Two months into 2016 and there are five trends to watch this year for office and industrial commercial real estate. Marcus & Millichap experts discussed topics such as jobs, oil, interest rates and inflation as factors influencing the company’s 2016 U.S. Office & Industrial Investment Forecast.  See below for what they and other commercial real estate advisers have to say.

GDP growth continues despite global slowdown.

The U.S. GDP is entering its seventh year of growth, with the current growth cycle beyond the average of 60 months. Declining oil prices are placing additional stresses on the market, yet falling gas prices are a net positive for the economy. U.S. economic outlook is positive; however, concern is forming over the impact of the overall global economy as the European Union shifts into a lower gear in how to handle a drop in China’s external trade and how the influx of refugees could impede trade between European countries.

Job creation and compensation broadening.

U.S. employment growth is entering its 65th continuous month (there are 4.9 million more jobs than at the onset of the recession of December 2007), with a slight slowdown anticipated this year due to the fact that the number of people available to be hired can over the long term only grow in line with population growth. The jobless rate fell to 4.9% in January, due to more people joining the labor force instead of people dropping out. While job numbers rise, wage slowly does too. January showed a 0.5% increase in the average hourly earnings and a small increase in the length of the average workweek. With inflation still low, an increase in an average worker’s pay translates into a gain in buying power.

Limited construction demand.

Based on the 2016 Forecast, office product type completions are at two-thirds of what they were prior to the recession, which has given the sector opportunity to recover and drive vacancy rates back down. Office vacancies hover at 14.5% at the start of 2016, which is driving up rents. A decline of space per employee has impacted absorption rates, even with job growth. Office construction remains highly concentrated in Houston, San Jose, Dallas/Ft. Worth and New York. Industrial construction is at two-thirds of the last cycle despite e-commerce’s impact and the greater demand for urban-located fulfillment facilities. According to the Associated General Contractors of America, the industry’s unemployment rate is at a 17-year low of 8.5%, which is unclear if it’s due to a lack of talent or if broader economic uncertainty is leading to a decline in demand. Dallas/Ft. Worth, Inland Empire, Atlanta and Houston are seeing the highest industrial completions.

Transaction activity pushing new heights.

Growth in transactions has been steadily accelerating since the end of the recession; at this point, office transactions are at 22% above the peak of the last cycle although pricing is slightly down. Growth is driven by solid fundamentals and increased capital, due to investors looking for alternative places than Wall Street to put their money. In San Diego, infill is driving sales of industrial and office space, with REITs and other large investment owners being a large contributor. Worldwide, Savills World Research’s 2016 “Around the World in Dollars and Cents” report, calculates the value of all high-quality commercial real estate at $29 trillion. The report notes that this value is unevenly distributed, with nearly half (45%) of all global CRE assets located in North America. About 1% of all global real estate assets trade each year in big-ticket transactions, Savills concludes, adding that differences in monetary conditions and investor practices around the world have “important and profound implications for global real estate trends.”

Cap rate compression.

According to  Real Capital Analytics, cap rates averaged 6.5% nationwide during 2015, while the 10-year treasury rate averaged in the low 2% range for most of 2015 and early 2016. This implies a spread of over 4% (or 400 basis points). Today’s spreads are significantly higher than those observed pre-crash where they averaged slightly below 200 basis points and even below 100 basis points for class A assets in top markets according to the commercial real estate economics researchers at the Lakemont Group. Tightening vacancies and climbing rent growth continue to support pricing appreciation for office moving forward. Downtown markets and suburban markets are 8.5% and 3.5%, respectively, below peak of the last cycle, but both are getting solid lift off of the trough of the market in 2008-2009.

With a variety of economic and monetary factors at play in commercial real estate, differences of conditions and practices leave it up to the investor to be as informed as possible. To learn how to maximize the return on investment of your commercial real estate assets, contact Brent Williams of Meissner Jacquét Commercial Real Estate Services at 858-373-1113 or [email protected].

Sources:

NAIOP Blog, February 18, 2016, Five Trends to Watch in 2016

NAIOP Source, February 2016, Global Real Estate Assets are Worth $217 Trillion

Our City San Diego, Business, Real Estate & Politics, January/February 2016

The Daily Transcript, vol. 131, No. 25, January’s Job Numbers Answer Some Questions

The Daily Transcript, vol. 131, No. 25, Construction Employment at 7-Year High

SVN Blog, January 29, 2016, Commercial Real Estate Market Outlook

A leading factor in building occupancy is talent, and talent is a driver in corporate location decisions, planning, and business growth. A talent study recently released this year and produced by the San Diego Regional EDC, compared ten key U.S. metros – Seattle, Portland, San Francisco, San Jose, San Diego, Denver, Austin, Pittsburgh, Baltimore and Boston – with regard to highly-skilled scientific, engineering and technology talent, with the goal of proving that talent is a key factor in economic growth.

