Each year, ULI and PWC release Emerging Trends in Real Estate, a report that effectively predicts the CRE outlook across North America. I’ve heard it coined “the real estate bible.” In my opinion, Emerging Trends is a comprehensive look at the broader real estate market with details that many of us choose to avoid until it’s too late. It’s worth the full 121-page read, but for those of you who prefer cliff notes, feel free to enjoy my synopsis below. Hopefully there’s something of value, or at a minimum, a stat you can throw around at your next closing dinner.
Caveat – I’m just an office investment sales broker focused on the Southeast, so if my opinions come off as biased, they probably are. Anyway, here’s what I took away from Emerging Trends 2019.
General Overview: Investor Adaptation
- What’s the difference between Value-Add and Opportunistic?
Opportunistic investors chasing higher yields are subject to significant questions about future liquidity, price, and user-market attractiveness. Long story short, it may be leasable, but the first question you should ask yourself is, “How do I get out of this?” At this stage in the cycle, value-add means SOME “meat on the bone;” opportunistic means caution.
- Capital is Undergoing Functional Transformation
- Investment decisions are intensely concerned with elements of obsolescence – location, technological, design – under the potential impact of innovation. One portfolio manager noted, “one of my top concerns is that I will purchase an office building that in 5 years won’t meet the needs of the market.” Ceiling heights, window lines, and non-walkable commodity suburban properties will receive further scrutiny over time
- The Pace of Change Makes Investment Decisions More Complicated
- Investment committee decisions are more focused on viability and adaptability of an asset to weather any potential storm. The search for yield at the given point in the cycle is pushing capital to pursue more opportunistic and entrepreneurial ventures, though once past the peak, we’ll rotate to risk aversion and capital conservation
Interesting Stats by Product Type:
- Office – 45% of total absorption was accounted for in just 4 markets: San Jose, San Francisco, Seattle, and Washington, DC (of 58 markets surveyed)
- Industrial – 41% of people polled in 2018 are willing to pay extra for same-day delivery
- Retail – Compared to the U.K., Germany, and France, the U.S. has 6, 8, and 10 times more square feet of retail per capita
- Senior Housing – Two of every three senior housing properties were built before 2000, creating a relatively old stock of product.
- Residential – Millennials experienced the largest gains in homeownership rates among all age groups in 2017, representing 1/3 of all home purchases
- Self-Storage – In 1987, 1 in 45 people used self-storage, today, 1 in 13 people use it
The Changing Office Environment: Amenities Gone Wild
Consider it an example of curation in real estate services. Office tenants are looking for robust amenity packages beyond a “check the box” fitness center and conference room. Landlords are operating more like full-service hotels, providing direct tenant services, focusing on optimal use of common areas. They are attracting tenants with access to cooking classes, yoga, and golf simulators. As amenities continue to ratchet up, behavioral economists note “loss aversion is more powerful than the satisfaction of prospective gains, leading to an endowment affect that causes people to overvalue a good once they possess it.” Multi-family developers started the trend, and these amenities are here to stay.
Equity Sector Review:
- Institutional Volume Slipped
- Core assets are scarcer, and pricing is extremely high
- Volume for Institutional Investors and Pension Funds represented 21% in 2017, down from 26% the prior year
- REIT’s – Trading Below their NAV’s
- Meaning their share price is lower than their total implied asset values, across the majority of REIT sectors
- This makes acquisitions erosive to shareholders, not accretive
- Off-Shore Capital – Becoming Less Active
- China and Canada still lead volume in this sector
- South Korea, Germany, and the Middle East are stepping up allocations in U.S. investment
- Private Equity Remains Most Active Capital Source
- Accounted for 53% market share in secondary markets in 2017, and 67% of market share in tertiary markets
- Average price of a private capital deal is $10.8M (1/3 of other capital sources)
- A New Entrant into Real Estate Investing – Defined Contribution Retirement Plans
- These plans exceed $20 trillion in capital, and yet typically do not invest in real estate
- Slow growth in returns for DC’s has them eyeing real estate as a potential new asset class with as much as 10% allocation in their portfolio ($2 trillion of new capital into our space)
- This would be a serious game changer
Debt Sector Review:
- The rollback of Dodd-Frank restrictions will free up additional debt capital for the years ahead
- Loan-to-cost ratios and loan constants have been holding steady
- Life CO’s – very little difference exists in the interest rates between 5, 7, and 10-year loans, potentially because lending volume is greater at the longer maturities that better match life companies’ liability structures
- Debt funds are growing rapidly, but still account for only 1% of commercial real estate debt universe, with 104 private debt vehicles in the market
Jared Londry is a Director on the Charlotte Capital Markets team where he specializes in the disposition of office and mixed-use assets on behalf of institutional investors throughout the Carolinas. He has been involved in over $1.3 billion of investment property transactions in his tenure with Cushman & Wakefield.