Professional Documents
Culture Documents
UNCHARTED
TERRITORY
US economic expansion
approaches record length
PAGE 2
Positive trends
emerge in retail
PAGE 40
®
Expectations & Market Realities in Real Estate 2019
Uncharted Territory
© 2019
Deloitte Development LLC
NATIONAL ASSOCIATION OF REALTORS®
RERC LLC
Situs
All Rights Reserved.
Disclaimer: This report is designed to provide general information in regard to the subject
matter covered. It is sold with the understanding that the authors of this report are not
engaged in rendering legal or accounting services. This report does not constitute an offer
to sell or a solicitation of an offer to buy any securities, and the authors of this report advise
that no statement in this report is to be construed as a recommendation to make any real
estate investment or to buy or sell any security or as investment advice. The examples
contained in the report are intended for use as background on the real estate industry as a
whole, not as support for any particular real estate investment or security. Neither Deloitte,
NAR, Situs, RERC LLC, nor any of their respective directors, officers, and employees warrant
as to the accuracy of or assume any liability for the information contained herein.
ii ©2019 Deloitte Development LLC, NATIONAL ASSOCIATION OF REALTORS®, Situs RERC. All Rights Reserved.
EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
TABLE OF CONTENTS
CHAPTER 1: INTRODUCTION
Uncharted Territory......................................................................................................................2
US Economy’s Long and Slow Recovery.......................................................................................2
CRE is an Attractive Investment Alternative...................................................................................3
Yield Curve Inversion: Signal or Noise?........................................................................................5
Cyclical and Structural Changes..................................................................................................6
The Deloitte 2019 Commercial Real Estate Outlook..................................................................10
The 2018 Deloitte Dbrief...........................................................................................................11
Global Perspectives...................................................................................................................15
US Economy.............................................................................................................................16
Employment Trends...................................................................................................................18
Housing ...................................................................................................................................19
CHAPTER 5: OUTLOOK
Economy...................................................................................................................................50
Financial Markets......................................................................................................................50
Situs RERC 10-year Treasury Forecast........................................................................................51
CRE Debt Market Outlook..........................................................................................................51
CRE Equity Market Outlook........................................................................................................51
Situs RERC Total Return Forecasts.............................................................................................53
Property Type Outlook................................................................................................................56
Conclusions..............................................................................................................................58
Alternative Economic Scenarios.................................................................................................59
Sponsoring Firms......................................................................................................................62
Situs RERC................................................................................................................................62
Deloitte.....................................................................................................................................63
NATIONAL ASSOCIATION OF REALTORS®.....................................................................................64
iii
ABOUT OUR PARTNERS
DELOITTE NATIONAL ASSOCIATION SITUS RERC AND SITUS
OF REALTORS®
Deloitte is a recognized leader in provid- Since 1931, Situs RERC, a wholly owned
ing audit, tax, consulting and risk and The NATIONAL ASSOCIATION of REAL- subsidiary of Situs, has partnered with cli-
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estate industry. Our clients include top ation, representing 1.3 million members industry’s most comprehensive valuation
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includes over 8,000 professionals located third-party loan servicer in Europe. Situs’
in more than 50 countries throughout acquisition in 2017 of The Collingwood
the Deloitte Touche Tohmatsu Limited Group, a Washington, DC, advisory firm
network of member firms. focused on residential housing finance,
expanded Situs’ offer in the residential
market, and Situs was further bolstered
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iv ©2019 Deloitte Development LLC, NATIONAL ASSOCIATION OF REALTORS®, Situs RERC. All Rights Reserved.
EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
FOREWORD
Dear Readers,
The good news for CRE investors is that solid property fundamen-
tals are underlying strong valuations and these valuations are
supporting high prices. All the property types seem to be holding
their own — including retail — which has struggled in recent
years due to overbuilding and the rise in e-commerce. Surviving
retailers are learning how to adapt to new technology and changes
in consumer shopping tastes. As more consumers make online
purchases, the need for distribution centers increases and demand
for industrial space keeps growing. The apartment sector exhibits George Ratiu
renewed strength, thanks — in part — to a continuing problem Director, Housing & Commercial Research
with affordability for single-family housing. In the hotel sector, NATIONAL ASSOCIATION OF REALTORS®
room supply, room demand, occupancy, average daily rate (ADR)
and revenue per available room (RevPAR) are at all-time highs. The
office sector has been spurred by increased investment in non-ma-
jor and suburban markets.
For this report, Situs RERC, Deloitte and the NATIONAL ASSOCIA-
TION OF REALTORS® are once again pleased to provide you with
our outlook into the commercial real estate market, the economy,
the capital markets and the property markets and to provide our
collective perspectives for 2019.
We would like to extend our gratitude to all who contributed to Kenneth P. Riggs, Jr., CFA, CRE, MAI, FRICS
this report. This includes the data providers, survey respondents, President and Global Head
economists, researchers and analysts, and reviewers and busi- Situs RERC
ness colleagues, without whom this report would not have been
possible. We also would like to thank our clients, subscribers and
consultants for their continued support of this annual publication.
v
ACKNOWLEDGMENTS
SPONSORING FIRMS & CHAIRS Nick Gibbs, MAI
Manager
Matthew G. Kimmel, CRE, FRICS, MAI Deloitte Transactions and Business Analytics LLP
Principal
Deloitte Transactions and Business Analytics LLP Surabhi Kejriwal
Research Leader, Real Estate
George Ratiu Deloitte Support Services India Pvt. Ltd.
Director, Housing & Commercial Research
NATIONAL ASSOCIATION OF REALTORS® Nick LeVeque
Senior Consultant
Kenneth P. Riggs, Jr., CFA, CRE, MAI, FRICS Deloitte Transactions and Business Analytics LLP
President and Global Head
Situs RERC Saurabh Mahajan
Manager, Real Estate
LEAD CONTRIBUTORS Deloitte Support Services India Pvt. Ltd.
vi ©2019 Deloitte Development LLC, NATIONAL ASSOCIATION OF REALTORS®, Situs RERC. All Rights Reserved.
EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
CHAPTER 1:
INTRODUCTION
CHAPTER 1 INTRODUCTION 1
SEATTLE
INTRODUCTION
UNCHARTED TERRITORY the residential lending market would be a
trigger because they didn’t take into account
Real estate has historically been known for what was happening with derivatives and
its cycles, which have included some big its ripple effect. It’s entirely possible that the
highs and some low lows, but we are now next economic downturn could be caused by
at a unique time in the current cycle – and something that the economic experts haven’t
the norms of the past regarding pace and anticipated. Maybe the lingering effects of
cadence are foundationally different. This the record-long US government shutdown or
causes us to ask, what does this mean and some unforeseen fallout from Brexit?
what can we expect?
The GFC was the world’s worst financial
We are entering uncharted territory. If downturn since the Great Depression of the
the current economic expansion continues 1930s, and few believe the next downturn
through June 2019, it would mark the lon- will approach anything that severe, accord-
gest expansion in US economic history since ing to a Forbes article titled 4 Market Trends
records started being collected in the 1850s. to Watch in 2019. The GFC was structurally
Based on data from the National Bureau of different from past recessions and more like
Economic Research (NBER), the average the Great Depression than a typical down-
post-World War II expansion phase was 58.4 turn. The deeper the ditch, the longer it
months; the current expansion phase will takes to climb out, and that was the case in
surpass 120 months in July 2019, assuming the aftermath from the GFC.
it reaches this historic milestone. We have
been crawling the wall of worry for at least Investors are trying to predict the impact of
the past two years that a correction — in the numerous challenges around the world
both real estate and the overall economy — and at home, including the US government
is looming. A future recession is inevitable, shutdown, the collapse of Brexit talks, mili-
but there is no way of knowing when it will tary conflicts across the globe and political
occur or how severe it will be. and social unrest. It’s unclear how any — or
if — these challenges will end up affecting
It’s clear that the concerns and accompa- the US or world economy in major ways, but
nying jitters caused by certain elements are it’s not unreasonable to worry.
impacting how people view the economic
landscape and what will come next. The US ECONOMY’S LONG AND SLOW
Federal Reserve’s past and the potential for RECOVERY
future rate increases, trade disputes, global
and geographic disputes and the psycholog- Gross Domestic Product (GDP) growth has
ical effect of approaching 10 years of expan- been slow and steady during this expan-
sion are all contributors to these jitters. Even sion, averaging 2.3%. By comparison, GDP
absent some other factors, just the psycho- growth ranged from 2.9% to 7.0% (averag-
logical aspect of the 10-year mark is making ing 4.6%) across all other recovery cycles
people nervous, whether it’s warranted or since the aftermath of World War II. Histor-
not. ically, slower economic growth has been
associated with longer expansion periods.
The length of any cycle is not set in stone,
and many things are different now from The tax cuts passed at the end of 2017 likely
previous cycles. It is important to separate helped boost GDP and wage growth in the
the cyclical changes from the structural short term. In 2Q 2018, GDP growth reached
changes. Even though there are many struc- 4.2%, the highest rate in nearly four years,
tural changes, we should not fall into the but declined to 3.4% in 3Q. The long-term
“this time will be different” mentality. effect of the tax cuts is uncertain. In Decem-
ber 2018, the Federal Open Market Committee
Before the Global Financial Crisis (GFC), (FOMC) projected that GDP growth would be
people didn’t believe that the problems in 1.8% by 2021, 40 basis points (bps) lower than
2 ©2019 Deloitte Development LLC, NATIONAL ASSOCIATION OF REALTORS®, Situs RERC. All Rights Reserved.
EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
2Q 2018’s 2.2%. As the tax cuts have not been consumer confidence is at an 18-year high, 26,616.71 on January 26 2018, the index fell 4%
accompanied by a major decrease in federal and inflation and wages are finally starting the next week, and on February 8 the Dow
spending, the federal deficit, which is already to pick up. This has helped fuel continued fell more than 1,000 points to 23,860.46. The
at historic highs, will continue to increase, GDP growth, which was 3.5% in 3Q 2018, market recovered, however, rising past 26,800
weighing down on future economic growth. down from 2Q 2018 but still above expecta- by October 3. Unfortunately for investors,
tions and the 2.2% growth rate in 1Q 2018. the stock market experienced several major
Wage growth and inflation have finally begun The tight labor market, high consumer con- declines in October and November, essentially
to pick up, and the ultra-accommodative pol- fidence and increasing wage growth con- erasing all the 2018 gains. In just two days —
icies of the Fed began to reverse course just in tinue to boost the economy. November 19 and 20 — the Dow Jones dropped
the past two years. Public debt, which helped nearly 950 points or 3.73%. Then, in Decem-
shake us out of the crisis, has been at or near AMID VOLATILITY OF STOCKS AND ber, the Dow, S&P 500 and Nasdaq all dropped
100% of GDP since 2012 and this has likely WEAKENING BONDS, CRE IS AN about 9%. The Dow finished the year barely
contributed to the ongoing sluggish economic ATTRACTIVE INVESTMENT ALTERNATIVE above 23,000, a drop of about 7.5% from the
growth since the recession. Recent pro-cycli- beginning of the year, despite a record 1,080-
cal fiscal policies will likely only exacerbate According to data from the Federal Reserve point rise (4.9%) on December 27. Following
the problem long term. Bank of St. Louis (FRED), the Dow Jones Indus- the poor stock performance in December 2018,
trial Average (Dow) had its worst yearly price there was a rebound in January 2019.
The unemployment rate — which remained change in a decade in 2018, and the year was
3.7% for three straight months before notch- filled with volatility. The Dow increased or The S&P 500 total return index and Nasdaq
ing up to 4.0% in January despite contin- decreased by more than 2% in a single day on suffered through similar ups and downs in
ued job growth – is near a 50-year low, 21 occasions in 2018. After climbing to a record 2018 based on data from FRED. The S&P
ATLANTA
CHAPTER 1 INTRODUCTION 3
500 either increased or decreased by greater find that private CRE holds its own against Baa have averaged 400 bps and 320 bps,
than 2% in a single day on 18 occasions in stocks over the long term without having the respectively. These spreads are commen-
2018. The Nasdaq was arguably more vol- added risk of volatility. In 3Q 2018, private CRE surate with historical bond returns. The
atile; it increased or decreased by greater total returns, as measured by the National Moody’s Aaa 10-year and 15-year average
than 3% in a single day on 11 occasions in Council of Real Estate Investment Fiducia- return spreads compared to private CRE
2018. The S&P 500 total return index stayed ries (NCREIF) Property Index (NPI), declined return expectations were 420 bps and 400
approximately in the 5,500-5,700 range slightly, but the institutional investors that bps respectively, while the Moody’s Baa
during 3Q 2018, with a return of 7.82% year- we talk to are content with the enduring sta- 10-year and 15-year average return spreads
to-date (YTD) as of September 30, 2018, bility of the income component, considering were 310 bps and 300 bps, respectively.
while the Nasdaq stayed approximately in the wildly fluctuating returns for other asset
the 7,600-8,100 range during the quarter, classes. As of 3Q 2018, YTD returns for CRE, The 10-year Treasury rate increased almost
with a return of 12.18% YTD as of Septem- as measured by the NPI, were roughly 250 80 bps between January and its 2018 peak
ber 30, 2018. By the end of the year, though, bps lower than the S&P 500 and 130 bps less on November 8; however, the rate declined
with losses paralleling those of the Dow than the Dow. The NCREIF Fund Index-Open by over 50 bps between November and
in November and December, the S&P 500 End Diversified Core Equity (NFI-ODCE) was December 2018. Treasury rates are incred-
tumbled to about 2,500 (down 7% since the just over 200 bps lower than the S&P 500 and ibly low from a historical perspective and
beginning of the year) and the Nasdaq fell to only 81 bps lower than the Dow over the same appear to not be satiating investor appe-
below 6,600 (down about 5% for the year). period. See Exhibit 1-A for a comparison of tite for yield. Situs RERC finds that CRE
returns. expected yield spreads have averaged 500
The attractiveness of a particular asset class bps YTD as of 3Q 2018. While below the
is relative to the desirability of alternative Comparing historical Situs RERC real estate 10-year and 15-year average spreads of 600
asset classes, which can vary depending on yields vis-à-vis capital market returns pro- bps and 550 bps, respectively, the cushion
the risk appetite of the market - risk on and vides evidence that CRE returns remain at has still been enough to attract investors to
risk off. Comparing historical private CRE competitive and acceptable levels. 3Q YTD the CRE asset class.
returns to other investment alternatives, we spreads between CRE and Moody’s Aaa and
Dow Jones Industrial Average3 6.56% 20.76% 20.49% 14.57% 12.22% 9.97%
Nareit Index (Equity REITs)3 1.78% 4.31% 8.97% 9.57% 7.77% 9.63%
1
Based on published data from the Bureau of Labor Statistics (seasonally adjusted).
