The Urban Land Institute recently released their annual Emerging Trends in Real Estate report. Now in its 35th year, the report offers an excellent review of the past year and forecast of what is ahead for commercial real estate. Here are a few take aways from the report.
- In 2014, improving fundamentals and operational improvements will unseat cap rate compression and high leverage as the driver of total returns. Emerging Trends interviewees expect “space market fundamentals and property enhancements to emerge as the primary drivers of total returns”.
- Ten-year treasuries are expected to rise moderately in 2014, as are commercial mortgage rates.
- Expect a marked increase in capital availability from almost all sources in 2014. “The markets will be awash in both equity and debt … foreign capital will be on the rise.”
- All real estate property types will experience a change going forward. Office users require less space per worker as collaboration increases, and retail will continue to seek locations that cater to urban dwellers. Online retailers will continue to change the face of retail and as a consequence industrial space will seek to locate where it can efficiently serve this paradigm shift. Amenities and common area will increase in multifamily projects but unit sizes will continue to shrink.
- Continued increase in foreign investments. “From January to August 2013, they acquired $22.8 billion in U.S. real estate, which accounted for 13 percent of all real estate transactions in the country, up from 9 percent in 2012, according to Real Capital Analytics.”
- Seattle will remain a strong market with tech driving growth. Foreign investors like Seattle as a 24 hour gateway city.
- Respondents say they feel good about industrial/distribution, office, and retail in Seattle. The “buy” rating for each of these property types is ranked in the top five among the competitive market set.
- As online shopping increases, “brick-and-mortar” retail will continue to converge with online shopping as all retailers become progressively drawn into competition with Amazon to deliver goods to customers on the same day they are ordered. Stores will increasingly fill online orders from their own shelves, effectively blurring the line between retail and warehouse space.
- Retail is coming back. As consumer confidence continues to increases, retail will improve with it. “Neighborhood/community shopping centers were the most highly rated among retail sectors for investment prospects, rising slightly from last year’s rating. Close to 50 percent of respondents recommended “buy” for this sector”
There are a number of quotes I highlighted while reading through the report. Here are a few quotes that stood out to me.
As one fund manager says of the moderate 2.5 percent gross domestic product (GDP) growth in the second quarter of 2013, “That is not huge, but it is enough to create demand for real estate product — that is, demand for space and improving rent — because at the same time there’s almost no new supply. It’s a sweet spot for real estate.”
With interest rates expected to rise, the market will begin to look at improving cash flows to drive returns. This transition from cap rate compression to fundamental performance will increase the emphasis on asset management to enhance returns.
Many interviewees expressed the opinion that commercial real estate will get a lot more “institutional” in 2014 and the years beyond. “Availability of capital will be good,” explains a fund manager. “It’s dramatically better than it was three or four years ago, and a little better than a year ago. But as people rotate out of the bond market and into equities, where does the capital go? Real estate ownership is becoming more institutional. It will become more routine, more liquid, more accurately priced.”
By the end of 2014, employment levels in over half of the markets in the survey will be back to their pre-recession peak. What this means is that additional employment from this point could be accretive to positive real estate demand.
Seattle is up one spot to number six in this year’s survey. Prospects for all three market components — investment, development, and homebuilding — improved in 2014, with homebuilding prospects posting the largest gain. Survey respondents rated each component as offering “good” prospects for 2014. A national real estate consultant expresses the following view of the market: “Seattle is enjoying good job growth due to the tech industry. It is also becoming a core market for foreign investors.”
If you would like a copy of the full report, click here to download a PDF copy: Emerging Trends in Real Estate® 2014.