The U.S. property market landscape in 2016 will appear similar to that of 2015, with a number of interwoven aspects that bode well for savvy investors who can step out in front of ongoing, and in some cases intensifying, economic, demographic and technological trends.
On the economic side, the Federal Reserve made it clear in December that the central bank sees U.S. growth as relatively stable, when the federal funds rate was notched higher by a quarter point. Nevertheless, underlying inflation is extremely tame (with worries of deflation in some sectors and economies) in the U.S. and major emerging markets, providing no impetus for significantly higher rates. That may put some pressure on other global economies, including the Eurozone and China, but will also make U.S. assets more attractive in the coming year.
Most economists agree that the U.S. employment situation will remain on its current trajectory, with unemployment falling below 5 percent early in the coming year, adding to demand for housing in a variety of forms, as well as for office space, retail properties and industrial/distribution facilities. Demographic shifts that have been underway will continue, as Millennials find jobs, form their own households and either buy or rent their first homes. Baby boomers will continue to retire at the current rate of about 10,000 per day and to downsize their homes and move either to walkable urban communities or into seniors housing. Technology will continue to change the landscape in numerous ways—from the way we shop to the way we work to the way we interact with our surroundings. Some trends appear larger as we look ahead. Inspired by our conversations with industry colleagues, including several members of the Counselors of Real Estate (who produce the widely read annual Top Ten Issues Affecting Real Estate) here are six trends that we believe will play a significant role in commercial real estate in the upcoming year.
The global urbanization trend will continue in the U.S., as it does elsewhere, as boomers and Millennials seek enhanced access to jobs and amenities, from shopping to entertainment to healthcare. The U.S. urban population increased by 12.1 percent from 2000 to 2010, according to the U.S. Census, outpacing the nation's overall growth rate of 9.7 percent during that same 10-year period.
That trend continues. Even suburban communities are taking on more of an urban form, with mixed-use development and public transportation options—and limited automobile dependence—creating higher densities and more of an ‘urban’ feel. While the trend toward urbanization continues, it creates enormous demand for housing, retail, office and other property types.
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Interest rates on the rise—for sure this time—as the Fed move in December demonstrated. Forecasts vary, but the likelihood is that the FFR will rise at least to, or above, 1.0 in 2016, with 10-yr treasuries pushing fractionally higher, toward the 3.0 percent mark. A number of factors are keeping rates low for now, including limited inflation due to soft energy and import prices and the strong dollar. Further, the Fed is more than likely to weigh the effects of each move it makes before adding any additional friction to current (if unspectacular) economic growth trends.
The squeeze on cap rate spreads will become a real concern for some investments, especially as frothiness in some gateway, class-A, markets emerges [see our cautionary note from early 2015]. Currently, there is little indication that the first rate increase will push cap rates dramatically higher. But there are indications that yields will likely begin to drift upward as a result of further rate increases.
And, as pricing in first tier markets stalls and yields hover in the sub-4 range in some of the major gateway markets, which are in some cases already in dicey territory, we should probably expect investors to move more aggressively into secondary and tertiary markets and to opportunities beyond core assets to core-plus and value-add properties, as well as some of the niche property sectors, including medical office, student and seniors housing and data centers.
Continued (and increased) international capital flows into U.S. real estate assets—global economic/political uncertainty will continue to drive capital to a ‘safe haven’ in the United States. The U.S. property market is the most stable, transparent in the world, making it an easy investment choice. And while slowing growth in China and much of Europe may dampen currencies and incomes over there, there is still abundant non-U.S. capital looking for placement and still very high demand for U.S. assets, as 2015 proved with record inflows.
In 2015, foreign purchases of U.S. real estate assets rose to $62 billion over the 12-month period ending in October, according to research firm Real Capital Analytics (RCA), with Canada, Norway, Singapore and China all leading the wave. Among members of the Association of Foreign Investors in Real Estate (AFIRE), a substantial proportion expect to increase investment in the U.S, in 2016.
Continued stress on retail and continued retail shifts, including mixed (virtual/physical) spaces and entertainment-themed spaces. The economy is still putting pressure on spending, but with interest rates rising, consumers will be paying more to use their credit cards, the result being somewhat more discernment in how they spend their money, perhaps offset slightly by an anticipated windfall in energy prices (see #6, below).
The technology of retail continues to evolve as well. During the 2015 Thanksgiving shopping weekend, online purchases outpaced in-store purchases for the first time. Analysts suspect that the more successful retailers will be those who can optimize a combination of online and in-store shopping experiences. Amazon has begun to explore physical shopping spaces in combination with its wildly successful online model by opening its first physical store in Seattle this past fall (ironically, in a former Barnes & Noble location). It would not be a surprise to find physical retailers pushing similar formats in the other direction, including more ‘showroom’ styled storefronts with digital spaces offering fulfillment.
Some retailers should probably seek out hospice care—our guess is that, in its 130th year, Sears could finally succumb in 2016, with some of its brands, like Craftsman and Kenmore, being spun off to something/someone else. JCPenney is being squeezed by competition from the lower-end Kohl’s and Marshalls, and by the higher-end Macys as well.
Continued limited supply additions, with only modest supply growth in a few sectors—multifamily (peaking, then slowing slightly in late 2016), student and seniors housing (creeping up), single-tenant industrial (regional/nodal distribution centers)—and repurposing in others (suburban malls and those abandoned Sears and K-Mart stores). Lending sources were extremely skeptical about funding new construction coming out of the last recession. The recession was deep and protracted, and many local and regional banks had gotten hit by the residential mortgage crisis. Real estate, both residential and commercial, came to be seen as a highly risky sector. Many lenders left the commercial real estate construction and development lending business altogether. Of all the property sectors, only multifamily can be said to be near long-term supply levels.
Last year saw a dramatic drop in oil prices. Increased production and reduced demand due to slowing emerging market growth have led to a drop in oil prices from $110 per barrel to under $50 per barrel. The world is oversupplied, and major oil producing countries have not reduced production. This is has had a profound economic impact and carries with it implications for property market fundamentals and commercial real estate pricing.
The impacts will vary considerably by region and sector. Negative effects are largely concentrated in a few metros with high economic exposure to the energy industry. For most metros and property types, lower oil prices have been a net positive. Spending less on gasoline encourages consumers to spend more on other items, which may help retail and hotel market fundamentals. Lower oil and energy costs will also reduce certain construction, manufacturing and logistics costs. This aids business investment and expansion, which in turn increases demand for industrial and manufacturing space.
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