2
Based on average quarterly T-bond rates.
3
Based on total return index, and includes the dividend yield.
4
Based on price index, and does not include the dividend yield.
5
NCREIF total return, composed of capital and income returns.
6
Year-to-date (YTD) averages are not compounded annually except for CPI and NAREIT.
Sources BLS, Federal Reserve Board, S&P, Dow Jones, NCREIF, Nareit, compiled by Situs RERC, current as of September 30, 2018.
4 ©2019 Deloitte Development LLC, NATIONAL ASSOCIATION OF REALTORS®, Situs RERC. All Rights Reserved.
EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
Over the past few years, the Fed has been those in Germany (13%) and Canada (12%)
relatively transparent (and dovish) with show similar levels of interest.
NEW YORK CITY
the timing and pace of its short-term rate
increases. These steady, incremental short- In the current environment, it’s more
term rate hikes have not appeared to have important than ever to remember something
had much impact on CRE, but developers Warren Buffet famously wrote in a 2008 let-
and investors may be adversely affected by ter to the shareholders of Berkshire Hatha-
higher borrowing costs if the Fed maintains way: “Price is what you pay; value is what
its pace of rate hikes. Higher interest rates you get.” It is important to keep in mind that
lead to higher capitalization (cap) rates and pricing and value are both grounded in the
lower property valuation, which in turn will confidence that conclusions about price and
impact transaction volume. Research con- value are valid.
ducted by Situs RERC has found increased
institutional investor concerns over the past As the CRE expansion continues amid ris-
year regarding the impact of higher interest ing interest rates, CRE total returns are
rates on CRE. The extent to which the Fed will expected to continue to decline from their
continue to openly communicate its policy recent peaks. With price and value gains
decisions in advance and to be flexible with now slowing to more of a measured pace,
respect to rate increases and the winding and net operating income (NOI) continuing
down of its balance sheet will likely deter- on pace with a slow level of growth, CRE will
mine how the market reacts in the future. But rely on income to drive total returns moving
even if the rate hikes are steady and trans- forward versus value or price appreciation.
parent, they could take their toll over time if This is especially true of the gateway cities
they continue for several years. and involves major core assets.
Private CRE gives investors a bond-like Prices are inflated in many markets, includ-
return plus an equity upside like that of a ing CRE markets, but the underlying confi-
stock investment. Institutional CRE is cur- dence on value of CRE generally supports
rently positioned well to achieve reason- the prices being paid today. Given the data
able returns in an otherwise shaky invest- provided to the authors of this report by
ment environment. The tangible nature of CoStar8 (and presented in chapter four of
the CRE asset class creates these favorable this report), investors should be confident
investment dynamics: cost barriers or sup- that rent growth and space market funda-
ply checks and balances; an observable and mentals will continue to be strong. This con-
understandable investment; transparency fidence about expectations is crucial, and
in the form of market data; and consistent today there is confidence about the expec-
valuation methodologies used by the indus- tations of solid private CRE performance,
try. These dynamics lead to relative stabil- even though these expectations are lower
ity and the predictability associated with than historical levels.
operating income from commercial proper-
ties vs. other alternatives. Thus, buyers and YIELD CURVE INVERSION: SIGNAL OR
sellers are on equal footing and are able to NOISE?
discern price vs. value in a more confident
manner relative to alternatives, making it There has been talk in the media and among
a viable asset class. In fact, Deloitte’s 2019 investors about inverted yield curves and
Commercial Real Estate Outlook: Agility is what they mean for the markets and the
Key to Winning in the Digital Era7 finds that economy. Inverted yield curves have been
97% of global investors surveyed plan to a reliable leading indicator of recessions for
increase their capital commitment to CRE the last 50 years, so the fear in the markets
over the next 18 months; respondents from is reasonable. Data from the Research Divi-
the US plan to increase their capital com- sion of FRED indicates that the two-year
mitments by 13% in this time frame, while and 10-year Treasury yield curve declined
To download the full Deloitte 2019 Commercial Real Estate Outlook: Agility is Key to Winning in the Digital Era, visit https://www2.
7
deloitte.com/us/en/pages/real-estate/articles/commercial-real-estate-industry-outlook.html
CRE fundamentals data are provided by CoStar Market Analytics (www.costar.com), 3Q 2018. The information is provided “As Is” and
8
CHAPTER 1 INTRODUCTION 5
dramatically between late-November and The same article explains that banks make At the same time, markets have gyrated on
early December 2018. The two-year and more profit by borrowing short term at factors like the US-China trade tensions,
10-year spread reached its tightest since lower interest rates and charging borrowers rising short-term interest rates, the length
June 2007 on both December 4 and Decem- higher longer-term interest rates. When the of the current business cycle and declining
ber 11 at 11 bps. spread is negative, banks will lose money bond buying by the world’s central banks. A
on their loans, turning their business Financial Times article titled US Credit Mar-
Simply put, an inverted yield curve occurs unprofitable and forcing them to cut down kets Dry Up as Volatility Rattles Investors
when a short-term Treasury bond has a on their lending. This will likely trickle mentioned that not a single company in the
higher yield than a longer-term bond. The down to reduced business investments US had borrowed money through the high-
most commonly watched yield curve is and hiring as businesses won’t be able to yield corporate bond market in December
between the two-year and 10-year bonds. access capital from banks. If such an envi- 2018 at the time of the writing. It would be
Yield curves in general represent the yields ronment persists, the US economy will slip the first time since November 2008 that no
on US Treasurys with different maturities. into a recession. It is important to remem- high-yield bonds were issued in the market,
Short-term yields are heavily influenced by ber that the statistic that specifically refers further illustrating the uncertainty in the
the Fed’s actions, while long-term yields to an inversion is the spread between the markets.
are more heavily influenced by the market’s two-year and 10-year Treasury bonds. The
longer-term view on economic growth. The alarm in the markets in December 2018 was The yield curve should not be ignored com-
Treasury yield curve, therefore, is often a caused by the inversion of the two-year and pletely, but it important to weigh all the risk
proxy for investor sentiment on the direc- three-year Treasury bonds and the five- factors cautiously and find opportunities in
tion of the economy. year Treasury bond. According to the afore- the mix. Rising interest rates usually trans-
mentioned CNBC article, the three-year late to rising cap rates and, thus, declining
A CNBC article titled Why Investors Near and five-year Treasury yield curve inverted property prices. In general, higher interest
Retirement Should Fear the Big Yield Curve an average of 26.3 months before the reces- rates also mean that investors will have to
Inversion further summarizes the issue and sion in the last three recessions. make higher interest payments on their
explains why an inverted yield curve makes debts. We believe that the yield curve will
investors nervous. A 10-year Treasury bond The three-year and five-year yield curve likely widen through 2019, but remain at
usually pays a higher interest rate than inversion may be foretelling that a recession low levels. Investors should be vigilant
a two-year Treasury bond to compensate is imminent; however, a yield curve is not about their loan-to-value (LTV) ratios,
investors for the risks associated with a lon- a singular factor that moves the economy income growth projections and whether
ger holding period. The difference between from growth to recession overnight. Yield their income growth will be able to service
these two bonds is called the spread. If the curves tend to move slowly, and investors their debt. This may mean negotiating lease
spread is greater than zero, the yield on should view the inversion as a process renewals now when the economy is still
the 10-year bond is higher than the yield rather than an event. The yield curve has healthy and refinancing the loans at a lower
on the two-year bond. Under this circum- been flattening for a few years, but the econ- rate while it is still available.
stance, the spread between these two bonds omy has kept humming along. Many factors
will create an upward-sloping yield curve. have counteracted the effect of the yield CYCLICAL AND STRUCTURAL CHANGES
However, when the spread is negative, the curve on the overall economy, including the
two-year bond has a higher yield than the tax cuts, a strong labor market and robust Uncertainty is playing a major role in today’s
10-year bond, and the yield curve inverts. consumer confidence. economy — and the investment world — and
6 ©2019 Deloitte Development LLC, NATIONAL ASSOCIATION OF REALTORS®, Situs RERC. All Rights Reserved.
EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
this uncertainty is expected to continue CRE INVESTMENT Frank (NKF) in its 3Q 2018 US Capital Mar-
through 2019. The key is being able to differ- kets Report, which found that Canadian
entiate between the cyclical and structural While the pressure on value is of some con- firms continue to invest the most in United
parts of the CRE market. cern for investors, volumes are still pretty States real estate, with multibillion-dollar
strong and private equity players seem to entity-level purchases, such as the $15 bil-
Throughout this report, the authors will be active. There is more dry powder than lion Brookfield acquisition of GGP. France
present analysis and outlooks primarily ever before. The amount of dry powder ear- and Singapore took the second and third
regarding the cyclical, or market forces, of marked in private equity real estate funds spots, respectively. Combined, these coun-
CRE. For instance, since the recovery began, reached an all-time high of $180 billion tries made up almost 64% of the interna-
private CRE prices, as measured by the Real as of September 30, 2018, with $70 billion tional capital distribution in the 12 months
Capital Analytics Commercial Property allocated to North America-focused funds, ending in 3Q 2018. The same NKF report
Price Indices (RCA CPPI), have exceeded according to an NREI article, Will CRE states that foreign lenders, faced with price
their pre-recession peaks for all property remain a favored investment alternative in a compression in their home countries, have
types, except retail. According to research volatile market? turned to higher yielding loans in the US.
by Situs RERC, solid property fundamen- Canadian firms such as TD Bank, CIBC, RBC
tals are underlying strong valuations and The Deloitte Commercial Real Estate Outlook and Bank of Montreal in particular have
these valuations are supporting high prices. also highlights the growing global inter- become the top foreign lenders, with over
Favorable economic conditions, including est in CRE. The majority of institutional $64 billion in US loans.
historic employment gains, are expected to investors surveyed for this report plan to
allow further room for rent growth. increase their capital commitments to CRE Some public REITs, however, are trading at
in the next 18 months. Respondents from less than active value, particularly malls
In addition to the short-term cyclical the United States plan to increase their cap- and hospitality areas. Many of the success-
changes in CRE, long-term structural ital commitments by 13% in this time frame, ful malls and retailers tend to be held by
changes are affecting CRE investment strat- while those in Germany (13%) and Canada investors and REITs for the long term and
egies as well as the CRE industry itself. (12%) show similar levels of interest. In are infrequently on the market. Accord-
The question becomes, how much will the terms of inbound capital, the United States ing to the 2019 REIT Economic Outlook by
structural parts of CRE — the return char- is the most preferred CRE market globally, Nareit, investors in the past few years have
acteristics, the hard assets’ costs going followed by Hong Kong and China. Canada been preoccupied with tech stocks and ven-
up — absorb the cyclical impacts that are is the biggest foreign investor in the US ture capital, and REITs have become under-
expected to eventually happen in the cap- real estate market in the last 12 months, led valued; investors finally started noticing
ital markets and the economy? For exam- by Brookfield. There has also been a lot of the advantages of REITs in October 2018.
ple, could structural changes support a activity on the debt side. Asian investors, Through mid-December, REIT returns for
strong rise in inflation? An estimate by Lib- especially South Koreans, have been very 2018 were 2.6% – better than the stock
erty Street Advisors, posted on the Federal interested and have structured numerous market but unimpressive. However, NOI
Reserve Bank of New York’s website, is that big deals in debt positions in the last six to from REIT-owned properties is growing;
that the overall consumer price index (CPI) 12 months. same-store NOI has grown 2.82% over the
is 0.3 percentage points higher due to the past four quarters, according to Nareit’s
imposition of tariffs. The increase in global capital flows is sup- T-Tracker®. Nareit found that the average
ported by research from Newmark Knight occupancy rate at REIT-owned properties is
DENVER
CHAPTER 1 INTRODUCTION 7
94.29%, the highest percentage since data the biggest drivers of structural change in
CHICAGO began being collected in 2000, and that the the near future. Below, the authors of this
occupancy rate for REIT-owned retail prop- report explore some of the ways that tech-
erties is 95.43%. REITs are set up to perform nology will likely shape the property types.
well in the near future, thanks to current
valuations and underlying operating fun- As the last of the millennials (generally con-
damentals; investors are looking for value. sidered those born from 1981 to 1996) start
entering the workforce, office landlords,
CRE MARKET9 tenants, construction companies and all
employers should — more than ever — con-
The CRE market is fully priced generally, sider their needs. Millennials are obviously
especially for core property types. Even as a not a monolithic group, but surveys have
record amount of capital continues to pour shown they prefer to work in offices with
in, the market has reached maturity. There open floor plans to those with cubicles and
still are sellers and buyers despite being so far private offices. These preferences, combined
into this recovery. However, as we enter into with the rapid changes in technology, are
the peak and/or potential correction area, it is forcing investors in CRE to be more creative.
important to understand that the double-digit Landlords need to offer spaces with sleek
unleveraged returns enjoyed during the designs and state-of-the-art technologies
beginning of the financial recovery are a thing that produce a “wow factor” to attract new
of the past, and the market understands that. tenants. In addition, in part due to changes
in technology and tastes, more people are
According to the Bureau of Economic Analysis working remotely. As a result, many offices
(BEA) advanced estimate, personal consump- are using less square feet per employee – but
tion expenditures increased by 4% quarter companies will probably still need central
over quarter (QoQ) in 3Q 2018. With approxi- spaces for their employees. Office tenants,
mately 68% of the nation’s GDP coming from however, will likely want more tech options
personal consumption expenditures, higher in their buildings – smart devices, employee
wage growth and increased consumer confi- tracking systems, fiber internet, etc. Some of
dence are an integral part of the US economy. these may be very costly to update in older
Increased consumer spending will support buildings, inspiring the continued need for
certain segments of the retail sector that are new developments. WeWork, Knotel and
struggling. Higher wage growth may impel other flexible office providers will continue to
discouraged workers to leave the sidelines grow over the next year, according to an arti-
and raise the labor force participation rate — cle in The Real Deal titled Co-working Goes
which has been stagnant despite the excep- Corporate. New technologies inspire entre-
tionally low unemployment rate — and boost preneurship; as the number of startups and
demand for office space. Higher wages will entrepreneurs grow, the demand for flexible
also support apartment sector rent growth, work spaces should grow as well. Flex spaces
which is already being buoyed by lowered often have top-notch amenities that can help
housing affordability and rising mortgage business attract workers without having to
rates, especially for first-time buyers. More invest in their own real estate upgrades. Flex
spending will likely also translate into more leasing options are likely to become more
demand for industrial space as consumer popular as the flex office sector grows. Flex
tastes for shopping through e-commerce leasing options allow tenants to sign leases
increases the need for order processing and by the year, month or sometimes even the
delivery centers. hour (when five to 10 years has historically
been the norm), according to a Bisnow article
IMPACT OF TECHNOLOGY* titled LiquidSpace Report Highlights Rise of
Flex Office Space. We can expect the changes
Technology is transforming every prop- to accelerate as Generation Z workers enter
erty type and the industry as a whole. As the workforce. They have needs and prefer-
advances in technology continue to grow ences of their own, and they are expected
at an exponential rate, they will likely be to account for 32% of the global population
The viewpoints represented in this section represent the collective perspectives of the authors of this report and may not represent the
9,*
8 ©2019 Deloitte Development LLC, NATIONAL ASSOCIATION OF REALTORS®, Situs RERC. All Rights Reserved.
EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
in 2019, a larger percentage than all other facilities, bowling alleys and the like. Many
generations, according to an August 2018 retailers are cutting down their space, mov- LOS ANGELES
Bloomberg article titled Gen Z is Set to Out- ing their inventory to warehouses because so
number Millennials Within a Year. many consumers prefer to shop online and
get their products shipped directly to their
In the industrial sector, e-commerce will homes. Retailers have also been challenged
likely continue to gain popularity with by growing income inequality. According to
consumers and industrial CRE will have the Deloitte report The Great Retail Bifurca-
to adapt to changing space requirements. tion10, only 20% of consumers had improved
Advances in supply chain management are their financial situations from 2007 to 2016,
likely to lead to additional changes. End-to- leaving them with little money left for dis-
end supply chain is becoming more chal- cretionary income spending. In addition,
lenging and complex, as customers want technological changes have forced many
their shipments faster. The focus on “first of those less well-off to spend significantly
mile” delivery (i.e., the process of getting more on digital devices than they had pre-
goods from a manufacturer or retailer to a viously, leaving less money for other types
distribution center) and “last mile” deliv- of purchases. It’s not surprising, therefore,
ery (i.e., the process of getting goods from that the companies that have performed
a distribution center to the end consumer) the best during these times have been those
changes space requirements. Industrial that appeal to “premium” consumers and
properties will need to be able to accommo- “priced-based” consumers, while the “bal-
date technological advances in inventory anced” retailers have struggled. Even though
and network optimization tools, warehouse the store closings of the balanced retailers
management and yard management. Indus- have received the most attention, price-
trial assets will continue to be tied to the based and premium retailers are opening
cost efficiencies in transportation, includ- more stores than they’re closing.
ing the infrastructure requirements of driv-
erless trucks. Improvements in methods like Housing affordability in many major mar-
3-D printing and the use of delivery drones kets, combined with slow wage growth and
could create leaner supply chains and tran- high student debt, has forced many indi-
sition manufacturing facilities closer to viduals, especially millennials, to rent out
major population centers, despite the scar- of necessity. Up until recently, millennials
city and high costs of developable land near have postponed household formation and
major arteries. We expect that data centers, child bearing, which has also helped fuel
especially those that can meet the infra- demand for apartments in the recent past. A
structure and space needs of cloud-based survey conducted by Situs RERC in 2Q 2018
companies, will continue to increase in found that just over 60% of current renters
popularity. The full impact of tariffs on the cited financial obstacles to homeownership
manufacturing industry has yet to be seen, as the primary reason that they rent instead
but we anticipate that a rise in new business of own. A significant share of renters would
formation of small manufacturing compa- prefer to own a home, but have been unable
nies that sell their goods via e-commerce to purchase one because they can’t afford it
will stoke demand in the flex sector in 2019. or meet the mortgage finance requirements.
At the same time, baby boomers are further-
Advances in technology have also had a ing apartment demand as they age out of the
profound effect on the retail industry – pri- workforce and move into rental units. Chang-
marily the rise of e-commerce. The retail ing demographics and economic trends will
landscape is littered with large chains that likely impact the apartment sector for years
have either gone out of business, declared to come. The economic situation is finally
bankruptcy or find themselves in extreme starting to improve for many consumers, who
peril. The survivors — including some of have struggled since the financial crisis. Mod-
the largest malls — have adapted by making erate wage growth has finally emerged, and
the shopping experience more fun, adding it’s hoped to be strong in 2019. At the start of
more restaurants, theaters, rock-climbing 2019, more millennials were starting families
For more information, download the full Deloitte Insights report, The Great Retail Bifurcation: Why the Retail “Apocalypse” is Really a
10
CHAPTER 1 INTRODUCTION 9
and moving to suburban areas, which offer THE DELOITTE 2019 COMMERCIAL TECHNOLOGY
greater affordability and more space, sim- REAL ESTATE OUTLOOK7
ilar to previous generations. The Colling- The CRE industry is playing catch-up in
wood Group, a Situs company, projects a In addition to the structural changes technological advancement compared to
dramatic expansion of household creation. that should likely continue to transform other industries. The industry needs to
Over the next five to eight years, millenni- tenant demands and the use of assets, update its digital strategy and infrastruc-
als are projected to create roughly 25 million several trends are expected to change the ture. Data from this Deloitte outlook report
new households, yet we will likely not see CRE industry itself and the strategies that indicate that institutional investors wish
homeownership return to the levels seen firms can leverage to better adapt to these to see an increase in the use of predictive
in the late 1990s and early 2000s. As of 3Q changes. analytics and business intelligence in order
2018, the homeownership rate was 64.4%, to make their buildings future ready and to
far below the historical peak of 69.2% in 4Q GLOBAL CAPITAL FLOWS better utilize IoT in the design and redesign
2004, based on data from FRED. We antic- of buildings.
ipate that structural changes such as the Business models are shifting in the CRE
ones mentioned above will keep the home- industry even as the economy stays strong. CRE companies should consider being more
ownership rate near the long-term average In order to maintain capital commitment proactive in embracing technology. Their
of 65%, which will benefit the apartment and investment, Deloitte suggests invest- digital core should be more dynamic, auto-
sector. Alternative housing, such as sin- ing in new and emerging business models mated and easily integrated with emerging
gle-family rentals and communal-style that reflect the changing nature of work and solutions. Much of this technology can take
living, is expected to become more com- tenant preferences. This involves invest- advantage of external cloud-based services.
monplace in the real estate sector, based on ments offering flexible and varying leasing Machine learning and other predictive ana-
survey data from Situs. Seen as an evolution options, as well flexible spaces. lytics can help generate valuable insights
of the on-demand accommodations provided from large data sets, allowing for an easier,
by platforms like Craigslist and Airbnb, Mixed-use, data centers, senior housing and faster and more informed business deci-
startups such as Common and WeLive are mobile towers are all potentially beneficial sion-making process.
pioneering a business model around luxury to include in a portfolio. Portfolios should
buildings with full amenities and a more flex- include experimental and engaging prop- CYBER RISK MANAGEMENT
ible, short-term approach to rent. This type of erties that focus on the tenant and make
living arrangement offers a more affordable use of augmented reality (AR) and virtual Traditional CRE risk management centers
and convenient way for individuals to live in reality (VR) technology to interact with around interest rates and financing risk,
large metro areas without sacrificing ameni- potential tenants. Internet of Things (IoT), but as the use of technology increases,
ties. And while rents will likely be the ongo- artificial intelligence (AI), and predictive the scope of risk expands. This can lead to
ing major driver of apartment demand, renter analytics technology can be valuable to suit increased concerns about information and
tastes for smart technology and cutting-edge and anticipate tenant needs in order to get data privacy, including potential holes in
appliances in units will be a major asset dif- and retain valuable client bases for each safe IoT integration.
ferentiator in the future. property.
10 ©2019 Deloitte Development LLC, NATIONAL ASSOCIATION OF REALTORS®, Situs RERC. All Rights Reserved.
EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
DALLAS
The scope of risk is expanding with the presence should help attract new talent. the highest number of respondents — 34.8%
increased use of technology in the industry, Knowledge-transfer programs can help — believed that the CRE market was expe-
so companies should plan accordingly. CRE retool existing talent and help create a cul- riencing a gradual slowing of deal volume
boards and members of senior management ture of lifelong learning. Making efforts to and price increase. Only 2.7% of the respon-
should get involved in governance and over- teach inclusion, connection and mentorship dents believed that the CRE market would
sight. They should create policies to deal can also help women and minority popula- experience a deceleration in 2018, compared
with emerging issues, designate roles and tions prepare for leadership roles. to 3.9% in 2017. Respondents were split
responsibilities, create consistent reporting between anticipating minimal change (-2%
and tracking methods, and budget accord- THE 2018 DELOITTE DBRIEF to +2%) and moderate improvement (+2% to
ingly. There should be constant communica- +5%) in CRE values over the next 12 months,
tion about emerging risks, and all employ- For the past seven years, the authors of this similar to responses in 2017.
ees should be trained and aware. report have conducted a webcast, known
as Deloitte Dbrief, to showcase the results About 37% of the respondents believed that
TALENT of our report. Each year, we poll the web- multifamily assets would offer the most
cast participants to gauge their sentiment favorable investment opportunity based on
The workforce is changing and talent strate- about the market. The 2018 Dbrief poll was recent performance of fundamentals, the
gies are constantly evolving. Most Gen Z and conducted on January 30. The number of largest percentage among the property types.
Millennial workers prefer a startup culture. responses for these survey questions ranged However, the endorsement of multifamily
The industry seems to be struggling to recruit, from 1,779 to 2,475. See Exhibits 1-B through declined by 10 percentage points year over
engage and retain this new pool of talent, 1-F for charts of the poll results. year (YoY). The largest yearly increase among
according to the Deloitte 2019 Commercial the property types was for industrial/ware-
Real Estate Outlook. As a result, many CRE The 2018 Dbrief poll participants showed house, deemed favorable by approximately
companies face a scarcity of skilled employ- increased confidence in the state of the econ- 20% of the respondents, up from about 14%
ees. In addition, many companies are unpre- omy and a relatively optimistic view of the in 2017. Hotel offered the least favorable
pared to deal with the high number of baby CRE market. About 20% of the respondents investment opportunity, with only 4% of the
boomers expected to retire in the coming believed that the economy would hit on respondents preferring the asset class.
years. The survey also notes that the majority all cylinders in 2018, compared to 13.1% in
of respondents believe that a more diversified 2017. Additionally, 41.5% of the respondents Dbrief participants believed that the capital
board helps generate better returns. believed that the economy would continue to availability for CRE in 2018 would remain
grow in a slow to modest pace in 2018, compa- comparable to that of 2017. About 30% of
Companies can use technology to screen rable to 42.1% of the respondents in 2017. the respondents believed that the standards
resumes and spot risk for turnover. They and availability would remain the same in
should highlight social responsibility and In terms of the CRE market, about 19% of 2018 compared to 2017. The percentage of
community engagement opportunities the respondents believed that robust trans- respondents suggesting they would seek
when reaching out to younger generations. action volume and price appreciation would riskier positions declined from 29% in 2017
Strong branding and a robust social media continue in the CRE market in 2018, while to 24.8% in 2018.
CHAPTER 1 INTRODUCTION 11
EXHIBIT 1-B. DELOITTE Dbrief POLL RESULTS — WHAT IS YOUR VIEW OF THE STATE OF THE ECONOMY?
Finally Hitting on All Cylinders — Full Speed Ahead Touch and Go — Still Trying to Get Its Bearings Downturn Likely This Year
Continued Slow to Modest Growth Expected Weak — Would See Little/No Growth Without Federal Support Don’t Know/Not Applicable
60
50
40
Percent
30
20
10
0
2014 2015 2016 2017 2018
Sources The Deloitte Dbriefs Real Estate series, Expectations and Market Realities in Real Estate, January 2018.
EXHIBIT 1-C. DELOITTE Dbrief POLL RESULTS — WHAT IS YOUR VIEW OF THE CURRENT STATE OF CRE?
Robust Transaction Volume and Price Appreciation Continue Flattening or Sluggish Transaction Volume and Pricing Deceleration on the Way
Gradual Slowing of Deal Volume and Price Increase Uncertainty Not Sure
60
50
40
Percent
30
20
10
0
2011 2012 2013 2014 2015 2016 2017 2018
Sources The Deloitte Dbriefs Real Estate series, Expectations and Market Realities in Real Estate, January 2018.
EXHIBIT 1-D. DELOITTE Dbrief POLL RESULTS — TO WHAT EXTENT DO YOU EXPECT COMMERCIAL REAL ESTATE VALUES
TO CHANGE OVER THE NEXT 12 MONTHS?
More Stress -15% to -2% Moderate Improvement +2% to +5%
Minimal -2% to +2% Robust Strengthening +5% to +5% Not Sure
60
50
40
Percent
30
20
10
0
2012 2013 2014 2015 2016 2017 2018
Sources The Deloitte Dbriefs Real Estate series, Expectations and Market Realities in Real Estate, January 2018.
12 ©2019 Deloitte Development LLC, NATIONAL ASSOCIATION OF REALTORS®, Situs RERC. All Rights Reserved.
EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
EXHIBIT 1-E. DELOITTE Dbrief POLL RESULTS — PROPERTY TYPE INVESTMENT OPPORTUNITY
WHICH PROPERTY TYPE DO YOU VIEW AS OFFERING THE MOST FAVORABLE INVESTMENT OPPORTUNITY BASED ON RECENT PERFORMANCE OF FUNDAMENTALS?
Not Sure 27.4 19.1 18.2 18.2 21.4 20.3 17.1 17.7
Sources The Deloitte Dbriefs Real Estate series, Expectations and Market Realities in Real Estate, January 2018.
EXHIBIT 1-F. DELOITTE Dbrief POLL RESULTS — HOW DO YOU VIEW THE OUTLOOK FOR CAPITAL AVAILABILITY FOR
COMMERCIAL REAL ESTATE IN 2018 VERSUS LAST YEAR?
Tighter Standards and Less Availability Expanding Capital Reaching Out to Riskier Positions
Same Standards and Availbility Too Much Capital Resulting in Broad-market, Aggresive Pricing Not Sure
60
50
40
Percent
30
20
10
0
2011 2012 2013 2014 2015 2016 2017 2018
Note Wording of this response option changed slightly in 2015.
Sources The Deloitte Dbriefs Real Estate series, Expectations and Market Realities in Real Estate, January 2018.
SAN FRANCISCO
Most Favorable
Least Favorable
Sources The Deloitte Dbriefs Real Estate series, Expectations and Market Realities in Real Estate, January 2018.
