10 trends in commercial real estate for 2015

The sustained performance of the U.S. commercial real estate industry is expected to continue in 2015, fueled by improving fundamentals and robust investor appetite, in both domestic and foreign arenas, according to Emerging Trends in Real Estate 2015, co-published by PwC US and the Urban Land Institute (ULI).

“Unlike previous reports and previous cycles, we are seeing sustained growth,” said Mitch Roschelle, partner, U.S. real estate advisory practice leader, PwC. “In the past several years, we reported that real estate market participants’ main fears revolved around the uncertainty with the economy. Now, the trepidation in their eyes has more to do with the ability of the growing real estate markets to adapt to a series of mega trends impacting society and the global economy. These mega trends include accelerating urbanization, demographic shifts and the impact of distributive technological advancements.” 

ULI Global Chief Executive Officer Patrick L. Phillips pointed to the continued rise of markets other than the largest coastal cities as top choices for overall real estate prospects. Houston and Austin, which are ranked first and second, respectively, topped San Francisco as favorites for 2015; Charlotte N.C., in seventh place, is rated higher than Seattle and Boston; and Nashville, ranked at 14, tops Manhattan. “Investors are looking closely at opportunities beyond the core markets. These cities are positioning themselves as highly competitive, in terms of livability, employment offerings, and recreational and cultural amenities,” Phillips said.

 

PwC and ULI outline the top trends in real estate for 2015:

1. The 18-hour city comes of age

The urbanization of America has given life to cities that had been historically nine-to-five. According to interviewees, no longer is it accepted that only the great coastal cities can be alive around the clock and on weekends. Downtown transformations have combined the key ingredients of housing, retail, dining, and walk-to-work offices to generate urban cores, spurring investment and development and raising the quality of life for a roster of cities. Buyers have more markets to consider now that the 18-hour centers are putting the elements in place to ratchet up their investment capital flows.

 

2. The changing age game

The millennials are an even larger cohort than their parents – the baby-boom generation. While the tendency of millennials to postpone homeownership and rent longer will affect the apartment sector over the next several years, many survey interviewees noted that investors should consider how the housing preferences of millennials could change in the 2020s. Looking beyond the millennials, the report anticipates further industry changes resulting from the emergence of the smaller “Generation Z.” Planning for a nation with lesser household formation, fewer new consumers, and a meager number of workforce entrants is the challenge ahead for a real estate industry with its eye on the 2020s. The report also notes that baby boomers – as workers and retirees -- will continue to have a significant impact on real estate development and investment for at least two more decades.

 

3. Labor markets are trending toward a tipping point

The report states that forward-looking businesses are waking up to a realization that while we were worried about the “jobless recovery,” longer-term labor market trends were moving in exactly the opposite direction. Retirements will accelerate while the peak of millennial labor force entrants has already passed. Within a few years, the talk will be about labor shortages, not surpluses. The notion that “jobs are chasing people” will morph into a primary rule of the labor market. Survey respondents place job growth at the top of the list of most important issues for real estate, closely followed by the related concerns of wage and income growth.

 

4. Real estate’s love / hate relationship with technology intensifies

No form of real estate is exempt from the exponential expansion of technology. Interviewees see technological disruption as providing new business tools and environments, opening new business paths, and cycling forward as a source of user demand in an era when more traditional industries may be sluggish. Technology is pushing change in space use, locations, and demand levels at an accelerated pace. It is now the norm to anticipate, strategize, and respond to new technologies before they are mainstream. Overall, the fear factor about technological disruption is easing, according to surveyed respondents. E-commerce and crowdfunding, for example, are being viewed as an adaptation challenge, as retailers become “omnichannel distributors” and e-tailers begin to open brick-and-mortar stores.

 

5. Event risk is here to stay

There is nothing new in seeing investors along the continuum from “core” to “opportunistic,” but the trend will be that such distinctions are heightened over time, and 2015 looks to be a year when this will be especially evident, interviewees note. The reason is that the concern about “event risk” is troubling the minds of more and more interviewees (geopolitical risks, global unrest, and natural disasters). This is why international investors are considered to be the best prospect for increasing investment volume in 2015, according to the survey.

 

6. A Darwinian market keeps the squeeze on companies

Competition is unrelenting, and the need to have a clear “brand identity” is important as firms seek to navigate in the swift stream of capital. The recent spin-off activities in the retail, office, and hospitality real estate investment trust (REIT) sectors sound a theme that will echo as a trend in 2015. The drive for efficiency and effectiveness in both service delivery and cost will filter from investor expectations down to the service providers, the report states.

 

7. A new 900-pound gorilla swings into view

Emerging Trends 2014 alerted readers to the establishment of the Defined Contribution Real Estate Council to help plan sponsors and their participants achieve better investment outcomes through the use of institutional quality real estate. With a combined $12.6 trillion in capital, individual retirement account (IRA) and defined contribution (DC) funds will be identifying and taking advantage of the benefits of having high-quality commercial property in a mixed-asset portfolio.

 

8. Infrastructure: time for the United States to get serious?

For all our vaunted technological innovations, the foundation of our commerce is eroding around us. It’s not just bridges and roads – since 2009, spending on educational buildings and health care facilities (by both public and private sectors) is down by one-third in real-dollar terms.

 

9. Housing steps off the roller coaster

Housing seems to be putting the excesses of the bubble and the ensuing collapse behind it. The trend in residential real estate, according to interviewees, looks to be returning to the classic principles of supply and demand. As this major segment of the economy returns to textbook fundamentals, confidence in the residential sector should continue to rise.

