Jim Glassman said. “A careful examination of this historical regularity indicates, however, that this pattern has been the result of two imbalances — a building inflation problem that requires the Fed to adopt a restrictive policy posture, or unprecedented financial imbalances. “In that regard, there are no obvious imbalances that have the potential to trigger a downturn, so the current expansion is likely to settle into a lengthy period of balanced, noninflationary growth.” Though U.S. economic growth and job gains were strong in 2018, some economists and analysts predict the economy will slow in 2019 due to continued short-term interest rate bumps by the Federal Reserve and waning fiscal stimulus from federal tax cuts. “Inevitable disruption is probably the appropriate risk strategy mode to be in for 2019. Real estate is not immune from business cycles, economic recessions or disruptive black swan events — such as a trade war, currency crisis or cyberterrorism,” Conway said. 6. Investor Demand For U.S. Assets To Keep Transaction Volume Strong “Though property markets peaked for this cycle in 2015, leasing and sales transaction activity remain robust and pricing firm,” Nelson told Bisnow. “Transaction volume through Q3 2018 [was] 11% above its level for the comparable period last year and is approaching the total closed in 2015 — the peak sales year for this cycle. “While all four core sectors have shared in this year’s gains, apartment and office — perennial investor favorites — have posted the highest sales totals and the strongest price appreciation to date. But both [will] likely slow sharply in the next two years, along with price appreciation and rent growth, as the economy slows or even turns negative.” 7. Industrywide PropTech Adoption To Accelerate Commercial real estate professionals — from owners and operators to brokers and architects — can no longer deny the impact technology is having on the industry. More real estate firms are embracing the latest innovations to streamline work tasks and create a more paperless, transparent approach to sourcing deals, managing assets, analyzing data and closing transactions. Mihir Shah, co-CEO of JLL Spark — JLL’s PropTech division that has a $100M global fund dedicated to investing in real estate tech companies — told Bisnow that PropTech companies have become increasingly valuable as their products have helped real estate firms further their initiatives. “As part of this effort, we are seeing companies that typically went through long RFPs showing interest in piloting new products to see which ones are viable. This helps them prove [return on investment] faster and helps the winners grow faster,” Shah said. “This willingness to try new things will help PropTech adoption in 2019 and beyond.” 8. Investment In Value-Add Assets To Help Assuage U.S. Workforce Housing Availability, Affordability Concerns Demand for available and affordable workforce housing options will remain a topic of interest in the multifamily sector, as expensive land and development costs make it increasingly difficult to build affordable housing from the ground up. This is particularly a pain point in urban metros, JPMorgan Chase Head of Commercial Real Estate Al Brooks told Bisnow. “The ongoing job growth we’ve been experiencing in the U.S. is having a huge impact on workforce housing affordability in major cities. This influx of talent continues to be fueled by the need to be in close proximity to work, the convenience of mass transit options, as well as the appeal of being at the center of the action in major metropolitan areas,” Brooks said. CBRE Americas Head of Multifamily Research Jeanette Rice said investment in value-add multifamily assets will help assuage these concerns. “Workforce housing will also remain appealing in 2019 due to demand outpacing available supply, thereby keeping vacancy rates low and rental growth above the overall multifamily market. “Investor interest will also remain very high in 2019. Interest is coming from all types of capital, including institutional and foreign capital as well as traditional sources like smaller private buyers. The appetite for workforce housing is very strong for the better property fundamentals and higher yields. Value-add investment will likely still dominate in 2019 and remain largely successful. Acquisitions of stabilized product will also be appealing for some investors, particularly those with longer-term hold horizons,” Rice said. Unsplash/Raphaël Biscaldi 9. Millennials To Continue Flocking To Hipsturbias And 18-Hour Suburban Cities Research and data has dispelled the long-held myth that millennials are city-flocking suburbia haters. With aging millennials now hitting their early 30s, many are turning to the suburbs with their families. More than 2.6 million Americans relocated from the city to the suburbs in the last two years, according to the U.S. Census Bureau as reported by ULI. This has renewed investor interest and confidence in select non-gateway markets, ULI reports in its 2019 Trends survey. “Hipsturbias” or “Urban-burbs” have been used to classify these suburban markets with increased walkability and access to public transit that so resemble urban metros. A U.S. bank senior researcher told ULI the following: “The first phase is millennials moving to the suburbs for larger, more affordable homes and access to schools, so adequate single-family and multifamily housing will