CHAPTER 1 INTRODUCTION 13
CHAPTER 2:
THE ECONOMY
14 ©2019 Deloitte Development LLC, NATIONAL ASSOCIATION OF REALTORS®, Situs RERC. All Rights Reserved.
EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
THE ECONOMY11
GLOBAL PERSPECTIVES EXHIBIT 2-A. 2018* ANNUAL GDP GROWTH BY REGION
Americas Europe Asia
8
Global economic activity continued on
an expansionary path in 2018. However, 7
Percent
4
accommodative for a large swath of devel-
oped economies — although less so for the 3
The viewpoints represented in this chapter are those of the NATIONAL ASSOCIATION OF REALTORS® (NAR) and do not necessarily reflect the viewpoints of the other sponsoring firms of this report.
11
HONG KONG
LONDON
16 ©2019 Deloitte Development LLC, NATIONAL ASSOCIATION OF REALTORS®, Situs RERC. All Rights Reserved.
EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
economy picked up speed in 2018, buoyed EXHIBIT 2-B. QUARTERLY GDP GROWTH IN THE US
by reductions in personal and corporate 6
taxes and increased government spending.
4
The year started in the wake of the Decem-
ber 2017 passage of the Tax Cuts and Jobs 2
Percent
-2
increased government spending. As the hir-
-4
ing momentum continued and wage growth
accelerated, consumers’ optimism trans- -6
lated into higher spending. Following the -8
first quarter’s GDP advance at an annual- -10
ized 2.2% rate, 2Q output rose 4.2%, accord- 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
ing to data from the BEA. The upward trend Source Bureau of Economic Analysis (BEA), 3Q 2018.
continued in the third quarter, with a GDP
gain of 3.5% (see Exhibit 2-B).
Percent
as about $200 billion worth of Chinese 4
products. Against this backdrop, exports
advanced in the first six months, but 2
retreated in the third quarter, as trading
partners took retaliatory measures against 0
US goods. Imports — a negative contribution 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
to GDP — offered a mixed picture, advanc- Source Bureau of Labor Statistics (BLS), 3Q 2018.
ing 3.0 % in the first quarter, declining 0.6%
in the second and rising a solid 9.1% in the
third quarter, based on data from BEA.
with 517,000 net new positions, based on new jobs by the end of the year. The mining
The other major GDP component — govern- data from the BLS. Benefitting from con- and logging sector continued its expansion,
ment spending — posted gains in each of the sumers’ renewed interest in travel and rec- with a net gain of 60,000 new positions.
first three quarters. The federal government reation, the leisure and hospitality sectors
boosted its spending on both defense and added 306,000 net new employees to pay- Following employment advances, the unem-
nondefense goods and services. State and rolls by the end of December. ployment rate decreased throughout the year,
local governments also accelerated their from 4.1% in the first quarter to 3.9% by the
spending and infrastructure investments. Even with higher import tariffs, demand end of December, based on information from
for industrial warehouses and distribu- BLS. The average duration of unemployment
EMPLOYMENT TRENDS tion centers continued on an upward path, fluctuated during the year, but declined from
boosted by strong advances in e-commerce, 24 weeks in January to 22 weeks in Decem-
As economic output expanded and employ- leading to noticeable transportation and ber. The number of Americans employed part
ers continued to be relatively optimistic, warehousing employment gains of 189,800 time for economic reasons declined from 5.1
job growth maintained an upward trajec- new positions. The trend also benefitted the million in the first quarter to 4.7 million by
tory during 2018 (see Exhibit 2-C). Payroll wholesale trade sector, which added 88,900 the end of the year. Mirroring the trends, the
employment recorded a net gain of 2.64 mil- net new positions to payrolls. The same average number of employees quitting their
lion new positions in 2018, based on data advance in e-commerce had the opposite jobs for other opportunities rose to 35.8 mil-
from the Bureau of Labor Statistics (BLS). result for the traditional retail sector, which lion during the January to November time
The private sector accounted for the major- experienced continued store closings and frame, an 8.7% increase from 2017 and a
ity of new jobs. As of the third quarter of the attendant layoffs. Retail trade employment 13.9% gain from 2016.
year, average weekly earnings of private increased by 69,300 jobs in the first quarter,
employees increased by 3.1% compared to only to decline by 30,800 jobs during the The labor force participation (LFP) rate,
the prior year. April-through-October time frame, accord- which had been on a downward trend for
ing to BLS. The traditional holiday season almost two decades, has flattened (see
Private service-providing industries were experienced a rebound, leading to a gain of Exhibit 2-D). From a high of 67.3% during
the driver of employment growth dynamics, 53,100 payroll positions. the 1998-2000 period, the LFP rate fell to
accounting for 1.94 million net new jobs in 62.3% in September 2015, the same level as
2018, based on data from BLS. Within the Accompanying solid growth in service in October 1977, according to BLS data. The
service industries, riding the wave of an industries, employment in goods-producing LFP rate has been moving mostly sideways
expanding corporate sector, professional industries experienced its second-strongest for the past three years — despite monthly
and business services companies hired gain of the post-Great Recession expan- shifts — at 62.9%. The figure held steady
583,000 new employees during the period. sion during 2018, with a total 624,000 net during 2018, with 163.2 million Americans
As financial services added an additional new jobs, according to BLS. With the White in the labor force as of the end of December.
110,000 new positions, demand for office House encouraging domestic production,
space remained solid during the year, post- manufacturing companies responded by The solid employment gains of 2018 were
ing positive net absorption figures. expanding existing US operations and reflected in the main measures of con-
added 284,000 new positions to payrolls sumer confidence. The Conference Board’s
The education and health services sectors during the period, based on data from BLS. Consumer Confidence Index advanced to
were the second-largest employment base, Construction companies added 280,000 128.1 by December, the highest value since
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
EXHIBIT 2-D. HISTORICAL LABOR FORCE PARTICIPATION RATE September of 2000. The index was 6.4%
68 higher in the fourth quarter of the year, com-
pared with the value from 2017. Separately,
67
the Consumer Sentiment Index compiled by
66
the University of Michigan rose from 95.7 in
65 January to 98.3 in December of 2018, while
posting a 2.5% higher reading YoY.
Percent
64
63
HOUSING
62
new households, a solid measure of hous- Source US Census Bureau, October 2018.
ing demand.
125
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
CHAPTER 3:
THE CAPITAL
MARKETS
LAWS AND POLICIES IMPACTING and exam cycles for small and mid-sized
THE CAPITAL MARKETS banks, the legislation includes provisions
from H.R. 2148, Clarifying Commercial Real
THE ECONOMIC GROWTH, Estate Loans, legislation that passed the
REGULATORY RELIEF, AND House in November 2017, devoted exclusively
CONSUMER PROTECTION ACT12 to CRE considerations, aimed at improving
the workability of Basel III and Dodd-Frank
In May 2018, President Trump signed legisla- rules.
tion to partially repeal the Dodd-Frank Wall
Street Reform and Consumer Protection Act The passage of H.R. 2148 followed the release
of 2010 (Dodd-Frank). The Economic Growth, of the Office of Comptroller of the Currency
Regulatory Relief and Consumer Protec- (OCC), Federal Deposit Insurance Corpora-
tion Act aims to cut numerous restrictions tion (FDIC) and Federal Reserve Board’s pro-
imposed on banks and financial institutions posed rule to refine HVCRE requirements,
by the Dodd-Frank response to the finan- which were first imposed by Dodd-Frank’s
cial crisis. S. 2155 reduces the frequency and codification of Basel III standards. Basel III
thresholds for stress testing and enhanced significantly increased the requirements for
supervision. In March 2018, in an effort to HVCRE loans, increasing the risk weight-
lessen the confusion surrounding the Basel ing from 100% to 150% and raising holding
III High Volatility Commercial Real Estate requirements from 8% to 12%. Last year’s
(HVCRE) rule created for construction loans, proposed rule from the OCC, FDIC and Fed-
the Senate also incorporated provisions eral Reserve Board reduced the size of the
from S. 2405, Clarifying Commercial Real capital charge from 150% to 130%, but actu-
Estate Loans, into the larger package of bills ally expanded the number of loans subject
included under S. 2155. to higher capital charges under the HVCRE
definition.
S. 2155 amends Dodd-Frank to exempt small,
mid-size and community banks from some of The legislation also provides some clarity
the most burdensome requirements. Under for High Volatility Acquisition, Development
the legislation, banks with less than $100 or Construction (HVADC) loans. HVADC
billion in assets will no longer be subject to loans can be exempt from HVCRE statutory
stress testing. Banks with assets between requirements if the loan-to-value (LTV) is
$100 billion and $250 billion may require 80% or lower, the borrower contributes 15%
only periodic stress testing as opposed to capital in cash or ”readily marketable assets”
an annual review, subject to regulatory and the borrower’s 15% capital is contributed
approval. prior to lender’s funding.
Perhaps most notably, the legislation raises Under S. 2155, CRE borrowers will be able to
the threshold for enhanced supervision of fulfill the 15% equity threshold for HVCRE
“systemically important financial institu- exemption using the appraised value of the
tions” from $50 billion to $250 billion in property, in lieu of the current cost basis
assets. Banks with less than $10 billion in assessment. All loans originated prior to
assets will be exempt from the Volcker Rule 2015, when the Basel III standards became
as well. Several provisions are designed to effective, will be exempt from the need to
provide targeted relief to community banks, satisfy HVCRE criteria. The legislation also
including a simplification of capital calcula- creates an off-ramp from HVCRE status once
tions and longer exam cycles. an ADC loan reaches maturity.
In addition to changes in capital calculations The banking industry has praised the new
Unless otherwise noted, the analysis of The Economic Growth, Regulatory Relief and Consumer Protection Act was taken from an article
12
by Situs, CRE Clarifications & Concentrated Supervision in New Legislation Could Drive Community Investment & Economic Development,
and may not reflect the viewpoints of the other sponsoring firms of this report.
22 ©2019 Deloitte Development LLC, NATIONAL ASSOCIATION OF REALTORS®, Situs RERC. All Rights Reserved.
EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
CHARLOTTE
law, saying it will now be easier for borrow- designed to better tailor regulatory oversight 2155 should have the combined result of driv-
ers to obtain mortgages from community and the amended CRE provisions could spur ing new investment, economic development,
banks and credit unions - especially in rural new investment and development by easing construction and job growth in communities
areas where banking options are more lim- capital and regulatory requirements, reduc- across the country.
ited, according to the the New York Times ing borrowing costs and opening up credit.
(Congress Approves First Big Dodd-Frank TARIFFS
Rollback). The hope is that the relief from red The original HVCRE requirements in some
tape will help invigorate small communities instances required borrowers to refinance At of the end of December 2018, the trade
and encourage more investment there in CRE an ADC loan at the end of the risk period. dispute between the United States and China
and home mortgages. All Republicans voted Now, borrowers will be allowed to deploy was in a “cease-fire.” When President Trump
in favor of the new bill, along with some their own internal capital in an ADC proj- and Chinese President Xi Jinping met on
Democrats. ect. Finally, the legislation provides a new December 1 in Buenos Aires during the G-20
exemption for refinancing loans on perform- summit, they agreed that neither side would
In the wake of the original law, there has ing income-generating properties. This pro- escalate the “war” for three months. Accord-
been a huge increase in the amount of non- vision should ease the restrictions on acquir- ing to Politico’s ‘Incredible Deal’ or Face-Sav-
bank lending in this decade – from just ing and renovating existing rental properties ing Punt? How the Next 90 Days Must Save the
under 10% of the market in 2010 to about half by allowing borrowers to bypass capital US-China Agreement, China offered no public
in 2017, according to CNBC. Tougher regula- penalties. The clarifications to ADC lending guarantee that it would address US concerns
tions on banks opened the door for nonbank will likely have a positive impact across the about: China’s subsidies of state-owned busi-
lenders like Quicken Loans, loanDepot and CRE market, from local communities to small nesses; its policy of forcing US firms to hand
Caliber Home Loans to move in free from banks and borrowers. The amended require- over technology to do business there; and its
many of the regulations imposed on banks. ments provide CRE borrowers more flexibil- toleration of outright intellectual property
Deregulation could stop or even reverse ity to navigate and satisfy HVCRE standards theft. But China agreed to resume buying
that trend, with big banks increasing their and meet exemption thresholds when possi- an unspecified amount of US agricultural
involvement in the mortgage market. Ana- ble. The workable requirements and revised goods, which it had suspended when the US
lysts expect smaller banks to increase their supervisory thresholds should also allow first imposed new tariffs on China.
lending activity as well. more small and mid-size banks to play a
greater role in CRE lending. The illumination From 1790 to 1860, tariffs — taxes on imports,
Situs posits that the law delivers some con- of a clear HVCRE definition under Basel III collected by Customs and Border Protec-
siderable wins for the CRE market by imple- and new federal proposed regulations should tion agents at hundreds of ports of entry
menting key clarifications to HVCRE and ADC reduce borrower costs and expand credit in — produced about 90% of federal revenue,
lending requirements. The broader changes the area. Most importantly, the impact of S. compared to about 1% at the beginning of
13
Unless otherwise noted, the analysis of qualified opportunity zones was taken from an issue summary by the NATIONAL ASSOCIATION OF
REALTORS® (NAR), Federal Tax/Qualified Opportunity Zones, and may not reflect the viewpoints of the other sponsoring firms of this report.
24 ©2019 Deloitte Development LLC, NATIONAL ASSOCIATION OF REALTORS®, Situs RERC. All Rights Reserved.
EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
Investments in Opportunity Funds (O Funds) to help provide clarity and guidelines for QOZ are tax-free if they are held for at least 10
may be gains from a previous sale (within potential investors in the so-called O Zones, years.
180 days) and/or non-gains funds, but only but the meeting was canceled because of On the front end, it provides a way for real
reinvested capital gains are eligible for the the government shutdown. According to an estate investors to invest capital gains with-
tax benefits. If both gains and non-gains article in the Wall Street, Government Shut- out paying the tax on those gains immedi-
funds are invested, they are treated as sep- down Stymies Opportunity-Zone Investors, ately, which may encourage them to sell real
arate investments and will receive differ- potential investors were frustrated by the estate assets they might otherwise hold on
ent tax treatments. To qualify for the tax delay because they didn’t want to take any to in order to avoid taxes. On the back end,
benefits, investments into a QOZ must be action until they were clear about how the the O Funds created to invest in the zones
made through an O Fund, which may be a tax breaks will work. They do understand, will likely be looking for business property to
partnership or corporation organized for however, that the benefits from the pro- invest in, which in many cases will include
the purpose of investing in QOZ property. gram decline over time, and they want to get real property and/or involve development
started as soon as possible. opportunities for real estate.
