While many variables will determine the course of U.S. commercial real estate, here are five market trends that you can bank on:
1. The inevitable end of the bull market: With this bull market in commercial real estate now five years old (six for public real estate securities), isn’t it time to be cautious? The bull market’s duration does not, by itself, indicate how long it may last. Only a huge unexpected economic downturn or dramatically rising interest rates could derail the bull market at this point. The commercial real estate market is underpinned by a slow growing but steady economy. Firms are in good shape with high profitability, growing book value, increasing productivity and benign labor cost growth—thus they continue to demand more space. Fundamentals are still good with very low levels of supply except in the case of multifamily in some markets.
2. The potential rise in interest rates: The rate increases are largely priced in already. The Fed has signaled that rates will be gradual and we must bear in mind that rates are historically low. Moreover, real rates may still be held down by a modern version of financial repression: pension funds and insurance companies have been forced, by regulations and accounting, into owning more bonds, while central banks have bought huge amounts of government debt and show no sign of selling it. Even slight rate increases will still mean a very low cost of capital. It is also important to not fall for the fallacy that there is a 1:1 correlation with rising interest rates and decompressing cap rates. There is a connection, but capital market forces (supply and demand) are fall more important. Despite higher rates, it is likely that demand for commercial investment real estate will continue to increase, countering, to some degree, rising rates.
3. Bricks-and-mortar retail vs. e-commerce: “Whither will she go?” Like Mark Twain’s classic refrain, the death of physical retail real estate has been greatly exaggerated. Having said that, online retail continues to grow at double-digit rates and more and more people are finding online shopping faster, more convenient and less expensive. It is estimated that 10 percent to 15 percent of all retail centers are now functionally obsolete. The suburban mall, as a fixture in the automobile-driven landscape, is rapidly disappearing, or at least transforming into a shadow of its old self. The result is a bifurcation of high-end urban retail destinations and highly localized, grocery-anchored strip centers. While economic growth and housing markets will determine the future of some retailers and retail platforms, it is becoming clear that brick-and-mortar retailers will be forced to change their business models, incorporating e-commerce into their marketing and physical space portfolios. Most consumers still enjoy onsite retail, yet more and more are finding their purchasing needs satisfied online, which promises delivery to one’s door within a day or two. As a result, many, if not most, retailers are becoming part physical showroom and part online sales as consumers browse the physical store only to return home to complete their purchases online.
4. The growth of crowdfunding: Consumers want to have more direct control over their investing lives. As usual, commercial real estate is late to the party. Direct access of a wide range of investment vehicles has been available to consumers for nearly 20 years now in the form of online discount brokerage platforms such as Ameritrade and Charles Schwab. Consumers like having the information and the means to make and manage their own investments. These websites and firms have grown significantly. It was only a matter of time before this technology came to private equity real estate. If properly informed and guided, why wouldn’t the average investor want all that private equity real estate can deliver? Will there be hiccups and bumps along the way—no doubt, but the trend follows other asset classes and the returns and characteristics that commercial real estate delivers, will make is increasingly in demand by the investing public. Venture funding of real estate technology startups reached $605 million in 2014, up from $241 million the year before. Real estate has become one of the hottest sectors for technology entrepreneurs and many big backers from Silicon Valley and elsewhere see the industry primed for disruption.
5. The urban population boom: While suburbia is in no way of going the way of the dinosaur, the urban trend continues and in fact has been accelerating in recent years. More people of all ages—millenials and baby boomers alike, prefer to live in cities, particularly dense urban cores. Density, mixed-use, walkability and a range of services, cultural resources are all reasons cited for people wanting to live in cities. While cities have long been the locus of economic opportunity, more than ever, the most dynamic industries, the higher paying jobs, the more entrepreneurial companies, are locating in cities. In 2011, population growth in urban areas began to outpace the suburbs in the U.S. for the first time in over 100 years. Firms and employers are following the feet of the flow of urbanites, creating new vertical/mixed-use retail formats and more collaborative and compact office buildings. Adaptive reuse of properties in urban locations results from this trend as developers take previously overlooked properties and turn them into unique apartments, offices and shops.