Surprisingly, the United States property market landscape in 2016 has remained very similar to what it was like in 2015. This result is a mix of mediocre and impressive numbers, due to interwoven themes which came into play and, yet, poised good opportunity for investors who were savvy. These opportunities brought technological, economic, and demographic trends to the CRE market. The United States Federal Reserve announced last December that the central bank forecasted growth in America to be stable. With inflation is being under control in the United States and in the emerging markets. The United States employment also remains positive. In 2016, unemployment dropped below 5 percent this year, and added to housing demand for office space, for retail, and for industrial or distribution.
For the second half of 2016, existing trends are continuing to still hang around, according to the Counselors of Real Estate annual Top Ten Issues Affecting Real Estate for 2016 report. The following are six trends were highlighted as commercial real estate trends in the upcoming year:
Global economic and political uncertainties. We would be remiss if we did not point to developments in the United States and abroad that are certain to have an impact on the state of the economy and the investment environment for the foreseeable future, starting with volatility in the energy sector that has prevailed throughout the year thus far. While oil prices have recovered considerable ground in recent months, continued volatility in the sector has injected uncertainty into the market—something investors typically try to avoid. In addition, the recent Brexit vote in the United Kingdom has introduced new uncertainties that will not be fully understood—much less resolved—in the near term. The International Monetary Fund has downgraded global growth twice since January as uncertainties blur the outlook. For U.S. markets—real estate in particular—the impact is likely to be largely positive as U.S. assets become more attractive and valuable to global investors. We can probably expect enhanced inbound foreign investment in U.S. real estate markets as the United States becomes even more of a safe haven for investors worldwide.
Steady interest rate environment. While it seemed fairly certain, at the end of 2015 and the beginning of 2016, that interest rates would begin an upward trajectory, the uncertainties mentioned in number 1, above, have probably dampened the Fed’s enthusiasm for further rate hikes in 2016. The slightest possibility remains that the funds rate could be boosted by perhaps 0.25 percent to 0.50 percent, but both inflation and employment appear to be coming in under the Fed’s expectations. And, with global economic growth lower than expected earlier in the year, the Fed will more likely maintain a wait-and-see position in the short term. We still believe that the Fed is more than likely to weigh the effects of each move it makes before adding any additional friction to current (if unspectacular) economic growth trends. Ten-year Treasury yields have been in flux as early concerns about the effects of Brexit have begun to smooth out. Yields, which had fallen to as low as 1.24 percent in the immediate aftermath of the Brexit vote, have risen back to over 1.5 percent in recent weeks. As concerns about global economic developments ease, we should expect those yields to push back toward a more normalized 1.75 to 2 percent range by year-end. The squeeze on cap-rate spreads remains of some concern for real estate investments should rates rise more rapidly than expected, especially as the “frothiness” we have seen in certain gateway, Class A markets emerges (see our cautionary note from early 2015). At present, little indication exists that a rate increase will push cap rates dramatically higher. Nonetheless, there are indications that yields may begin to drift upward. And, as pricing in first-tier markets stalls and yields hover in the sub–4 percent range in some of the major gateway markets—which are, in some cases, already in peak pricing territory—we should probably expect investors to move more aggressively into secondary and tertiary markets—and to opportunities beyond core assets to core-plus and value-add properties as well as some of the niche property sectors, including medical office, student and senior housing, and data centers.
Foreign investment in the United States. Global economic and political uncertainty continues to drive capital to the United States. International capital flows into U.S. real estate assets will continue—and increase. The U.S. property market is the most stable and transparent in the world, with higher relative yields and price appreciation potential, making it an easy investment choice. And, while slowing growth in China and much of Europe may dampen currencies and incomes over there, there is still abundant non-U.S. capital looking for placement and very strong demand for U.S. assets, as 2015 proved with record inflows. That year, foreign purchases of U.S. real estate assets rose to more than $87 billion over the 12 months ending in December, according to the Association of Foreign Investors in Real Estate (AFIRE), with China, Canada, Norway, and Singapore all riding the wave. That volume is up from just $4.7 billion in 2009, according to Real Capital Analytics. Among members of AFIRE, a substantial proportion expect to increase investment in the United States in 2016. Changes in the 1980 Foreign Investment in Real Property Tax Act (FIRPTA), which now allow foreign investors to be treated in a fashion similar to their U.S. counterparts, will likely lead to an increase in foreign investment in the U.S. real estate market as well.