An O Fund must hold at least 90% of its
assets in QOZ property (which can be stock, On December 12, 2018, the White House However, opponents of the QOZ program
partnership interests, and/or tangible prop- issued an Executive Order establishing the argue that it will encourage gentrification of
erty used in a trade or business within a QOZ, White House Opportunity and Revitaliza- neighborhoods as opposed to creating eco-
such as real estate) and it must certify with tion Council, chaired by Housing and Urban nomic opportunities for current residents.
the Treasury and IRS, via a self-certification Development Secretary Ben Carson and com- They argue that the perceived lack of “guard-
filed with federal tax returns (Form 8996). posed of 13 federal agencies. The Council will rails” from the government about what
focus on ways to revitalize low-income com- is developed (e.g., affordable housing, or
In addition, at least 70% of the “QOZ business munities, through streamlining coordinating requirements that jobs be created) will lead
property” that an O Fund invests in must be existing federal programs to economically to fraud and abuse of the program.
in a QOZ. The statute also requires that after distressed areas, including Opportunity
an O Fund acquires QOZ business prop- Zones. Though the program does not have ENVIRONMENTAL POLICIES
erty that it be either new or “substantially final regulations yet, an extension bill was AND CLIMATE CHANGE
improved,” which means investing at least introduced by Rep. Mark Meadows (R-NC)
as much on the improvement as was paid in September 2018: H.R. 6890, the Creating President Trump has pushed hard for dereg-
for the used asset. The proposed rules state Advancement and Personal Improvement in ulation of the rules enforced by the Envi-
that the basis of the land a business sits on Targeted American Localities (CAPITAL) Act, ronmental Protection Agency (EPA), which
does not need to be included for that require- which would allow for the designation of new may have a direct impact on CRE. According
ment, thus reducing the required investment opportunity zones every 10 years. to Commercial Property Executive (CPE),
amounts. the Insurance Information Institute, based
There are several potential tax benefits for on data compiled by Munich’s Re’s Natural
The Treasury released the first set of pro- investors in a QOZs, if all requirements are Catastrophe (NatCat) Service, cites concerns
posed rules for QOZs in October 2018, which met. First, capital gains reinvested (within 180 about a long-term trend of increasing num-
outlined several administrative aspects of days of a sale to a nonrelated person) into a bers of natural catastrophes linked to global
the program. Further proposed rules are QOZ are tax-free for up to nine years, through warming and exposing real estate owners
expected to address the remaining questions, 2026. If held for five years, the tax ultimately and investors to rising insurance premi-
including how to define “original use” or paid on the reinvested gains is reduced by ums. A 29-company coalition of insurers is
QOZ business property that was abandoned 10%; if held for seven years, that reduction is warning about a growing “protection gap”
or vacant. The IRS had been scheduled to increased to 15%. In addition, gains accrued between covered losses and actual costs of
hold a public hearing on January 12, 2019, on deferred-gains funds while invested in a disasters. The same CPE article states that
PORTLAND
PHOENIX
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
(HUD) and the IRS, including the Small Busi- EXHIBIT 3-A. SITUS RERC RATINGS OF INVESTMENT ALTERNATIVES
ness Administration (SBA), Federal Hous- CRE Cash Bonds Stocks
ing Authority (FHA) and US Census data, 8
according to National Real Estate Investor
(NREI) in an article titled A Breakdown of the 7
Government Shutdown’s Impact on CRE. The
FDIC and the Fed remained open and contin- 6
ued their oversight of the banking industry.
Rating
An analyst quoted in the same NREI article 5
said the short-term effect was minimal and
she hoped it would be business as usual once
4
the agencies reopened.
3
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
FINANCIAL AND CAPITAL MARKETS Source Situs RERC, 3Q 2018.
OVERVIEW
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
The Fed also removed “accommodative” lan- since 4Q 2016. However, underwriting stan- requirements that have been in place since
guage from its press release, perhaps imply- dards appear to have stabilized over the past the beginning of the recovery remain and
ing that the economy can grow without the year (despite a dip in 1Q 2018). The discipline have generally kept lending in check. The
monetary push. Likewise, the US Treasurys rating was 6.5 in 3Q 2018, compared to 6.6 in discipline in debt underwriting was rated at
were considered a more attractive risk hedge 2Q 2018 and 6.6 in 3Q 2017. The Situs RERC 6.6 in 3Q 2018, compared to 6.8 in 3Q 2017.
compared to the Eurozone bonds. Underwriting Index shows the extent to
which the availability of capital and disci- CRE DEBT MARKET
While steady, incremental hikes do not have pline of underwriting standards are aligned.
much impact on CRE, developers and inves- The index has generally increased over the According to RCA, the LTV ratio for the apart-
tors may be adversely affected by higher bor- past year, indicating that the availability of ment sector started at 68% in the beginning
rowing costs if the Fed maintains its pace of capital is exceeding discipline. This is a trend of the year and declined to 62% by August
rate hikes. Higher interest rates lead to higher to watch over the coming quarters, but the 2018. On the other hand, the LTV ratio for
cap rates and lower property valuation, which index is still historically low, so there is no commercial (office, industrial and retail)
in turn will impact transaction volume. Over cause for concern yet. stayed in the range of 60% to 62% during the
the past year, Situs RERC’s institutional sur- first three quarters of 2018, reaching 62% in
vey respondents have voiced a growing con- In 2Q 2014, Situs RERC began analyzing the August 2018.
cern over the impact of higher interest rates availability and discipline of capital for debt
on CRE. For now, CRE has remained a stable and equity separately. In 3Q 2018, the avail- Data on debt yield ratios were provided by
asset class with NPI-ODCE and NFI-ODCE ability of equity capital rating declined QoQ, RCA. Debt yield ratios declined slowly from
returning 5.27% and 5.75% YTD as of Sep- while the underwriting standards for equity 10.7% in January 2018 to 10.4% in August
tember 30, 2018, respectively. See Exhibit 3-D capital increased. Institutional investors 2018 for the retail, industrial and office sec-
for CRE rates and 10-year Treasury spreads. noted that uncertainty about the direction tors combined. Debt yield ratios for the apart-
of the economic cycle, and pricing that feels ment sector hovered around 8.6% during the
AVAILABILITY OF CAPITAL AND DISCIPLINE like it is at a peak, are making equity capital year, but jumped to 9.2% in August 2018.
OF UNDERWRITING STANDARDS cautious. Debt yield ratios were below the high of 15%
in 2010 for the retail, industrial and office sec-
The 3Q 2018 Situs RERC Real Estate Report Survey research by Situs RERC shows the tors and the 10.5% for the apartment sector
shows that since its post-recession peak in availability of debt capital rating increased recorded in 2004.
3Q 2014, the availability of capital generally QoQ and the underwriting standards for the
trended downward, but it has been trending debt capital declined in 3Q 2018. Situs RERC’s RCA provided trends analysis regarding the
back up since 1Q 2017. On a scale of 1 to 10, institutional survey respondents rated the debt service coverage ratio (DSCR). Accord-
with 10 being excellent, the availability of availability of debt capital 7.7 in 3Q 2018 com- ing to RCA’s methodology, DSCR is provided
capital remained at 7.5 QoQ in 3Q 2018, up pared to 7.1 in 3Q 2017. These respondents through commercial mortgage-backed secu-
slightly YoY from 7.4 in 3Q 2017. Since peak- indicated that debt is very available and the rities (CMBS) tapes and only includes ratios
ing in 4Q 2009, discipline (underwriting competitiveness of debt funds in the market between 1 and 2.5. The commercial DSCR was
standards) has generally trended downward, is causing a slight erosion of overall under- volatile during 2018 - starting the year at 1.87,
but it has been trending slightly upward writing standards. However, the stricter sliding to 1.73 in March but climbing back to
DETROIT
The Q2 2018 Commercial/Multifamily Quar- EXHIBIT 3-G. COMMERCIAL REAL ESTATE NET ACQUISITIONS
Cross-Border Inst’l/Eq Fund Listed/REITs Private User/Other Unknown
terly Data Book reported that the commercial 35
and multifamily mortgage debt outstanding
25
increased by $52.3 billion in 2Q 2018. The
total commercial and multifamily debt out- 15
standing stood at $3.27 trillion at the end
5
$ Billions
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
stated the total CMBS outstanding was $475 previous year. The US-chartered depository REITs, pension funds, foreign investors, life
billion as of June 20, 2018. institutions, which constituted roughly half insurance companies, commercial banks,
of the total debt, grew 4.4% YoY in origi- GSEs and others, as shown in Exhibit 3-F.
Situs RERC estimates the investment market nations in 3Q 2018. While foreign banking
for CRE in the US in debt-based institutional offices in US accounted for only about 2% of At 51% as of 3Q 2018, Situs RERC estimates
investment properties and equity-based total debt, the category grew another 2.2% that private equity continued to hold the
institutional investment properties. As YoY in 3Q 2018, after particularly strong majority of equity-based CRE. REIT invest-
shown in Exhibit 3-E, key investors in the growth in 2017. The CMBS, CDO and other ment continued to account for the next larg-
debt market included US-chartered depos- ABS category strengthened, as its proportion est piece of the investor universe, at roughly
itory institutions (banks and savings insti- of the debt market rose to 17% in 3Q 2018 from 28% of total equity. The remaining equity
tutions), government-sponsored entities 16% in 3Q 2017. The originations by this cate- investment was held by pension funds (11%),
(GSEs), CMBS, collateralized debt obligations gory increased by 13.5% YoY in 3Q 2018. GSE corporations (4%), life insurers (2%), govern-
(CDOs) and other asset-backed securities totaled 12% of the debt market, and gained ment, GSEs and others (2%), foreign inves-
(ABS), life insurance companies, and foreign 3.3% YoY in debt levels in 3Q 2018. tors (1%), and commercial banks (1%).
banking offices, among others.
CRE EQUITY MARKET Over $396 billion in total CRE acquisitions
The Fed indicated that originations grew occurred through the first three quarters
roughly 6% in 3Q 2018 compared to the Equity investors included private investors, of 2018, according to RCA. This is an 11.4%
160
140
120
100
$ Billions
80
60
40
20
0
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Source RCA, 3Q 2018.
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
All-Property Index rose 2.3% in 3Q 2018 from EXHIBIT 3-K. COMMERCIAL PROPERTY CAP RATES
2Q 2018. The index was up 7.2% in 3Q 2018 Retail Office Industrial Apartment
from one year prior. US deal volume in the 10
3Q 2018 was the highest quarterly volume
since 4Q 2015, and was made up primarily of
apartment and office transactions. Overall 8
transaction volume increased 20% over 3Q
Percent
2017 (Exhibit 3-J).
6
According to transaction data from RCA,
overall volume for the first three quarters of
2018 was up 12% from the first three quarters
of 2017. Total office volume increased 15% 4
YoY in 3Q 2018, with the majority of the trans- 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
CHAPTER 4:
THE PROPERTY
MARKETS
70
Total office volume increased 15% YoY in 3Q
2018, according to data provided by RCA (see 60 250
Exhibit 4-A). The majority of the transacted
Volume ($ Billions)
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
40
Percent
0
20
0 -5
-20
-10
-40
-60 -15
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 YTD 2018
The information provided is “As Is” and without any representations, warranties or guarantees.
Source CoStar Market Analytics, 3Q 2018.
FUNDAMENTALS
14
CRE fundamentals data are provided by CoStar Market Analytics
(www.costar.com), 3Q 2018. The information is provided “As Is”
and without any representations, warranties or guarantees.
Volume ($ Billions)
2018. 0 40
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Entity sales buoyed the industrial sector, Source RCA, 3Q 2018.
with a YoY increase in volume of 76% in 3Q
2018, per RCA. Individual sales increased by
nearly 9% YoY, but portfolio sales declined
by 60%. Portfolio sales account for only 13% EXHIBIT 4-E. AVERAGE INDUSTRIAL CAP RATES
of total industrial volume, however. Indi- 10
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
100 4
Percent
50 2
0 0
-50
-2
-100
-150 -4
-200 -6
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 YTD 2018
The information provided is “As Is” and without any representations, warranties or guarantees.
Source CoStar Market Analytics, 3Q 2018.
FUNDAMENTALS CoStar14. In 3Q 2018, YoY rent growth dipped post-recession average of 155.5 million SF.
below 6.0% for the first time in three years; Net completions also declined in 3Q 2018;
Industrial continues to be the star of CRE, however, rent growth is still near record-low 12-month net completions totaled 212.5 mil-
with its strength reflected in the sector’s levels. In 3Q 2018, 12-month net absorp- lion SF, an 8% decline YoY. However, com-
record-low vacancy (see Exhibit 4-F). In tion totaled 239.8 million SF, the lowest pletions are also above the post-recession
3Q 2018, industrial’s vacancy rate reached level in four years and a nearly 10% decline average of 101.3 million SF.
another record low of 4.8%, according to YoY. Absorption is still well above the
Volume ($ Billions)
tributed to the increase for the retail market Source RCA, 3Q 2018.
as a whole. Shop space, anchored retail and
unanchored retail showed minor decreases
in sales, reporting decreases of 3.2%, 6.7%
and 4.8%, respectively. Additionally, gro- EXHIBIT 4-H. AVERAGE RETAIL CAP RATES
cery space, single-tenant retail, drugstore Shops Centers
10
space and big box space reported larger
decreases in sales – 28.1%, 11.3%, 34.8%
9
and 25.8%, respectively. However, the
increases in property sales of 50.3%, 1.2%
8
and 15.2% for the retail center, lifestyle/
Percent
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
6
200
4
Millions of SF
150
2
Percent
0
100
-2
50
-4
0 -6
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 YTD 2018
The information provided is “As Is” and without any representations, warranties or guarantees.