Due to the changing nature of building occupation, infrastructure and creative office space are becoming critical requirements of career seekers and employers. Successful economic regions must attract and retain talent by providing innovative workspaces, lifestyle, competitive wages, and economic opportunity.

Building occupation will not be a constant, so businesses will need to draw on metrics regarding office use. Consequently, financiers, owners and real estate developers will need to factor fluidity of occupation into their portfolios. Lewis Beck, Director of Workplace Strategy, CBRE

The commercial real estate industry supplies the structures that house the employers and talent, which contribute to economy vitality and quality of life. A dispersed real estate model with mixed facilities and multi-purpose environments will be the norm, in order to allow fast response to changes in user needs and to meet new occupier use patterns and demands.

Tight Industrial Inventory

Right now is a good time to own light industrial buildings — 50,000- to 250,000-square-feet — according to Rene Circ, Director of Research, CoStar Portfolio Strategy and other speakers, at a session during NAIOP’s Commercial Real Estate Conference 2015 on growing demand for this product type.

Speakers noted that industrial inventory is tight, pushing rents higher, and keeping the market tight for at least another two years before construction begins to catch up with demand. Until recently developers have not jumped into this market because light industrial buildings could be purchased for less than the cost of building new ones and cap rates on bulk Class A projects are at peak or past peak.

Context for Office Space Drives Demand

A bigger purpose is driving office demand and it coincides with the three P’s – planet, people, and profit. Companies now have to prove to employees and commercial real estate players, including clients, tenants, and investors, that what their company does serves a larger purpose.

Mark Stapp, Executive Director of the Master of Real Estate program at Arizona State University, noted that boomers and millennials now want the same things — to live and work in vibrant, appealing, accessible places — and that is a big driver for CRE.

Employers added 15.3 million square feet of office space in the fourth quarter, more than any other quarter since the third quarter of 2007, according to real-estate research service Reis Inc. That pushed the vacancy rate down to 16.3%, while rents sought by landlords hit $30.86 a square foot, up from $29.94 a year earlier, according to Reis, which surveyed 79 markets.

Retail Driven by Personalized Experience

Much like with creative office space, “experience” continues to be the driving force behind brick-and-mortar retail leasing, with small-format grocery stores, as well as fitness and wellness facilities like gyms, yoga studios and massage services occupying space, while restaurants continue to generate demand. Yet the immense popularity of online shopping, done predominately by smartphones, acts to reduce retail footprints. A remedy to this may be the concept of showrooming, not only in terms of displaying goods to be touched and tried on before they are purchased online but also in terms of branding. However, those personalized experiences that cannot be achieved online — at least not yet — are still driving demand for retail space.

A study published by the National Bureau of Economic Research found that e-commerce and catalog sales combined grew by a factor of 10 between 1992 and 2013, moving from $35 billion to $348 billion in annual sales. At the same time, sales in the warehouse or supercenter category grew by a factor of 10.5, rising from $40 billion to $420 billion.

Summary

Changing demographics and economic vitality are causing markets and property types across the country to adapt in response, and commercial real estate professionals would prove prudent to invest in a diversified portfolio in order to reap the most reward. Meissner Jacquét Commercial Real Estate Services offers cost-effective solutions to a broad range of commercial real estate owners across all property types. Contact them today to learn about their Corporate Real Estate Services, including Leasing, Project Management, Acquisition / Disposition Due Diligence, Financial & Accounting Services, and Lease Administration.

Sources:

San Diego EDC, Talent: Where San Diego Stands, a Comparison of US Metros

NAIOP, Development Volume XLVI No. 4, Winter 2015/2016

Wall Street Journal

With 2016 quickly approaching, commercial real estate professionals and consumers alike are looking to the Federal Reserve in anticipation of potential interest rate hikes. As real estate investors closely monitor treasury rates and bond markets, it is the severity of the increase that has the potential to have the greatest impact on capital markets.

Due to the effect that velocity of change in basis points has on the economy, a significant increase in basis points within a relatively short amount of time can lead to economic volatility. However, according to Bank of America Merrill Lynch, “The consensus expectation…is that interest rates will increase gradually.”

Unemployment Rate & Inflation

Both inflation and job growth play a large role in the Fed’s determination of interest rates. The Fed has said it will likely raise rates if both job growth and inflation are in place. Looking back over the first three quarters of 2015, job creation and a shrinking unemployment rate lead to a steadily strengthening economy, which may put inflationary pressures in place for 2016 due to increasing wages, among other factors.

Federal Reserve economists estimate the unemployment rate will hit 5% by the end of 2015 – a sign of healthy employment. Incomes have not been rising fast enough to provoke inflation as of yet, giving the Fed the ability to keep rates low year-to-date in 2015.

Source: Federal Bank of St. Louis

What does this mean for commercial real estate investors?