Slowing new supply. Additions to supply will remain limited across the board, with only modest supply growth in a few sectors—multifamily (now slowing for the remainder of 2016), student and senior housing (creeping up), and single-tenant industrial (regional/nodal distribution centers)—and repurposing in others (suburban malls). Lending sources were extremely skeptical about funding new construction coming out of the last recession, and the current lending environment is showing signs of reticence as bank reserve requirements from Basel III and commercial mortgage–backed securities (CMBS) risk retention requirements from Dodd-Frank are due to kick in by late 2016. Market volatility has sharply reduced CMBS offerings as well. Insurance companies are stepping in to fill some of the gaps, and private debt funds are emerging as an alternative space. Of all the property sectors, only multifamily can be said to be near long-term new supply, although office is seeing some marginal supply additions in a few markets for the first time in years.
Ever-changing retail. There will be continued stress on retail and continued retail shifts—including mixed (virtual/physical) spaces and entertainment-themed spaces. The technology of retail continues to evolve, and the “Amazon effect” is becoming pronounced. Analysts expect that the more successful retailers will be those that can optimize a combination of virtual online and physical in-store shopping experiences (“clicks and bricks”). Amazon has begun to explore physical shopping spaces in combination with its wildly successful online model by opening its first physical store in Seattle this past fall (ironically, in a former Barnes & Noble location). It would not be a surprise to find physical retailers pushing similar formats in the other direction—including more “showroom”-styled storefronts (Tesla) with digital spaces offering fulfillment. As we said earlier this year, some retailers should probably seek out hospice care. In its 130th year, Sears could finally succumb in 2016, with some of its brands, like Craftsman and Kenmore, already being spun off to other outlets, while JCPenney is in recovery and taking up some of Sears’s traditional strengths (Penney’s is now competing in the appliance space). Macy’s is losing ground in the middle market, and has a short horizon to regain competitive advantage with lower-end discounters.
Volatile energy markets. As a colleague of ours remarks, “Whenever a key commodity demonstrates instability, it threatens global economic security.” Energy market volatility has already affected certain regional U.S. economies (e.g., Houston and North Dakota) and producer nations (e.g., Saudi Arabia and Venezuela). Last year saw a dramatic drop in oil prices, and the drop continued into early 2016, followed by substantial volatility through midyear. Increased production and reduced demand due to slowing global growth led to the decline that saw oil prices fall from $110 per barrel to a 13-year low of $27 per barrel in early 2016, with recovery to just $43 per barrel in July. The world is oversupplied, and major oil-producing countries have barely reduced production. This has had a profound economic impact and carries with it implications for property market fundamentals and commercial real estate pricing.
The impact on property market fundamentals varies by sector:
Office. Office demand is not likely to see an immediate impact from lower energy costs, but lower operational expenses do make office occupancy less expensive and contribute to higher corporate operating profits, which should, in turn, continue to fuel hiring and absorption of additional space.
Retail. Households typically spend windfalls. Retailers reported above-average, and better-than-expected, holiday sales at the end of 2015. Shopping centers and neighborhood shopping centers should benefit further should energy prices remain low to provide a windfall to consumer pocketbooks.
Industrial. The reduction of energy costs helps boost industrial production and lowers distribution costs. Petroleum-based products will benefit from lower input costs, which, in turn, can positively influence manufacturers’ decisions to increase production and occupancy. Demand for warehouse and distribution space should see an increase due to higher consumer spending. E-commerce operations will expand as well, likely resulting in more distribution and storage space.
Hospitality. Hotels benefit as leisure travelers find travel more affordable. And, lower oil prices should result in lower business travel costs, encouraging more business travel and lodging.
Apartments. Increased disposable income means that households will have more to spend on housing, including upgrading to higher-quality apartments. Furthermore, apartments in the suburbs will benefit with the lower costs of commuting.
*Counselors of Real Estate