If you are looking for predictions for 2019 for the commercial real estate market, you aren’t alone. From industrial markets continuing to sizzle to apartment rents remaining moderate, here are a few predictions for the new year.
- Industrial markets will continue to sizzle.
The industrial real estate market will continue to be the favored real estate sector with robust demand, growth and investor capital. This boom has been the result of strong economic growth, record consumer optimism, low-interest rates and the growing demand for products by e-commerce next day delivery. Average rent growth during the last two and a half years through Q-2 2018 was a strong 7.8%. In 2018, industrial cap rates fell by .5% to 1% to a national average of about 6.25% and through the first six months of 2018, 128 million square feet of industrial space was absorbed.
- Apartment rents will continue to moderate.
Apartment rents that have increased by 50% during the last few years in some hot markets on the West Coast and Northeast, will continue to moderate with national rent increases in the 1%-2.5% range. Per apartmentlist.com, the Q-3 YoY national rent increase was only 1.2%. Many more markets will begin offering “free rent” as the more than 1.5 million new units built during the last five years begin to further soften markets.
- More net asset value REITs will hit the private market.
The moribund non-traded REIT sector was brought back to life in 2017 with the introduction of the Blackstone REIT. This private open-end REIT was one of the first to allow investors to buy shares in the REIT at a monthly net asset value per share rather than the standard $10 per share initial offering price. The net asset value is calculated monthly by using financial metrics including cap rates and discounted cash flow rates. Blackstone has raised over $3 billion through Q-3 2018 and will probably raise at least $10 billion in the REIT. Due to its success in raising capital with real-time NAV pricing, other players are bringing similar REIT funds to the market including; Nuveen, Starwood Capital, and Jones Lang LaSalle.
- Interest rates will continue to rise.
Although interest rates have dropped the last two months, with the 10-Year Treasury sliding from 3.22% in September to 2.90% in December, we continue to believe the trade skirmish with China will be settled, stock market volatility will subside, and the economic boom will continue. The Federal Reserve may pause on raising rates in 2019, but the long end of the curve will increase with the 10-Year TNote at over 3.5% by the summer of 2019.
- Opportunity zones will draw billions in capital.
Opportunity zones which were created in December 2017 as part of the Tax Cut and Jobs Act, will continue to flourish with billions of capital invested in individual opportunity zones and opportunity zone funds. This is the first part of the current administration’s infrastructure spending policy that will benefit many blighted urban areas with new low and moderate-income development. Treasury Secretary Steven Mnuchin estimated as much as $100 billion in private capital could be invested in opportunity zones.
- Public REITs will generate sold returns.
Public REITs which will end 2018 with about a 5%-6% total return (including dividends) will post higher returns in 2019, estimated at 10% with 4% in a dividend and 6% in price appreciation. Even though we here at VOM expect long-term interest rates to increase in 2019, which will hurt REIT net asset values in the short run, the longer-term outlook is positive for public REITs. The average annual return for the FTSE-NAREIT All Equity Index was 11.69% during the last 10 years per NAREIT.
- Class B malls will generate robust returns.
The class B mall sector has been battered the last four years, especially in the REIT space, with many public REITs like CBL, DDR, Brixmor and Washington Prime Group, selling well below private market net asset values. Many class B malls are trading at 7%-10% cap rates, which are deep value plays in this market. With most retail bankruptcies in the rear-view mirror and less competition among large national retailers for consumer dollars, retail tenants and their landlords should see higher rents, sales per square foot, occupancies and CRE values.
- Shadow CRE lenders will increase market share.
The shadow or non-bank CRE lending market should see increased activity and deal flow in 2019. This sector includes public and private mortgage REITs, private funds, mortgage bankers and CMBS conduits. These lenders will benefit from slower loan growth by commercial banks as they become more risk averse due to pressure from the various regulatory agencies to temper CRE lending. According to the Mortgage Bankers Association, non-bank CRE loan volumes were $32 billion in 2016, $52 billion in 2017 and $23 billion through Q-2 2018. Some of the largest non-bank lenders include; Blackstone Mortgage Trust, Apollo Commercial, KKR Real Estate Finance, Mesa Capital and Hunt Mortgage.
- Consolidation of CRE brokers will increase.
There are currently six large publicly traded CRE brokers that control approximately 60% of large (over $10 million) commercial real estate transactions and further consolidation among these and smaller brokers will continue. These firms will need to ramp up their growth and one easy way to do this is to acquire smaller local or larger regional firms. Many brokerage mergers and acquisitions will be strategic with the target providing a unique client base or a specialized service and skill set. The CRE brokerage industry will be structured like an hourglass, with a few large firms at the top, many smaller firms at the bottom and a few midsized firms in the middle.
- Tech slowdown will lead to lower Northern California housing prices
The median price of a single-family home in San Francisco was $1.45 million at the end of November 2018. This is a reduction in the price of $265,000 or 15.5% from the bubble peak hit in February of $1.7 million. During the last five years housing prices in San Francisco and Silicon Valley have doubled, but they are beginning to come back down to earth. There are two primary reasons for the price declines, higher interest rates and a slowdown in the growth of technology stocks, which are the economic engine for Northern CA. As tech growth slows, the stock prices decline and the firms from Google to Facebook to Square, pull back their hiring quotas. For example, let’s say Facebook is still in a high growth mode and plans to hire 20,000 employees in 2019, with 15,000 in No CA. If their growth is slowing, then they will reduce the new headcount to 12,000, with only 10,000 in No CA. The effect of this is less demand for office space and apartments and less disposable income, which affects housing prices. We don’t think there will be a crash in Bay Area housing prices, but they can certainly decline about 20% during the next few years.
By: Joseph J. Ori (GlobeSt)
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