be necessary. Retail follows rooftops, so retail development to meet the new residents’ requirements will follow. Finally, you may begin to see more emphasis on employment centers as residents decide they want to work closer to where they live.” 10. Investors To Favor Industrial, Multifamily And Retail Assets In The New Year It comes as no surprise that industrial real estate assets would be an anticipated favorite for investors in 2019, along with multifamily assets, according to ULI’s 2019 Emerging Trends report. Deep-pocketed investors like Blackstone Group continue to gobble up entire portfolios of industrial assets at a rapid pace this year, such as its purchase of industrial REIT Gramercy Property Trust for $7.6B, a portfolio of last-mile logistics assets from Harvard University for nearly $1B and a portfolio of 41 warehouses from FRP Holdings Inc. for $359M. More interesting is the fact that retail is expected to attract interest from investors in 2019, particularly those assets ripe for redevelopment and upgrades. “Many shopping center properties are just not going to come back as successful retail assets. But while few have been reduced in price to mere land value, many are well below replacement cost and have good locations for alternative uses,” ULI reports. “If a site is sufficiently large, mixed-use is a great option for close-in suburbs looking to exploit maturing millennials’ desire to enter their next life-cycle phase. There also is an opportunity to turn the tables on the e-commerce trend that fostered the obsolescence by redevelopment into distribution facilities.” 11. Investors To Continue Flocking To Secondary, Tertiary Markets For Yield Commercial real estate investors on the hunt for solid risk-adjusted returns continue to bypass gateway markets to bet on assets in burgeoning secondary markets, and the trend is likely to continue in 2019. “Because of the high prices and limited opportunities in primary U.S. metros, investors are continuing to focus more on secondary markets, which are enjoying double-digit growth in investment activity and much stronger price increases than in the primary (largely coastal) metro markets,” Colliers’ Nelson said. “However, those trends are likely to reverse if/when we see the economic slowdown, and investors seek the security of larger, more liquid markets.” This behavior is typical in a late-stage cycle such as this, CBRE Chairman of Americas Research Spencer Levy said. “The downside of the coin is it’s typical of late-cycle investment activity that you see a shift from primary to secondary in search of yields. What is new is we have not seen a compression of yields that would be typical in late-market activity,” he said. “What happens is cap rates in primaries and secondaries converge; we have not seen that in office and retail, but we have seen that in multifamily. The question is, is this trend durable during a recession that will occur in the next couple of years?” 12. Construction Industry To Continue Grappling With High Costs, Labor Shortage Rising construction costs were the No. 1 real estate and development concern for respondents that participated in ULI’s Emerging Trends in Real Estate 2019 survey. On a scale of one to five, five being of the greatest importance, construction costs ranked 4.59, with land costs and housing costs and availability following close behind at 4.14 and 4, ULI reports. “Rising construction costs may be the most undertold story of 2018 that should become a material story in 2019,” CCIM’s Conway said. Conway identified a number of factors exacerbating cost and labor challenges in the construction industry, including a decline in immigrant construction laborers following the financial crisis, crazy superstorms as a result of climate change that has led to massive rebuilding efforts across the country, and tariffs and the trade war. “Key materials like steel, … bathroom fixtures from China, lumber from Canada, etc., are impacted. Pay attention to the quarterly earnings reports from construction materials companies as to the kind of input cost increases being experienced. Caterpillar, for example, reported solid sales in Q3 2018, but a large rise in material inputs like steel. The result is growing pressure on margins. “That is the key takeaway regarding construction labor and material costs increases — margins are going to be squeezed, cost overruns incurred, and values under pressure unless rents and [net operating income] can be increased to cover the increasing costs of new construction,” Conway said. 13. U.S. Office Real Estate Markets To Remain Stable, Though Demand May Slow CBRE said in its 2019 U.S. Outlook report that office net absorption is expected to reach 37M SF in 2019, representing the sector’s 10th consecutive year of positive absorption. Should the country continue to experience strong office-using job growth in the new year, it could lead to strong absorption rates and renewed interest from investors. “One portion of office real estate expansion is the demand for more office space near entertainment venues and other amenities. These office buildings are relying on smaller, flexible workspaces. Coworking spaces also have become more common as professionals choose alternative working methods,” Gerken told Bisnow. That said, Colliers’ Nelson anticipates office demand will taper off in response to a slowdown in job creation and robust supply levels. “Demand for office space will moderate in response to slower job creation, just as a significant volume of projects already under construction begins to enter the market,” Nelson said. “So vacancy will trend upward and rent growth will ease as market conditions become more competitive for landlords.” 