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18 Commercial Real Estate Trends To Dominate In 2019

Commercial real estate analysis

Goodbye 2018, hello 2019! As the new year approaches, Bishop talked with several business execs, researchers and economists to discover the significant trends expected to dominate the commercial property sector in the upcoming year. From the increase of opportunity zones to a slowdown in industrial absorption, these are 18 tendencies experts forecast for 2019.

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1. Opportunity Zones Craze To Persist

As investors anticipate finalized advice from the Department of the Treasury and the IRS regarding the Opportunity Zone program, the hunt is on for assets and investment opportunities in those designated areas that pose the most powerful upside potential. Investors are lining up to pour billions into Opportunity Zone Funds, with a report by Real Capital Analytics saying there's over $6 trillion in unrealized capital gains eligible to be set up into potential zones.

Though the program was made via the passing of this Tax Cuts and Jobs Act annually to drive economic development in underserved communities in exchange for a hefty tax break, study reveals many of those census tracts classified as chance zones have already attracted a substantial amount of investment prior to the launch of the new national plan. Critics of this program stress it will accelerate investment in areas already experiencing a surge in development activity, resulting in a convergence of investment into burgeoning neighborhoods currently in high demand, and too little investment in otherwise blighted communities.

2. Industrial Boom To Keep Thanks To High Demand From E-Commerce Players, Though A Few Headwinds May Surface

Industrial real estate demand soared to new heights this past season, and CBRE Head of Industrial Research David Egan anticipates more of the same in 2019.

"I believe that the market has outperformed this season, at least from consumer action. There has been an overall expectation for a number of years that this can't last and it turns out that hasn't been accurate. We've got a massive amount of demand on the market for logistics properties of all kinds; of course the most Class-A big-bulk warehouses are what get the majority of the attention, but the need is quite broad-based and extending all of the way down to secondary and tertiary markets," he said. "My anticipation in 2019 is that we ought to see less or more of the exact same dynamic."

Web absorption resulting from e-commerce growth is expected to moderate between 75M SF and 94M SFexactly the same as this year, according to CBRE's 2019 Outlook report, and a lack of new supply has pushed vacancy levels down to 4.3 percent, a historic low.

"According to the demand that we are seeing in the e-commerce industry -- as well as from conventional brick-and-mortar retailers that are entering or expanding in the internet space -- we can fully expect that e-commerce will continue to push the marketplace next year," Bridge Development Partners President Anthony Pricco said. "This is especially true for infill sites proximate to the significant population centres. While the increasing costs of land and construction could be viewed as emerging economy headwinds, the upside of industrial growth remains exceptionally powerful, as rents have been appreciating at a much quicker rate."

Egan advised Bisnow that he would not be shocked if internet absorption tapered off in 2019 due to new supply not keeping pace with strong demand levels.

"You can just absorb what is available," he said. "While we expect to see supply-demand relatively in check, those growth metrics will continue to be positive."

3. Federal Reserve To Slowly Boost Interest Rates as a Result of Power Of The Economy

With robust jobs growth continuing to increase at a healthy clip and the unemployment rate steady at 3.7 percent, a 50-year low, Fed officials hint that they'll probably continue their course of action in 2019 to gradually boost short-term interest levels to temper inflation and keep a stable economy.

"Inflation exists above the Fed's target of 2% to 2.5%, with more job openings than jobless and more homebuyers than new home inventory. The Fed sees inflation forward first and foremost and will continue on a hike-pause-hike-pause pattern in 2019 as long as GDP stays above 2 percent and unemployment below 5 percent," CCIM Institute Chief Economist K.C. Conway said.

The Fed boosted prices three times annually to a range of 2 percent to 2.25 percent, and several expect central bankers to bump prices again in December. Big Wall Street banks polled by Reuters expect central bankers to increase rates another three times in 2019.

"Though the latest Fed guidance has appeared less definitive on its future path, the current market and most analysts expect another increase this month and 2 to four next year, as both inflation and wage growth surpass their targets," Colliers International U.S. Chief Economist Andrew Nelson said. "This will ultimately translate into declines in consumer and business borrowing and curb spending and investing."

4. Online Retailers Will Continue To Open Brick-And-Mortar Stores, Further Validating That Physical Retail Is Far From Dead

With the retail industry stabilizing in 2018, CBRE Head Of Global Retail Research Melina Cordero expects retailers to begin reinvesting in their physical footprints to accomplish the perfect omnichannel buying experience for consumers. Additionally, digitally native (or even e-commerce only) retailers will increasingly shift to open physical stores to grow their business and keep more customers, Cordero said.

"In terms of retail and property, I believe the retailers have finally sort of learned things to do. There's a good deal of investment, changes and closures that had to occur to adjust to omnichannel. Over 2018 a lot of those investments finally started paying off.

"What we believe is going to happen over 2019 is a true return to the store. Retailers are finally beginning to realize the value of their property -- they can't just close a store and rely on online, they actually need the shop for profit margins, customer attention, customer acquisition, for many reasons. I believe we are going to find a lot of reinvesting from the shop and lots of reinvesting in strategies to try to get folks into the shop," Cordero said.

5. Industry To Continue Reading The Tea Leaves To Predict The Next Downturn

Everyone is on the lookout for signs of the next downturn, as the market nears its 10th year of expansion -- its longest period of growth .

"In the history of U.S. business cycles, downturns have typically occurred within one or two years after the market has reached full employment," JPMorgan Chase Commercial Banking Head Economist Jim Glassman said. "A careful evaluation of this historic regularity suggests, however, that this pattern has been the result of two imbalances -- a building inflation problem that needs the Fed to adopt a restrictive policy position, or unprecedented fiscal imbalances.