 

10. Keeping an eye on the bubble – emerging concerns

The generally positive outlook flowing from this year’s Emerging Trends interviews and survey does have a dark side. Upcycles breed optimism, but excessive optimism can promote bad investment patterns. However, in most cycles, overbuilding and excess leverage would likely have already started building momentum by now. To the degree that hasn’t happened, the industry looks like it has learned some lessons in self-regulation and self-correction.

 

 

Markets to Watch

Real estate investors continue to be willing to pay record prices for assets in the major markets due to the fact that these markets offer less volatile returns of capital that can only be found in a limited number of markets across the globe. This year, interviewees reflected a desire to take on a measured amount of new risk in search of higher yields. Two strategies mentioned repeatedly with interviewees focused on moving to more opportunistic-style investments in the major markets or in markets close to a major metropolitan area, or looking for the best assets in markets outside of the core major markets. This year’s market rankings reflect the attractiveness of markets for both of these strategies. 

A snapshot of the top five markets ranked by survey respondents and their outlook for each market:

1. Houston – Houston offers a significant amount of investment opportunity. Investors believe that the energy industry will continue to drive market growth and that will support real estate activity in 2015. Houston was ranked number one in both investment and development expectations for next year; housing market expectations are ranked number two.

2. Austin – Interviewees like the industrial base, the appeal to the millennial generation, and the lower cost of doing business in Austin. The market was a top choice for both the office sector and the single-family housing sector and the number two ranked market for retail. Interviewees are also attracted to Austin’s diverse employee base, and the market is an example of “jobs chasing people.”

3. San Francisco – The decline from the number one spot last year, according to surveyed participants, is due more to growth in the other cities than any identifiable flaw in the San Francisco market. The strong local economy and improved domestic and international travel have made San Francisco the number one choice for hotel investment in 2015. Respondents ranked the office market number three and the retail market number four.

4. Denver – Denver joins Austin and San Francisco as markets popular with the millennial generation. Denver’s industry exposure to the technology and energy industries has also attracted investor interest. The results of the survey put Denver retail at number five and office at number six.

5. Dallas/Fort Worth – Interviewees raise the possibility that despite being ranked lower than Houston, the economic diversity could make the current growth rate more sustainable in Dallas/Fort Worth. The market continues to be attractive to real estate investors because of its strong job growth, which benefits from the low cost of living and doing business. Single-family housing in the market is the highest ranked property sector – and it also has the highest ranked industrial sector (number four) among the top five markets from this year’s survey.

 

 

Property Types

Industrial

Since 2010, the industrial property sector has enjoyed a rising demand trend and supply additions that have not kept pace. Come 2015, however, industrials are entering a period when projected construction is accelerating, but demand is anticipated to decelerate, according to surveyed participants. Last year, many interviewees really liked industrials – a feeling that has not changed for many. The industrial sector stands atop the sector rankings for investment.

 

Hotels

The prospects for liquidity in the hospitality sector shape up as excellent for 2015. Remarkably, and in distinct comparison with most other property types, the survey shows no expectation of any alteration in cap rates for hotels. This year’s Emerging Trends survey shows hotels rated strongly in participants’ 2015 prospects for investment and development, especially in the limited-service category.

 

Apartments

The opinions of the Emerging Trends survey respondents seem sharply divided. For high-end multifamily, nearly half the respondents (48 percent) felt it would be smart to divest in 2015, while 30 percent consider it worthwhile to hold for a longer period. Only 21 percent suggest this is a good time to buy. At the more moderate income level, that relationship was reversed. Only 28 percent recommend selling while holding and acquisition are more attractive, with 37 percent and 35 percent recommending these as opportunities in the year ahead.

 

Offices

One of the more powerful trends for offices – the live/work/play theme – is not just hype, but statistically significant. The resurgence in downtown living is bolstering secondary office markets around the country. In addition, the drive toward space compression in office use is about at its end, and in the coming years the quality of the office environment will be used as a marketing tool to recruit talent. The millennial generation will not put up with the space cram-down much longer, especially as it gains seniority in the workforce. Greater flexibility and variety in office space design will be superseding cost-cutting as a prime imperative. And if the millennial generation’s impact is still evolving, so too is the boomers’. Survey respondents grasp the inexorable path of demand growth for medical offices – which is seen as a “buy” for 2015 by 36.3 percent of respondents, and a “hold” by 40.6 percent, with only 23.1 percent advising “sell.”

 

Retail

Investment and development strength in the retail sector ranks the lowest of all the major property types in the survey. Just as the slow recovery in jobs has hindered many other economic growth indicators, so too has the jobs recovery made real estate professionals wary of calling a bounce back in retail. Optimism has seemed premature – or even unrealistic. It’s time to question that as the story for retail for the second half of this decade should be of expectations exceeded.

 

Housing

Housing is well on the way back, according to survey respondents, and they rank urban/infill as the top opportunity for 2015. Yet, the after-effect of the housing bubble has not fully dissipated, and this will partially shape demand for the next several years. Even with jobs on the rise, doubling up in either parents’ homes or with several roommates is an accepted norm, even if temporarily, for millennials. This version of a “new normal” is not forever, but it will linger because of the combination of high student loan indebtedness, meager wage and salary growth, and inadequate savings.

Now in its 36th year, Emerging Trends in Real Estate® is one of the most highly regarded annual industry outlooks for the real estate and land use industry. It includes interviews and survey responses from more than 1,000 leading real estate experts, including investors, fund managers, developers, property companies, lenders, brokers, advisers, and consultants.