14. Retail Bankruptcies To Slow, Retailer Earnings To Stabilize “The retail real estate industry has experienced significant change in recent years, and the transformation is profound and will continue throughout 2019. The convergence of brick-and-mortar and online retail will continue to create major seismic shifts in the industry,” TD Bank Head of Commercial Real Estate Gregg Gerken told Bisnow. Though a wave of retailers filed for bankruptcy and shuttered stores this year — including Sears, Mattress Firm, Nine West and Claire’s — the circumstances surrounding most store closures next year should be vastly different, CBRE’s Cordero said. “I think the general industry sentiment is that 2017 was probably the peak year [for retail closures]. I think there will continue to be closers in 2019 — it’s hard to say whether we’ll have more or less — but I would say a lot of the closures that we’ll see in 2019 will be more about what we call portfolio rationalization or optimization than they are about retailers that are failing. “Retailers in lots of cases do need to close stores to reorient their portfolios — so I do expect closures in 2019, but I don’t really [associate] a lot of those closures as dying or failing retail, it’s more of morphing and adjusting retail,” Cordero said. 15. Multistory Warehouse Development In The U.S. To Accelerate Conditions have ripened for multistory warehouse development in the U.S., and this trend will continue into 2019. Facilities are underway or have already delivered in Seattle, San Francisco, New York, Miami and Chicago. While multistory warehouses are nothing new in Europe and Asia, the U.S. is in the beginning stages of developing these types of facilities now that building costs are no longer as cheap and there is less available land than in the past, CBRE’s Levy said. Unprecedented demand for warehouse and logistics space today has changed that dynamic. “The rents that are being achieved in these multistory industrial [facilities] could be two or three times what you’re seeing in traditional industrial. We think this particular trend is only at the beginning in the United States,” Levy said. Though the bumps in rent are substantial, CBRE Head of Industrial Research David Egan said these multistory facilities also can present operational challenges for users. “The users are going to have to change the way they operate in these buildings to make it work efficiently,” he said. “The operational issues are not small — to change the way they move inventory in and out of these buildings is not a small little tweak.” 16. Grocery Chains To Move Further Online, Expand Their Online Offerings With The Help Of Tech Up to now, delivering fresh groceries to consumers’ doors has been a fairly nascent concept — and it is no easy task. Grocers already battle low profit margins due to increasingly declining food prices and new low-cost rivals like Aldi entering the market. These challenges, coupled with expensive online delivery costs, has kept online grocery delivery in its infancy. But CBRE’s Cordero sees that trend shifting in 2019. “Grocery is probably, among all the retail categories, one of the lowest for online penetration. We think due to a combination of technological advancement, investment on the part of retailers and consumer demand, that we’re going to see a pretty important shift next year in grocery going online and retailers offering more to consumers in that domain,” she said. 17. Economic Development Teams Across The Country Continue To Feel The Impact Of HQ2 Competition “An open competition like the Amazon HQ2 search is an opportunity for communities to redefine their legacy image and showcase what is different about their economy today versus 10, 20 or 30 years ago. The 238 communities that competed for the Amazon HQ2 are winning economic development as a result,” CCIM’s Conway said. “Amazon is using the data to site select new fulfillment centers in places like Tucson, Arizona, and Birmingham, Alabama. Other major transportation and e-commerce companies, like Norfolk Southern Railroad, have used the information to make a relocation decision (in Norfolk Southern’s case, to Atlanta, which was among the 20 finalist cities for Amazon HQ2). In other words, the Amazon HQ2 search was to economic development what the census is to demographics.” 18. U.S. Hotel Occupancy To Break Records In 2019 The hotel sector is expected to experience a record-breaking year of occupancy levels in 2019, according to a forecast from CBRE Hotels America Research. Occupancy levels are expected to surge to 66.2% next year, the 10th consecutive year of growth. This increase will be driven by a 2.1% increase in demand to offset incoming supply. That strong demand may not be felt evenly across markets, Quadrum Hospitality Group President Foiz Ahmed said. “Although the hospitality sector continues to grow, the markets in which Quadrum is active will stay relatively flat given their higher-than-national average occupancy rates. While average daily rates are rising nationally, the industry will face some challenges due to the rapid adoption of apps that provide discounted rates”.