Supply and demand plays a large role. As an example, with the 10-year Treasury note paying near 2%, and cap rates – cash flow as a percentage of property value – near 5%, there is a reasonable return for real estate investments. But if – or rather when – rates rise, and the return diminishes, the disruption to the flow in capital will cause real estate investors to seek alternative investment options with greater returns.

Capital appears to be somewhat readily available for private equity groups due to easily obtainable and financially feasible financing. Favorable among private middle-market investors is new development, specifically multi-family, transit-oriented, and urban properties. While secondary and tertiary real estate markets are benefitting from investor capital seeking yield.

Summary

With primary elections and budget negotiations taking place in 2016, the Fed’s first rate hike is likely to occur at the same time. Yet despite talk of a frothy market, real estate investors still uphold guarded optimism while keeping a keen eye on key factors including, economic performance versus expectations, monetary policy outlook, and equity market valuation multiples.

Sources:

Bank of America Merrill Lynch, Real Estate Cycle: The Inevitable Rebound of Rates

Bank of America Merrill Lynch, The Real Estate Cycle: What Inning Are We In?

Investopedia, What is the Relationship Between The Federal Funds, Prime and LIBOR Rates?

With talk about a frothy commercial real estate market, what trends do the retail and industrial sectors have to hold? According to a recent ICSC NOI+ conference held at the Dallas Hyatt Regency, a panel of leading investors and investor advisers imparted that retail real estate prices are plateauing and the number of bidders for available properties are down. It seems that the industrial market is taking a hint from the retail sector, as the NAIOP Research Foundation predicts a slowdown in industrial space demand for 2016 and beyond.

Retail Market Sees Prices Peak

Although it might seem gloomy, the current retail market talk is not necessarily foretelling an imminent industry downturn, even with some analysts equating current market conditions with those in 2007 the current situation is considerably more stable than the pre-bust period last decade, even with current pricing 20% to 30% higher, said Mark Gibson, Executive Managing Director of Dallas-based HFF. Commercial real estate continues to offer more secure returns than virtually any other investment, and investors are now viewing it as a long-term hold, Gibson said.

HFF cited data showing that commercial real estate investor allocations have improved from 9.5% to 13% in the past five years. Moreover, foreign capital investment in U.S. commercial real estate through the second quarter of 2015 had already surpassed all of 2014, Gibson added.

Given its stability, retail real estate offers the best access to inflation protection for investors than any other class, Glenn Lowenstein of Houston-based Lionstone Investments said. Investors are now looking toward opportunities in secondary markets, one panelist said, explaining that because prices are topping out in the 10 biggest U.S. metropolitan statistical areas (MSAs) such as New York, Los Angeles and Chicago, investors are gravitating to quality properties in the top 50 MSA’s.

Rent growth is also up at retail properties, driven by lack of supply, panelists said.

Even with the supposed trust in commercial real estate investments, there are still legitimate concerns of excess liquidity and a fear that this will eventually create an asset bubble. The market is now seven years into the recovery — or about the time most cycles begin to play out, said Mark Myers, Executive Vice President and Head of Commercial Real Estate for Wells Fargo Bank of San Francisco. Overall, it would suite investors well to measure opportunities on a deal-by-deal basis.

Slowing Industrial Expansion

While the U.S. economy remains in slow, moderate growth and many economists cut their forecasts of GDP growth for 2015 and beyond, net industrial demand is still forecasted to remain positive, with over 60 million square feet of quarterly net absorption in the rest of 2015. However, the positive trend is set to begin its decline to rates below 50 million square feet quarterly by late 2016. Said to be impacting the domestic industrial space market, are declines in energy prices and the slowdown in the Chinese economy.

Even though large economic factors are forecasted to have negative effects on the industrial market, there is predicted to still be a large source of new industrial demand going into 2017 from the manufacturing and distribution of consumer goods due to the U.S. employment’s state of steady growth. Consumer goods manufacturing and distribution has seen a steady expansion since the end of the recession, with major retailers such as Amazon and Wal-Mart competing to shorten the click-to-delivery time for online sales – which means more capital must be placed into industrial spaces.

What is yet to be seen is how interest rates will affect industrial demand. If the Fed moves its target short-term rate up by the end of 2015, the rising rate could moderate consumer spending and thereby reduce the demand for consumer goods manufacturing and distribution – meaning less need for industrial space.

Summary

Given the predictions for peaking retail prices and slowing industrial demand, commercial real estate professionals should utilize the data and forecasts to make more prudent decisions on capitalizing and embarking on new deals based on objective measures of future market conditions.

Sources:

ICSC Shopping Centers Today, Retail Real Estate Prices are Peaking, Conference Told, published October 22, 2015

NAIOP Research Foundation, The NAIOP Industrial Space Demand Forecast, Third Quarter 2015 Report