As the industry mulls “what inning we’re in” one thing is sure: eventually every commercial real estate cycle winds down. Speakers at recent panels and seminars have warned that a recession is nigh, saying this cycle’s lengthened recovery is historically unique.
By the end of 2018, the economic model created by research firm CoStar Portfolio Strategy predicts an 80 percent chance of a recession, says Rene Circ, director of research at CoStar Portfolio Strategy.
“We are in the same camp [as those] that say a recession is likely,” he adds. “Lots of variables pointing to this, such as the unemployment rate nearing full employment and business investments down, which is flattening the yield curve. Fixed business investments are not as strong as a component of GDP.”
Circ cautions that the Federal Reserve raising interest rates will be a negative to the yield curve. “What concerns the most is the growth rate of corporate profits, for a few quarters now, corporate profits have been falling.” At the same time, he says “all signs point to this recession being milder,” because this cycle’s slow-growth economy has meant not many sectors are seeing a bubble.
According to Jim Costello, senior vice president with research firm Real Capital Analytics (RCA), “We’re in the second game of a double-header.”
But while no property type can be 100 percent recession-proof, certain assets are better positioned than others to weather an economic downturn, according to Tony Solomon, vice president and regional manager at real estate brokerage firm Marcus & Millichap.
In this gallery, we look at which property types might be good hedges against an economic downturn.
While retail as a property type certainly isn’t recession-proof, storefronts on urban high streets tends to suffer less during downturns than suburban retail centers, due to their reliance on higher-end consumers. Even during the Great Recession, while high-end consumers did pull back on spending, they “never stopped consuming,” according to Circ. The high rents commanded by highly coveted street locations in Manhattan or San Francisco, coupled with demand from luxury retailers, make these properties a unicorn for investors.
“This is safe harbor retail. They are great properties to hold from an investor standpoint, but it is very challenging to access this inventory,” Costello says.
Average retail rents globally has increased 3.7 percent year-over-year, with growth recorded in more than 50 percent of monitored prime retail locations, according to a report from real estate services firm CBRE. In the U.S. alone, retail rents at prime street locations grew 3.9 percent, with CBRE researchers noting that prime retail rents appreciated in a majority of U.S. markets.
Neighborhood shopping centers typically cater to the day-to-day needs of the populations in their immediate neighborhoods and are therefore more protected from economic headwinds as people still need food, medications and other daily necessities, even during recessions. This year, cap rates on neighborhood shopping centers have averaged 7.1 percent, according to Justin Tochtermann, a research consultant with the Costar Group.
“Grocery-anchored shopping centers have historically held up during downturns, as people still need to eat and tend to eat out less when saving money,” says Elizabeth Norton, managing research director for the Mid-Atlantic at commercial real estate services firm Transwestern. “Although grocers are experiencing some competition from Amazon Fresh, for example, these types of shopping centers still hold up during downturns given [that] not everyone has access to Amazon Fresh or other like competitors and some people prefer to pick out groceries themselves.”
Due to the “unabated development of off-campus ambulatory facilities required to meet healthcare demands, medical office buildings are one of the better-positioned properties in a recession,” Solomon says.
Medical-related real estate assets are the most recession-proof, Circ contends, adding that medical office buildings (MOBs) are showing vacancies that are 100 to 200 basis points lower than those at general office buildings.
In the third quarter of 2016, medical office buildings were trading at average cap rates in the low-7s, according to Marcus & Millichap.
Industrial sector assets are more resilient during a downturn, Costello says. “Sectors that are more cyclical, such as offices and hotels, may face more issues during a downturn due to problematic capex. When things are great, these assets have higher returns. But they are not strong performers when there is economic volatility,” he notes.
Meanwhile, big-box warehouses will continue to benefit from the growth of e-commerce, says Matt Dolly, director of research at Transwestern. In fact, “Purchases during a recession would more likely be made online, where consumers can shop different stores for better prices and avoid paying for gas. Millennials are naturally inclined to shop online, and they are becoming a larger purchasing group as they are now all in their 20s and 30s,” he notes.
CoStar data shows that average asking rents at big-box warehouses have climbed 20 percent since 2011, from $4.78 per sq. ft. in 2011 to $5.73 today.
“There is tremendous demand (seen through net absorption) for logistics that is much stronger than the overall economy, reflecting about 3-4 percent of GDP,” Circ says.
Retailers across the board will continue to create “new and additional fulfillment nodes” in the next few years, according to Circ. They are doing so to streamline their e-commerce strategies and catch up to major e-tailers such as Amazon.
Generally speaking, purchasing merchandise online is not always the cheapest option for consumers, so now e-commerce sellers are competing on convenience, Circ notes.
“For that to work, [retailers] need to have smaller distribution centers located close to downtown areas, fed by a big center maybe 100 miles away,” he says, adding that infill industrial facilities will become more and more in demand over the next year.
When Amazon first began building its supply chain model, it focused on big-box warehouse space. The company absorbed approximately 80 million sq. ft. of big-box warehouse space over the past five years, according to CoStar.
Now Amazon and other retailers are focusing on “infill fulfillment centers,” sized about 100,000 to 200,000 sq. ft. and located one to two miles away from main cities. These smaller warehouse spaces help retailers bridge the last mile to the consumer.
Demand for industrial property continues to surge. Logistics vacancy rates today are 300 basis points lower than they were at the peak of the last cycle, according to Circ.
It makes sense that self-storage facilities will continue to see demand as consumers and businesses might downsize during a downturn. Self-storage assets that cater to both groups of users are forecast to maintain strong fundamentals, according to Transwestern.
“As companies and consumers downsize, storage will continue to see demand,” says Dina Gouveia, research and marketing manager at Transwestern.
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