Source CoStar Market Analytics, 3Q 2018.
with REITs’ share down significantly from 16% and 13%, respectively, round out the 2006, and is forecasted to keep decreasing
14% in 3Q 2017. leading players. Financial agencies, inter- over the coming quarters.
national banks and private/other agencies
The lender pool proportions have seen some combined comprise the remaining 15% of Net asking rents for the overall retail mar-
minor shifts between 2017 and August 2018, the lender pool. ket averaged $20.91 per square foot as of 3Q
according to the August 2018 Real Capital 2018, which represents a 1.6% increase over
Analytics Trends Report. Making up the larg- FUNDAMENTALS asking rents of $20.59 per square foot in 2017,
est portion of the lender pool, CMBS, at 29% according to CoStar. Similar to the patterns
of the pool, slightly ahead of regional/local According to 3Q 2018 CoStar14 data, vacancy observed in vacancy rates, $20.91 per square
banks at 27%. The two combined continue to rates within the national overall retail mar- foot is the high mark of the last five years,
make up more than half of the lender pool. ket have decreased slightly since 1Q 2017, and is anticipated to increase by 1.4% by 3Q
It should be noted that CMBS has gradually down just 20 bps from 4.7% to 4.5% (see 2019. Rents have been slowly improving since
increased its share of the pool by marginal Exhibit 4-I). This represents a continued decreases in net asking rent were observed in
amounts over the last three years to pass decrease from the highest within the last 2010 and 2011, pointing to the stable state of
regional/local banks and lead the market. five years of 6.2% in 1Q 2014. The current the retail real estate market.
National banks and insurance agencies at vacancy rate represents the lowest since
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
shuttered many locations across the nation demonstrating why many best-in-class 2 Community article titled 14 Holiday Shop-
as they go out of business or drastically cut malls continued to thrive, regardless of the ping Stats to Help You Plan in 2018, which
back on their number of locations. Rede- worries in the marketplace. focuses on shopping trends during the holi-
velopment of these existing retail spaces day season states that 46% of shoppers still
continues to be a hot topic, as developers Other trends in desirable tenant mix the prefer the tactile side of shopping, desiring to
get creative with how to revamp the space. market has seen throughout the year is the touch and feel products prior to purchasing.
The trend continues to be transforming popularity of discount, or “off-price,” retail- This realization is leading some traditionally
abandoned big box or anchor tenant space ers, according to the January 2018 CBRE online companies, such as a popular eye-
into entertainment-use space. Develop- article US Retail Real Estate to See More glass manufacturer and retailer, to introduce
ers are doing anything to contribute to the Evolution, Gains in 2018. This concept, in or expand their brick-and-mortar presence,
live-work-play focus of many of these new which national department stores sell their sometimes by 100 or more stores nationally,
mixed-use retail redevelopments. Accord- items at steeply discounted prices, has been according to Forbes’ June 2018 article titled
ing to a January CNBC article titled Enough sought after by shopping centers, boosting 3 Retail and CRE Trends to Watch In The Sec-
with the Doom and Gloom. Retail and Its Real the success of the middle tier of retail prop- ond Half of 2018. Throughout recent years, it
Estate have Bright Spots, retail concepts that erties. Dollar stores and grocery tenants are has been interesting to observe how e-com-
include a restaurant, full bar, event space included in the list of popular and resilient merce, mobile commerce (m-commerce) and
and activity space (bowling lanes, arcade retail tenants, according to CNBC. Some are the traditional brick-and-mortar stores have
games, music stage, etc.) have been coming concerned, however, that this trend may all come together to form one cohesive retail
in to mall anchor stores or outdoor shop- reverse in the near future, as grocery deliv- industry.
ping centers. These tenants not only help ery services gain in popularity.
retail properties by occupying once-vacant National retailers scaling back their number
space, but also contribute to the success According to a Statista article titled of locations, or even going out of business
of the center as they draw large crowds for Online-Shopping and E-Commerce World- altogether, has become less of a shock each
various events. In fact, as noted in the Sep- wide Statistics & Facts, approximately time it is announced. Industry leaders have
tember 2018 Forbes article titled How Can 42% of consumers in the US had pur- now had a few years of experience dealing
Commercial Real Estate Investors Protect chased products online as of 2017. Online with the changing market to realize that
Their Property in the Digital Age, industry orders through the computer and shop- their properties can still succeed as they
specialists point out that if the experience ping through mobile devices are increas- adapt to the ever-changing competitive
concept is distinctive enough, social media ingly popular among consumers, with retail landscape. The retail real estate mar-
may contribute to the success of the tenant mobile shopping accounting for over 20% ket is learning that the retail industry will
and, in turn, the property. By thinking stra- of all digital spending. Online shopping is survive, and even thrive, even when several
tegically about dealing with large, vacant expected to keep increasing in the coming players scale back their presence.
spaces at their properties, landlords are years. However, an October 2018 Business
Volume ($ Billions)
130
volume is on pace to rebound by the end of 30 110
2018 (see Exhibit 4-J). A total of $120.1 billion
of significant apartment properties were sold 20 90
in the first three quarters of 2018, represent-
10
ing a YoY increase of 12% based on RCA data. 70
This is notable considering that the trend in 0 50
volume over the prior two years had been 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
downward with a 35% increase in 2015 fol- Source RCA, 3Q 2018.
lowed by a marginally positive increase of
5% in 2016, and a decrease of 3% in 2017.
Though the 2018 rebound from the prior year
is not expected to lead to further significant EXHIBIT 4-K. AVERAGE APARTMENT CAP RATES
volume increases in the foreseeable future, it 8
does indicate that many investors continue
to favor this property type despite its pro- 7
longed run.
Percent
Investors are continuing to focus outside the quarters of the prior year, per RCA. proportion of transactions occurring in sec-
major urban areas, with a YOY sales volume ondary and tertiary markets from investors
increase of 21% for secondary and tertiary As presented in Exhibit 4-K, average cap rates seeking opportunities for higher yields, it
markets, compared to -2% for major metro for the apartment sector have remained rel- appears that overall average cap rates may
markets. This is not surprising considering atively stable over the last year, decreasing continue to stabilize or possibly increase in
the cap rate compression in major markets slightly to an average of 5.5% in the first three 2019.
and the opportunity for higher yields with quarters of 2018 from an average of 5.6% over
apartments properties in non-core markets. the same period in the prior year. INVESTOR COMPOSITION
Based on the RCA CPPI, pricing for apart- As of 3Q 2018, the average cap rate for mid/ Private investors have overwhelmingly dom-
ment properties nationally has increased high-rise properties dipped into sub-5 terri- inated the market in the first half of 2018,
approximately 11% YoY through September tory (at 4.8%), while the average capitaliza- representing 67% of all transaction activity
2018. This is the largest increase of the major tion rate for garden-style properties dropped based on RCA data. This is an increase from
property types over this time frame, and it to 5.5%. In both cases, the rates are well 62% in 2017. The second largest group of buy-
is noted that pricing for apartments is now below historical levels, reflecting the avail- ers was institutions/funds at 22%, a decrease
nearly 70% above previous peak levels from ability of capital, low mortgage rates and the from 24 % in 2016. Notably, REITs acquired
late 2007. The average price per unit (PPU) high demand for this property type. approximately 21% less in terms of volume in
has also increased, averaging $154,192 in the first half of 2018 compared to the first half
2018 compared to $141,845 in the first three With interest rates on the rise and a greater of 2017.
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
300 6
250 4
Thousands of Units
200 2
Percent
150 0
100 -2
50 -4
0 -6
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 YTD 2018
The information provided is “As Is” and without any representations, warranties or guarantees.
Source CoStar Market Analytics, 3Q 2018.
Greystar Real Estate Partners (Greystar), every year since 2011, when just 79,268 new Phoenix, San Francisco and Orlando are
which acquired student housing REIT EdR units were completed. Based on the projec- expected to have the highest cumulative
in the third quarter of 2018 for approximately tion data, this trend is expected to culmi- potential rental revenue growth from 2018
$4.6 billion, was the most active buyer (in nate at a peak in 2019, thereafter declining to 2022 (potential rental revenue growth is
terms of investment volume), according to to 207,151 units in 2022. The total apartment the combined change in effective rental rates
RCA. Other notable buyers were BREIT (a stock as of 3Q 2018 was approximately 17.6 and occupancy). Of the top 20 markets, the
Blackstone entity that was also involved in million units. lowest performing markets are expected to
the joint venture for EdR properties), Brook- be Chicago, Dallas and the New York metro.
field Asset Management, Goldman Sachs, FUNDAMENTALS
and TIAA. After EdR, Starwood Capital,
Greystar and Caisse de Depot were the top Continuing upon a trend that started in 2016,
sellers during the period. property fundamentals in the apartment sec-
tor have weakened through 2018. According to
Through the first three quarters of 2018, the RealPage, annual effective rent growth was
geographic areas leading in terms of trans- 2.7% in 3Q 2018, a decline from 2.9% in the
action sales volume for apartment properties prior year and approximately half of the rate
include Los Angeles, Dallas, Houston and of growth of 5.1% at the end of 2015. Annual
Atlanta, according to RCA. However, markets effective rent growth is forecast to inch up
exhibiting the biggest YoY increases include slightly to 3.1% in the second quarter of 2019,
Houston, East Bay, Manhattan, other New thereafter declining down to 2.1% by the sec-
York City boroughs, Phoenix and Raleigh/ ond quarter of 2021 according to RealPage.
Durham.
Since the apartment recovery began in late
A diminishing supply of apartment proper- 2009, the vacancy rate fell in 26 consecutive
ties, strong sector fundamentals and intense quarters from 7.8% to 4.8% in 2Q 2016 (see
competition have led to a significant pipeline Exhibit 4-L). Since then, the vacancy rate
of new apartment projects, as developers has held relatively steady and was at 4.7% in
look to capitalize on the tight market condi- the third quarter of 2018. The vacancy rate is
tions. According to RealPage data, 301,397 expected to remain in the 5% territory over
apartment units are expected to be delivered the next several years, per RealPage.
in 2018, followed by 314,747 and 260,979 more
units in 2019 and 2020, respectively. The new According to forecast information from
supply of apartment units has increased in RealPage for the top 20 markets, Las Vegas,
Volume ($ Billions)
20 200
librium, investor confidence has improved
to the extent that the hotel sector was one 15 150
of two sectors posting transaction volume
10 100
growth in October (See Exhibit 4-M). Over
the last four quarters, there has been a con- 5 50
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
markets, cap rates for hotel properties were EXHIBIT 4-O. HOTEL NET ACQUISTIONS BY INVESTOR TYPE
unchanged in recent months but were down Cross-Border Inst’l/Eq Fund Listed/REITs Private User/Other Unknown
15
10 bps from 3Q 2017. Cap rates for limited-ser-
vice hotels came in at 8.9% vs. a 7.7% aver- 10
age for full-service hotels.20
5
Foreign capital investment in the hotel sector
$ Billions
0
continued to slow after record investment in
2016 (See Exhibit 4-O). With approximately
-5
$60.4 billion in acquisitions on a TTM basis,
3Q 2018 data from RCA shows that hotels -10
representing approximately $4.7 billion or
approximately 7.8% of all cross-border trans- -15
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 YTD 2018
actions. Cross-border investors completed
17% of total hotel acquisitions, down from Source RCA, 3Q 2018.
64
80
FUNDAMENTALS 63
60
62
Occupancy continues to deliver in the mid- 40
to high 60s and above the long run average 61 20
of approximately 62.3% (See Exhibit 4-P). 60 0
Through 3Q 2018, Smith Travel Research 2013 2014 2015 2016 2014 2018 2019 2020 2021 2022
(STR) reports YTD occupancy at approxi- Note Shaded area reflects forecast rates.
mately 67.7%. While ADR did respond with Source CBRE Hotels’ Americas Research, STR, 3Q 2018.
growth, the recorded growth in 2018 was
rather dismal — near 2.5% at $130. Both
occupancy and ADR provided a 3.1% lift
in revenue per available room (RevPAR)
to approximately $88. According to Smith
travel, RevPAR has grown at least 3.0% for
each year since 2010. Despite measured
growth, room supply, room demand, occu-
pancy, ADR, RevPAR and room revenue are
at all-time highs .21
STR, Trends for 2018 and Beyond, Ryan Lynch, November 2018.
21
by 2.8% of the existing hotel room base. In expected to be in near-equilibrium and very STR, US Hotel Supply Development Update, November 2018.
24
previous years, demand growth dominated, much in line with long-term averages. New
reflecting net supply/demand differentials supply is projected to be tepid and below
in excess of 3.5% in some years. In 2018 2.0% in in the near term.
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
CHAPTER 5:
OUTLOOK
CHAPTER 5 OUTLOOK 49
OUTLOOK25 OMAHA
ECONOMY
Rising consumer spending is expected to
The US economy is generally humming lead to an increase in exports. Many exist-
along as we enter 2019, although there are ing tariffs (and retaliatory tariffs) are likely
some concerns. Unemployment and con- to remain in place in 2019, but we expect
sumer confidence are near record lows and that corporate and investor uncertainty
inflation and wages are finally starting to surrounding international trade tensions
pick up. However, several central banks will ease as formal trade agreements are
and organizations have tempered their eco- signed into law and the trade deficit, which
nomic outlooks for 2019 and beyond. reached a 10-year high in October of 2018,
will decline modestly throughout 2019.
The IMF projected in its October 2018 World
Economic Outlook that global economic As the US population continues growing and
growth would notch a 3.7% annual gain in demand for housing remains on an upward
2018-2019. The figure represented a 20 bps trend, the undersupply of new homes will
downgrade from its April 2018 estimate and likely continue to weigh on markets into 2019.
placed the pace of growth on par with that Rising labor and materials costs are expected
of 2017. The ECB remained committed to to continue to hamper new construction.
its plan to scale back its bond-buying pro- However, rising mortgage rates and tight
gram, which it initiated in January of 2018, inventory will likely lead to a decline in hous-
announcing at its October meeting that it ing sales, resulting in a slower rate of price
would cease purchases by December. appreciation compared to 2018.
The Fed has lowered its growth and infla- CAPITAL MARKETS OUTLOOK
tion forecasts for 2019, from 2.5% to 2.3%.
Expectations are for two more rate hikes FINANCIAL MARKETS
in 2019 — originally, three hikes were pro-
jected. In addition, on January 4, 2019, Fed It is nearly impossible to predict what will
Chairman Jerome Powell said that the Fed happen in the financial markets, as evi-
would be “flexible on policy and in no hurry denced by the rocky events of 2018. There-
to raise interest rates” in 2019, as reported fore, it is with some trepidation that we offer
by CNBC. The statement resulted in a surge our outlook for the stock and bond markets.
in stock and bond yields.
