UNCHARTED TERRITORY - EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019 - Deloitte
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2019
UNCHARTED
TERRITORY
US economic expansion
approaches record length
PAGE 2
Preference soars for CRE vs.
stocks, bonds and cash
PAGE 28
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.
No part of this publication may be reproduced in any form
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without the written permission of the copyright owners.
Expectations & Market Realities in Real Estate 2019 is published by:
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NATIONAL ASSOCIATION OF REALTORS®
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RERC LLC and Situs
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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
CHAPTER 2: THE ECONOMY
Global Perspectives...................................................................................................................15
US Economy.............................................................................................................................16
Employment Trends...................................................................................................................18
Housing ...................................................................................................................................19
CHAPTER 3: THE CAPITAL MARKETS
Laws and Policies Impacting the Capital Markets.......................................................................22
The Equity Market.....................................................................................................................27
Investment Alternatives.............................................................................................................28
Inflation and the Fed.................................................................................................................28
Availability and Discipline of Capital..........................................................................................29
CRE Debt Market.......................................................................................................................29
CRE Equity Market....................................................................................................................31
CHAPTER 4: THE PROPERTY MARKETS
The Office Market......................................................................................................................36
The Industrial Market................................................................................................................38
The Retail Market......................................................................................................................40
The Apartment Market...............................................................................................................44
The Hotel Market.......................................................................................................................46
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
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real estate clients out of offices in 50 special servicer in Europe. With these two
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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,
Investors are traveling into uncharted territory as the US econ-
omy’s expansion surpasses its 10-year anniversary in July 2019,
which would break the record for the longest economic expansion
since the government started collecting records in the 1850s.
Unemployment fell below 4% – which would have been almost
unthinkable a decade ago – without sparking inflation to rise
much above 2%. While it is certainly good news that the economy Matthew G. Kimmel, CRE, FRICS, MAI
has been growing for a decade in the wake of the worst downturn Principal & US Real Estate Services Leader
since the Great Depression, many fear that another downturn Deloitte Transactions and Business Analytics LLP
could be on the horizon. Investors are worried because they know
nothing good lasts forever, and they see potential disruption in the
economy – perhaps caused by political turmoil around the world,
the potential for continued raising of interest rates, or uncertainty
caused by global trade discussions. In 2018, the stock market rode
a roller coaster and ended down for the year. So we enter 2019
asking the question: What will the year bring for the US and global
economies and the commercial real estate (CRE) market?
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.
We expect continued volatility in the financial markets, along with
a slow but steady rise in interest rates and Treasury rates. Debt and
equity capital should continue to be readily available. We expect
that equity capital will be more disciplined.
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.
Jodi Airhart Noel Nathan
Director Analyst
Situs RERC Situs RERC
Todd J. Dunlap, MAI, MRICS Madison Martin
Senior Manager Graphic Designer
Deloitte Transactions and Business Analytics LLP Situs RERC
Kenneth W. Kapecki, CRE, FRICS, MAI Alec Roth
Managing Director Analyst
Deloitte Transactions and Business Analytics LLP Situs RERC
Jen Rasmussen, PhD, Editor-in-Chief Matthew Schmitz
Assistant Vice President Marketing Intern
Situs RERC Situs RERC
ASSOCIATES Shradha Shrestha
Associate
Charles Ellis Situs RERC
Copy Editor
Situs RERC Nellie Tiggelaar
Senior Consultant
Deloitte Transactions and Business Analytics LLP
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
EXHIBIT 1-A. CRE & INVESTMENT ALTERNATIVES
YTD6 1-Year 3-Year 5-Year 10-Year 15-Year
Current as of September 30, 2018
Consumer Price Index1 1.23% 2.27% 2.00% 1.53% 1.42% 2.08%
10-Year Treasury Bond2 3.05% 2.33% 2.06% 2.64% 3.85% 3.96%
Dow Jones Industrial Average3 6.56% 20.76% 20.49% 14.57% 12.22% 9.97%
NASDAQ Composite4 12.18% 23.87% 20.31% 16.36% 14.47% 10.55%
NYSE Composite4 1.60% 7.15% 10.11% 6.34% 5.68% 5.76%
S&P 5003 7.82% 17.91% 17.31% 13.95% 11.97% 9.65%
NPI5 5.27% 7.16% 7.75% 9.57% 6.42% 8.97%
NFI-ODCE5 5.75% 7.71% 7.83% 9.71% 4.62% 7.28%
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
without any representations, warranties or guarantees.
CHAPTER 1 INTRODUCTION 5dramatically 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 794.29%, 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,*
viewpoints of the sponsoring firms as a whole.
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
Renaissance, visit https://www2.deloitte.com/insights/us/en/industry/retail-distribution/future-of-retail-renaissance-apocalypse.html
CHAPTER 1 INTRODUCTION 9and 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 11You can also read