We anticipate that volatility in the stock mar-
In 2019 Deloitte, NAR and Situs RERC ket will continue, at least through the early
expect that the US economy should enter part of 2019. Corporate earnings are expected
into the longest expansion period in his- to moderate as the initial boost from the tax
tory with moderate growth. We also expect cuts begins to fizzle out. We may see stocks
that unemployment will likely continue to rally later in 2019 if investors can separate the
be near historically low levels and wage news from the noise. This outlook, however,
growth will outpace inflation. The greatest assumes that the economy remains as strong
job gains will likely be found in education as is currently expected.
and health care. Job gains are also likely in
the leisure and hospitality sector (as con- On the bond side, investors will likely focus
sumer spending increases) and business on investment-grade bonds. Companies will
and professional services. Over the next likely continue to be profitable, but we have
year, we expect that the strong labor market, seen shareholder-friendly activities such as
moderate wage growth and a modest tax cut share buybacks and increase in dividends
for consumers will result in increased con- compared to capital spending, so bond-
sumer optimism and higher spending. holders should keep a close eye on these
The viewpoints represented in this entire chapter represent the collective perspectives and outlooks of the authors of this report (except
25
where otherwise noted) and may not represent the viewpoints of the sponsoring firms as a whole.
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
activities as we move further in the cycle. EXHIBIT 5-A. SITUS RERC’S 10-YEAR TREASURY FORECAST
Lower Case 10-Year Treasury Base Case Upper Case
SITUS RERC 10-YEAR TREASURY FORECAST26 5
Percent
5-A. We expect that bond yields will likely
increase, albeit not at as quick of a pace as 2
the first half of 2018.
1
The base case scenario assumes the most
probable economic situation over the next 0
two years, with a slow but steady rise in the 2015 2016 2017 2018 2019 2020
Treasury rates throughout 2019 and 2020. Note Data based on quarterly average. Shaded area indicates forecast.
This assumes the Fed will maintain a grad- Source Federal Reserve, compiled and forecast by Situs RERC, 3Q 2018.
ual pace of monetary tightening, keeping
inflation in check and the economy balanced
with a tight labor market and relatively
healthy fundamentals. The base case sce- the tax reform cools down sooner than An NREI article titled Moody’s Analyst Kevin
nario sees the 10-year Treasury rate inching expected, dragging down the economy. Fagan Explains the Current State of CMBS
up to 3.4% by 3Q 2019 and 3.6% by 3Q 2020. Underwriting reported a gradual decline in
CRE DEBT MARKET OUTLOOK CMBS loan quality in 2018, largely driven
The higher case scenario reflects stronger by the deterioration in single tenancy and
economic growth but has a lower probabil- Based on 3Q 2018 survey data from Situs interest-only loans. Our view is that the
ity of occurrence compared to the base case. RERC, we anticipate that debt capital will CMBS market will face some challenges as
The higher case scenario assumes that the continue to be readily available and that the we near the end of this real estate cycle;
tight labor market, higher oil prices and competitiveness of debt funds in the market however, some of these challenges should
stronger dollar forces the Fed to hike short- will cause a slight erosion of overall under- be mitigated by increased credit enhance-
term rates, putting upward pressure on the writing standards. Debt yield ratios will ments and a DSCR level that is higher than
10-year Treasury. This scenario predicts the likely increase in the coming quarters. The it was before the crisis.
10-year Treasury to increase to 4.3% in 3Q market is likely to remain rational, however,
2019 and to 4.5% in 3Q 2020. as stricter requirements that have been in CRE EQUITY MARKET OUTLOOK
place since the beginning of the recovery
The lower case scenario reflects a more remain and keep lending in check. In gen- Data from Situs RERC suggest that equity
pessimistic economic situation and is also eral, we expect that strong fundamentals capital will likely be readily available
less likely than the base case scenario. This and historically low interest rates will sup- in 2019. However, uncertainty about the
scenario predicts the 10-year Treasury rate port the CRE lending environment. We also direction of the economic cycle, combined
to drop to 2.3% by 3Q 2019 and 1.9% by 3Q believe that non-traditional lenders, such as with pricing that feels like it is at a peak, is
2020. The lower case scenario assumes the shadow banking, will continue to take more expected to make equity capital cautious.
trade war escalates and the boost from market share from traditional lenders. We anticipate that this caution may cause
Predicting rates is a difficult endeavor under any circumstance. The above scenarios are Situs RERC’s best estimates of inflection points for expected rates. The Situs RERC’s 10-Year Treasury Forecast produces similar
26
results to other third-party consensus forecasts and models, including analyses from Moody’s, Kiplinger and The Wall Street Journal.
LAS VEGAS
CHAPTER 5 OUTLOOK 51
underwriting standards to become more
disciplined throughout the year.
KANSAS CITY
The outlook for foreign investment into US
CRE is encouraging, but will be impacted
by trepidation about a potential trade war
between the US and China. Also, rising
interest rates will increase the costs for
foreign buyers seeking to acquire assets in
the US. However, property fundamentals
remain sturdy, and the US economy is on
the cusp of its longest expansion in history.
That, coupled with a more diverse group of
investors into the market, should account
for a continued flow of foreign capital into
the US in spite of the higher cost.
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
investments, and in some cases, buying EXHIBIT 5-B. SITUS RERC TOTAL RETURN FORECAST (BASE CASE SCENARIO)
empty newly constructed assets or newer Cash Flow Rate CapEx Appreciation Total
14
assets struggling to find occupants. There
are opportunities, but you have to pick your 12
spots carefully and with an eye to what can
10
help your portfolio grow.
8
Percent
SITUS RERC TOTAL RETURN FORECASTS
6
MIAMI
CHAPTER 5 OUTLOOK 53
EXHIBIT 5-C. SITUS RERC TOTAL RETURN FORECAST — OFFICE (BASE CASE SCENARIO)
Income Capital Total
30
20
10
Percent
-10
-20
-30
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Sources Situs RERC, NPI-ODCE, 3Q 2018.
EXHIBIT 5-D. SITUS RERC TOTAL RETURN FORECAST — INDUSTRIAL (BASE CASE SCENARIO)
Income Capital Total
20
10
0
Percent
-10
-20
-30
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Sources Situs RERC, NPI-ODCE, 3Q 2018.
54 ©2019 Deloitte Development LLC, NATIONAL ASSOCIATION OF REALTORS®, Situs RERC. All Rights Reserved.
EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
EXHIBIT 5-E. SITUS RERC TOTAL RETURN FORECAST — RETAIL (BASE CASE SCENARIO)
Income Capital Total
20
15
10
0
Percent
-5
-10
-15
-20
-25
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Sources Situs RERC, NPI-ODCE, 3Q 2018.
EXHIBIT 5-F. SITUS RERC TOTAL RETURN FORECAST — APARTMENT (BASE CASE SCENARIO)
Income Capital Total
25
20
15
10
5
Percent
-5
-10
-15
-20
-25
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Sources Situs RERC, NPI-ODCE, 3Q 2018.
HONOLULU
CHAPTER 5 OUTLOOK 55
PROPERTY TYPE OUTLOOK that fundamentals may not live up to expec-
tations, or that pricing will be inflated due
FORT WORTH
OFFICE to the strong demand; however, we believe
that industrial will continue to be the best
In 2019, we expect that the office sector performing sector in 2019.
will be a bright spot in the CRE market.
The already-low vacancy rate is expected RETAIL
to decline further in 2019 to approximately
9.5%, according to a 3Q 2018 forecast from Retail PPSF, which is the highest it has been
CoStar27. Further, offices in core markets in five years, is anticipated to increase by
tend to provide stable income during times of 1.4% by 3Q 2019, according to a forecast by
uncertainty. With solid job growth and low CoStar*. Rents have been slowly improv-
unemployment likely to continue in 2019, ing since decreases in net asking rent were
we expect that office will continue to see observed in 2010 and 2011, pointing to the
strong demand and tempered supply. Since stable state of the retail real estate market.
the office sector has lagged behind the other
property types in the recovery because of the Modest retail industry growth, but growth
lack of newer, first-tier properties and nom- nonetheless, has been observed over the
inal new construction, we may see slightly course of 2018, and we expect the trend to
increasing rents in desired submarkets. continue in 2019. The overall attitude within
the retail real estate industry is less a feeling
However, we anticipate that it will be more of panic, and more a feeling of understand-
challenging to find the best-valued office ing as the industry learns how to adapt to
markets in the coming year. Some top-tier the changing market. Many retailers are
markets are overpriced, and this will likely working to perfect their omni-channel shop-
push investors further into secondary mar- ping experiences to utilize both their online
kets. Additionally, ongoing technological portals and their brick-and-mortar stores to
advances for space optimization, coupled their fullest potential.
with an economy operating at nearly full
employment, raise the question of whether Despite pessimism swirling around malls,
vacancy will rise. The obsolescence of some we expect continuing capital coming back
office space is also a major challenge to the to this subsector as pricing comes down —
sector that will likely require enormous but it is dependent on the selectivity of the
amounts of capital to address. best assets. Nonetheless, a lack of quality
tenants — particularly in second- and third-
INDUSTRIAL tier tenants for community centers – and
oversupply of space in power centers, which
The industrial sector will likely continue are especially vulnerable to e-commerce,
to have the most favorable near-term fun- will likely continue to present major head-
damentals of all the main property types. winds for the sector.
In 2019, we expect vacancy rates to remain
near record lows and increased demand While the market appears to be inching
for warehouse distribution space and data toward an equilibrium, some possible shifts
centers, while a rise in new business forma- in consumer shopping patterns could poten-
tion of small manufacturing companies that tially cause trouble for the retail real estate
sell their goods via e-commerce will likely industry once again. For example, grocery
increase demand in the flex sector. Rising delivery services are gaining marginal pop-
construction costs and lack of developable ularity, making up between 2% and 4.3%
land are expected to add to undersupply. of the grocery retail market today but it is
forecasted to increase to approximately 20%
Some caution is warranted due to the of the grocery retail market by 2025, accord-
implementation of tariffs, the possibility ing to a May 2018 Forbes article, The Race
of a trade war and the age of the current Is On For Grocery Delivery, But Most Cus-
expansion. In addition, we have concerns tomers Still Want To Shop In Stores. Grocery
27
,*Data provided by CoStar Market Analytics (www.costar.com), 3Q 2018. The information is provided "As Is" and without any representations,
warranties or guarantees.
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
stores are one of the more stable tenants every year since 2011, when just 79,268 new of new units, especially true of Class A prop-
at retail centers thus far, but a decline in units were completed. Based on the projec- erties in major markets, suggest the apart-
their business may hurt occupancy and rent tion data, this trend is expected to culmi- ment sector is moderating as it achieves equi-
growth rates, sending property owners to nate at a peak in 2019, thereafter declining librium. With the supply of apartment units
the drawing board to figure out their ideal to 207,151 units in 2022. Annual effective projected to remain at a high level over the
tenant mix. In the meantime, the outlook of rent growth is forecast to inch up slightly to next several years, a shift on the demand side
the market is positive, with modest growth 3.1% in the second quarter of 2019, thereaf- with renters turning into homebuyers could
expected during the coming year. ter declining to 2.1% by 2Q 2021, according have a major impact on this sector.
to RealPage.
APARTMENT HOTEL
According to forecast information from
The outlook for the apartment market RealPage for the top 20 markets, Las Vegas, CBRE forecasts a 1.9% increase in the num-
appears to be steady in the short term, with Phoenix, San Francisco and Orlando are ber of available US hotel rooms from 2018 to
continued investor appetite in this sector expected to have the highest cumulative 2019. This is slightly less than 2018’s growth
and increasing property values. With inter- potential rental revenue growth from 2018 to rate of 2.0%. With the slowing growth rate, it
est rates on the rise and a greater propor- 2022 (potential rental revenue growth is the appears that supply growth has peaked. This
tion of transactions occurring in secondary combined change in effective rental rates should provide some relief for hotel owners
and tertiary markets from investors seeking and occupancy). Of the top 20 markets, the and operators in 2019 and beyond. That said,
opportunities for higher yields, it appears lowest performing markets are expected to CBRE expects 50 of the 60 markets covered
that overall average cap rates may continue be Chicago, Dallas and the New York metro. by CBRE to have supply growth greater than
to stabilize or possibly increase in 2019. 2.0% in 2019, which is up from the 39 mar-
Given the transaction volume and pricing, kets that realized growth greater than 2.0%
According to RealPage, 301,397 apartment apartments continue to be a preferred prop- in 2018. Nashville, Denver, Savannah, New
units are expected to be delivered in 2018, erty type for investors. However, trends in York and Seattle are a few of the markets that
followed by 314,747 and 260,979 more units apartment fundamentals (most notably the are expected to have the greatest rates of new
in 2019 and 2020, respectively. The new effective annual rent growth), coupled with hotel supply growth next year. Fortunately
supply of apartment units has increased in significant continued increases in the supply for owners and operators, a robust economy
NEW ORLEANS
CHAPTER 5 OUTLOOK 57
continues to support even greater increases in The hotel sector has stabilized recently that the timing of the cycle is not set in stone.
the demand for these new accommodations. and continues to operate at historic highs The economy will likely continue on solid
in terms of occupancy and gross revenue; footing in the immediate future and CRE
For 2019, CBRE is forecasting a 2.1% rise in however, supply, demand and ADR growth remains an attractive investment alterna-
the number of occupied rooms. This will have slowed. This slowdown has provided tive, given the wildly fluctuating stock and
mark the 10th consecutive year of occu- a needed break for hotel owners to evaluate bond markets. The attractiveness of a partic-
pancy growth for the US. With occupancy their investments and high price points in ular asset class is relative to the desirability
levels at record highs, one would expect some markets. Historically, hotel investors of alternative asset classes, which can vary
outsized increases in ADR, but this has not have looked to GDP growth, consumer confi- depending on the risk appetite of the market.
occurred during this cycle. ADR growth is dence and disposable income levels to predict Although concerns over the economic and
forecast to grow by 2.5% in 2019, which is just market growth fundamentals. These indica- current real estate cycle’s duration and ris-
above CBRE’s forecast of inflation. US. Hotel tors, and others, are providing strength and ing interest rates are putting some pressure
RevPAR is expected to grow by just 2.7% in stability to the hotel sector. Some hotel own- on values, CRE is expected to remain the best
2019. This is the lowest rate of growth since ers may consider a sale, taking advantage investment option compared to stocks, cash
the recovery began in 2010. While operating of market fundamentals and pricing to the and bonds. As we know and have come to
margins are at the highest levels since 1960, extent that buy-sell assumptions converge. expect, private CRE gives investors a bond-
CBRE does not expect any more growth in like return plus an equity upside like that of
the margin during this cycle, primarily CONCLUSIONS a stock investment. Institutional CRE is cur-
because of rising labor costs. Given CBRE’s rently positioned well to achieve reasonable
modest forecasts of RevPAR change over the The real estate industry is entering returns in an otherwise shaky investment
next few years, operators will need to keep uncharted territory as the business cycle environment.
expense growth to under 3.0% for hotels to completes its 10th year of expansion. While
achieve real gains in profits28 . we are watching and waiting for the next cor- Please refer to Exhibit 5-G for our outlooks
rection to occur, it is important to remember under three different economic scenarios.
DES MOINES
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
• US GDP growth averages less than 1.5% in • Growth continues between 1.8% and 2.3%29. • US GDP growth averages greater than 2.5%
2019. • Rate slows slightly but not enough to prevent in 2019.
US GDP • Tariffs and government shutdown depress the economy in 3Q 2019 from entering lon- • Government shutdown’s impact is minimal
Real Growth economic growth. gest expansion period in US history. and short-lived.
• US trade policy supports globalization.
• Unemployment rate rises to over 4.5%. • Unemployment rate remains in 3.8% to 4.2% • Unemployment rate falls below 3.8%.
• Labor-force participate rate declines. range in 201929. • Economic growth supports continued strong
• With declining economic growth, business • Wage growth ticks up and outpaces inflation. hiring in the private sector.
investment decreases. • Increasing wages attract discouraged workers • Wage growth gains momentum.
• Wage growth and consumer spending from the sidelines, bumping up overall • More deregulation boosts job gains in
Employment
stagnate. unemployment rate slightly. financial, professional and business services
• Tariffs hurt construction and manufacturing • Education and health care, leisure and sectors.
industries. hospitality and business and professional • Job growth occurs in nearly all other sectors.
• Low oil prices have negative impact on work- services sectors see greatest increase in
ers in energy sector. employment.
• Weak economy and low wage growth cause • Solid demand for housing is propelled by • The number of housing starts increase as
home prices to fall and new construction to accelerating household formation, popula- prices rise.
slow down. tion growth and increasing incomes. • Stronger job market and increasing wage
• Already high home prices, rising mortgage • Rising labor and materials costs continue to growth drive more renters to enter the hous-
Housing rates and tightened lending standards force hamper new construction. ing market, supporting high prices in many
Market more people out of the housing market. • Rising mortgage rates and tight inventory major markets.
slow sales and rate of price appreciation. • Lack of existing homes and strong price
• Affordability continues to be a concern in appreciation spur new construction, despite
most major metropolitan areas. rising labor and material costs.
• Weak employment situation leads to declin- • Strong labor market, moderate wage growth • Consumer spending gets boost from strong
ing wage growth and less disposable income and modest tax cut for consumers result wage growth, low unemployment.
for consumers. in increased consumer optimism, higher • Increasing home prices make households
Consumer • Falling consumer sentiment causes decrease spending. feel more secure in their wealth and increase
Spending in consumer spending, especially for durable • Structural trends, such as wealth inequality spending.
goods. and the declining retirement savings of baby • Trade policy that favors globalization keeps
• International tariffs increase the price of boomers, present longer-term challenges. price of durable goods reasonable so con-
consumables, further inhibiting spending. sumers can purchase more.
• New hiring and wage growth stall. • Business investment growth moderates as • Stock market recovers from losses of 2018
• Positive impact of corporate tax cuts fades. volatility in the stock markets and rising un- as US adopts trade policy that supports
• Tariffs (and retaliatory tariffs) remain in certainty regarding international trade offset global growth.
place, resulting in a decrease in profits and a lower corporate tax rates. • Deregulation continues, boosting business
Business
decline in business investment. • Investments in intellectual property and confidence and expanding access to capital.
Spending
• Stock market continues to experience information processing comprise the largest • Hiring continues at a rapid pace.
volatility and sharp losses, making investors increases in business spending. • Wage growth returns to pre-GFC rates.
nervous. • Commercial and residential real estate
investments soften.
• Tax revenues are substantially lower than • Federal spending increases modestly, partic- • Government spending increases as Congress
expected. ularly for Social Security and Medicare, as passes infrastructure spending plan with
• Brief stimulus from tax cuts fades and GDP the population ages. bipartisan support.
Government growth slows. • Proposed infrastructure spending plan fails • Economic stimulus generated by tax cuts
Spending • Increasing political gridlock leads to less to gain traction in Congress. boosts GDP.
government spending. • State and local governments continue to • Additional revenue leads to moderate
increase spending modestly, particularly for increased spending across all levels of
education. government.
CHAPTER 5 OUTLOOK 59
EXHIBIT 5-G. ALTERNATIVE ECONOMIC SCENARIOS (CONTINUED)
• Trade deficit changes little as other countries • Trade deficit, which reached 10-year high in • Trade deficit falls nearly 20% from 2018 as
retaliate against US tariffs. October 2018, declines modestly throughout the “trade war” diminishes.
• Protectionist US trade policy damages global 2019. • Policies favoring globalization replace
Trade confidence and weakens international trade. • Rising consumer spending contributes to protectionist policies in the US and around
Balance • The strong dollar, caused in part by a “hard increase in exports, but international trade the globe.
Brexit,” limits exports amid a global econom- tensions ease and formal trade agreements
ic slowdown. are signed into law.
• Inflation falls below the Fed’s 2% target rate • Inflation remains steady in the mid-2% range • Inflation rate rises to nearly 3%.
as wage growth and business investment as the Fed closely monitors the economy for • Prices increase for goods because busi-
declines. signs of overheating and adjusts monetary nesses forced to raise wages in tight labor
Inflation • Price of oil and gas continues to decline. policy accordingly. market.
• Price of agricultural goods drops as agri- • Increasing shelter and health care costs • US removes most protectionist tariffs, keep-
cultural exports stemming from tariffs keep offset by declining energy and oil prices. ing the cost of goods from rising even more.
prices low. • Food prices remain steady.
• 10-year Treasury rate to drops to the mid-2% • Long-term interest rates, as measured by the • 10-year Treasury increases to the mid-4%
range by the end of 2019. 10-year Treasury yield, gradually increase, range.
• Administration and federal government fail to reaching the mid-3% range by the end of • Tight labor market, higher oil prices and
reach agreement on policies. 2019. stronger dollar forces the Fed to hike short-
Interest
• Trade war escalates and the boost from tax • Short-term rates experience a slow but term rates, putting upward pressure on the
Rate30
reform cools down sooner than expected, steady rise throughout 2019 and 2020. The 10-year Treasury.
dragging down the economy. Fed maintains a gradual pace of monetary
tightening, keeping inflation in check and the
economy balanced.
• Total CRE returns fall to about 2% by the • CRE total returns continue to gradually • CRE total returns jump to over 8% due to a
end of 2019, as capital appreciation turns regress from previous peaks, reaching about surge in capital appreciation.
negative. 6%; income returns drive total returns. • Economy performs very well, which buoys
• Amid a slowing global economy and uncer- • Favorable economic conditions, including demand for CRE.
tainty over the length of the real estate cycle, historic employment gains, expected to allow • CRE prices increase (and cap rates com-
Commercial sales volume and property prices decline further room for rent growth. press), tied to the strong fundamentals.
Real Estate30 significantly, and cap rates increase at a • Solid property fundamentals underlie strong • Boost in prices spurs redevelopment and
faster pace. valuations and support prices. new construction.
• Availability of capital declines as a greater • Capital is readily available, but rising interest • Space market fundamentals improve for all
proportion of tenants default. rates, elevated prices and lack of quality property types.
• Vacancy rates start to increase across most product edge transaction volumes slightly
property types. downward.
Note These are not the only scenarios that are possible, and there will usually be differences between the forecast and actual results because events and circumstances frequently do not occur as expected, and
those differences may be material.
29
GDP and unemployment rate forecasts are provided by the NATIONAL ASSOCIATION OF REALTORS® and do not necessarily reflect the viewpoints of the other sponsoring firms of this report.
30
Interest rate and total return forecasts are provided by Situs RERC and do not necessarily reflect the viewpoints of the other sponsoring firms of this report.
Source NAR, Situs RERC, Deloitte, BLS, BEA, The Conference Board, RCA, NCREIF, The Wall Street Journal, January 2019.
SAN DIEGO
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
SPONSORING FIRMS 61
SPONSORING FIRM
LEADERSHIP
® Steven J. Powel
CEO
Situs
713.328.4403
Situs RERC was one of the first corporations in America to focus on real estate research and analysis and Steve.Powel@Situs.com
continues to be a leading expert in research, valuation and consulting. Real estate valuation is our core
business, along with our industry-renowned independent market research. Situs RERC appraises and Nick Rudenstine
performs appraisal reviews for thousands of commercial properties each quarter, globally, and is expe- President and COO
rienced with every major property type. Situs RERC’s valuation and advisory practice includes appraisal Situs
management, appraisal reviews, aggregating appraisal information, valuation reporting, application of 212.294.1316
Nick.Rudentine@Situs.com
valuation best practices, portfolio analytics, ad-hoc consulting, and data analytics and research.
Kenneth Riggs, Jr.
Situs RERC has an uncompromising dedication to delivering the highest quality product and service. CFA, CRE, MAI, FRICS
Situs RERC works closely with our clients to ensure they are receiving best-in-class services, which in President and Global Head
turn, results in outstanding client satisfaction. Situs RERC has a distinguished record of client longevity Situs RERC
and extremely low turnover across the industry. Our focus on client satisfaction and longevity allows for 312.587.1900
relationships to develop over time, adding maximum value to our client’s real estate platforms. RERC, riggs@rerc.com
LLC, is an SEC-registered investment advisor. Our industry experts have CFA, MAI, CRE, FRICS, CCIM and
AI-GRS credentials. Brian Velky
CFA, CRE
SITUS RERC VALUATION ADVISORY SERVICES Managing Director and Head of Americas
Situs RERC
515.309.7600
Situs RERC:
bvelky@rerc.com
• Conducts fair value assessments on more than $225 billion in institutional real estate assets on a
quarterly basis, globally. Del Kendall
CRE, MAI, FRICS
• Manages, conducts and/or reviews more than 2,500 real estate appraisals each quarter. Managing Director
Situs RERC
• Valuates 70% of all net assets in daily valued product in the market today. 713.661.8880
dkendall@rerc.com
We offer a unique thought leadership perspective for our clients, which include:
• Three of the top six largest pension funds in the US. Taco Brink
CRE, MAI, MRICS
Managing Director and Head of Europe
• Four of the US’s top five life insurance companies by total assets.
Situs RERC
+44 (0) 207 220 1874
• Three of the largest real estate investment managers in the world. Taco.Brink@Situs.com
Andrew Phillips
Managing Director
Situs
212.294.1340
Andrew.Phillips@Situs.com
Situs RERC
319-352-1500
www.situsrerc.com
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 / Uncharted Territory
SPONSORING FIRM
CONTACTS
Robert O’Brien
Partner
Global Real Estate Leader
In today’s competitive environment, it is critical to stay ahead of industry trends and respond dynamically Deloitte & Touche LLP
to market opportunities. 312.486.2717
robrien@deloitte.com
As a recognized leader in providing audit, tax, consulting and risk and financial advisory services to the
real estate industry, Deloitte’s clients include top REITs, private equity investors, developers, property Jim Berry
managers, lenders, brokerage firms, investment managers, pension funds, and leading homebuilding Partner
companies. US Real Estate Leader
Deloitte & Touche LLP
214.840.7360
Our multi-disciplinary approach allows us to provide regional, national, and global services to our clients.
jiberry@deloitte.com
Our real estate practice is recognized for bringing together teams with diverse experience and knowledge
to provide customized solutions for clients. Deloitte’s US Real Estate practice comprises more than Matt Kimmel
1,600 professionals assisting real estate clients out of offices in 50 cities. Globally the real estate prac- Principal
tice includes over 8,000 professionals located in more than 50 countries throughout the Deloitte Touche Real Estate
Tohmatsu Limited network of member firms. Deloitte Transactions and Business Analytics LLP
312.486.3327
mkimmel@deloitte.com
Sources Builder Online 2017, NAREIT (5/17), P&I (May-December 2017), PERE Fifty (2017), Fortune 500 (2017), NREI (2017)
*Investment banking products and services within the United States are offered exclusively through Deloitte Corporate Finance LLC (“DCF”), an SEC
registered broker-dealer and member FINRA and SIPC, and an indirect wholly-owned subsidiary of Deloitte Financial Advisory Services LLP and affiliate of
Deloitte Transactions and Business Analytics LLP.
This document contains general information only and Deloitte is not, by means of this document, rendering accounting, business, financial, investment,
legal, tax, or other professional advice or services. This document is not a substitute for such professional advice or services, nor should it be used as a
basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should
consult a qualified professional advisor. Deloitte shall not be responsible for any loss sustained by any person who relies on this document.
ABOUT DELOITTE
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SPONSORING FIRMS 63
CONTACTS
Lawrence Yun, PhD
Sr. Vice President,
Chief Economist
lyun@realtors.org
The Mission of the NATIONAL ASSOCIATION OF REALTORS® Research Group is to produce timely, data- George Ratiu
driven market analysis and authoritative business intelligence to serve members and inform consumers, Director,
policymakers and the media in a professional and accessible manner. Housing & Commercial Research
gratiu@realtors.org
The Research Group monitors and analyzes economic indicators, including gross domestic product, retail
sales, industrial production, producer price index and employment data that impact commercial markets
over time. Additionally, NAR Research examines how changes in the economy affect the commercial real
estate business and evaluates regulatory and legislative policy proposals for their impact on REALTORS®, NATIONAL ASSOCIATION
their clients and America’s property owners. OF REALTORS®
Headquarters
430 North Michigan Ave.
The Research Group publishes information and reports covering macroeconomic activity, housing, Chicago, IL 60611
consumer preferences, financing, as well as commercial real estate
DC Office
• Commercial Real Estate Outlook: The Research Division’s quarterly assessment of market fun- 500 New Jersey Ave., NW
Washington, DC 20001
damentals, the report covers macroeconomic conditions underpinning commercial core property
sectors, while providing a forward-looking outlook of supply and demand. 800-874-6500
www.nar.realtor
• Commercial Real Estate Quarterly Market Trends: Based on NAR’s national commercial members’
activity, the report covers trends in commercial markets. Each report provides an analysis of market
performance, sales and rental transactions, cap rates and business challenges.
• Commercial Real Estate Lending Trends: The annual report details liquidity conditions, funding
sources and the impact of capital markets on commercial members’ practice.
• Commercial Real Estate International Business Trends: An annual report focused on foreign
investment in smaller commercial markets, through the lens of REALTORS®’ experiences.
• Commercial Member Profile: The annual report details the business, transaction and demographic
characteristics of commercial members.
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019
D E L O I T TE | N A TI O N A L A S S O C I A TI O N O F R E A L TO R S ® | S I T U S R E R C ®
66 ©2019 Deloitte Development LLC, NATIONAL ASSOCIATION OF REALTORS®, Situs RERC. All Rights Reserved.