"In that regard, there are no obvious imbalances that have the capability to trigger a downturn, so the present expansion is likely to settle to a lengthy period of balanced, noninflationary growth."

Though U.S. economic growth and job gains were strong in 2018, several analysts and economists predict the economy will likely slow in 2019 due to continued short-term rate of interest bumps by the Federal Reserve and waning fiscal stimulus from federal tax reductions.

"Inevitable disruption is probably the appropriate risk plan mode to be in for 2019. Real estate is not immune from business cycles, economic recessions or disruptive black swan events -- such as a trade warfare, currency meltdown or cyberterrorism," Conway said.

6. Investor Demand For U.S. Assets To Maintain Transaction Volume Powerful

"Though property markets peaked for this cycle in 2015, leasing and sales transaction activity remain robust and pricing firm," Nelson informed Bisnow. "Transaction volume through Q3 2018 [has been ] 11% over its level for the comparable period last year and is approaching the entire closed in 2015 -- the peak sales year for this particular cycle.

"While all four core businesses have shared in this year's gains, apartment and office -- perennial investor favorites -- have posted the greatest sales totals and also the strongest price appreciation to date. However, both [will] likely slow sharply in the following two years, along with price appreciation and lease growth, as the economy slows or even turns negative."

7.

Commercial real estate professionals -- from operators and owners to brokers and architects -- can no longer deny the effect technology is having on the business. More property companies are embracing the latest innovations to streamline perform jobs and make a more paperless, transparent approach to sourcing deals, managing assets, assessing data and final transactions.

Mihir Shah, co-CEO of JLL Spark -- JLL's PropTech division that has a $100M global fund dedicated to investing in real estate tech companies -- informed Bisnow that PropTech companies are now increasingly precious as their products have helped property companies further their own initiatives.

"As part of the endeavor, we're seeing businesses that typically went through long RFPs showing interest in new products to see which ones are viable. This helps them establish [return on investment] quicker and assists the winners grow faster," Shah said. "This willingness to try new things will help PropTech adoption in 2019 and beyond."

8. Investment In Value-Add Assets To Help Assuage U.S. Workforce Housing Availability, Affordability Concerns

Demand for available and affordable workforce housing choices will remain a topic of interest from the multifamily sector, as costly land and development costs make it more difficult to build affordable housing from the ground up. This is particularly a pain point in urban metros, JPMorgan Chase Head of Commercial Real Estate Al Brooks told Bishop.

"The ongoing job growth we have been experiencing in the U.S. is having a massive effect on workforce housing affordability in major cities. This influx of talent continues to be fueled by the need to be in close proximity to work, the ease of mass transit options, as well as the allure of being in the center of the action in major metropolitan regions," Brooks said.

CBRE Americas Head of Multifamily Research Jeanette Rice said investment in value-add multifamily assets will help assuage those concerns.

"Workforce housing will also stay appealing in 2019 because of demand outpacing accessible supply, thereby keeping vacancy rates low and rental growth above the overall multifamily market.

"Investor interest will also remain very high in 2019. Interest is coming from all types of funds, including foreign and institutional capital in addition to conventional sources like smaller private buyers. The appetite for workforce housing is very strong for the better property fundamentals and greater yields. Value-add investment will likely still dominate in 2019 and stay mostly successful. Acquisitions of stabilized product will also be attractive for some investors, especially those with longer-term hold horizons," Rice explained.

9. Millennials To Continue Flocking To Hipsturbias And 18-Hour Suburban Cities

Research and data has dispelled the long-held myth that millennials are city-flocking suburbia haters. With aging millennials now hitting their early 30s, many are turning to the suburbs with their families. More than 2.6 million Americans relocated in the city to the suburbs in the previous two years, as stated by the U.S. Census Bureau according to ULI. This has renewed investor interest and confidence in select non-gateway markets, ULI reports in its 2019 Trends survey. "Hipsturbias" or"Urban-burbs" have been used to classify these suburban markets with greater walkability and access to public transit that resemble urban metros.

A U.S. lender senior researcher told ULI the following:

"The first phase is millennials moving into the suburbs for bigger, more affordable homes and accessibility to schools, so adequate single-family and multifamily housing will be necessary. Retail follows rooftops, so retail growth to satisfy the new residents' requirements will follow. Last, you may begin to view more emphasis on employment centers as individuals decide they want to work closer to where they live."
10. Investors To Favor Industrial, Multifamily And Retail Assets In The New Year

It comes as no surprise that industrial real estate assets are an anticipated favorite for investors in 2019, along with multifamily assets, based on ULI's 2019 Emerging Trends report. Deep-pocketed investors like Blackstone Group continue to gobble up entire portfolios of industrial resources at a rapid pace this year, for example its purchase of industrial REIT Gramercy Property Trust for $7.6B, a portfolio of last-mile logistics resources from Harvard University for nearly $1B plus also a portfolio of 41 warehouses from FRP Holdings Inc. for $359M.

More interesting is the fact that retail is expected to draw interest from investors in 2019, especially those resources ripe for redevelopment and updates.

"Many shopping centre properties are simply not going to come back as successful retail resources. However, while some are reduced in cost to mere property worth, many are well below replacement cost and have good places for alternative applications," ULI reports. "If a website is sufficiently large, mixed-use is a superb option for close-in suburbs appearing to exploit maturing millennials' desire to input their next life-cycle phase. There also is a chance to turn the tables on the e-commerce fashion that fostered the obsolescence by redevelopment into supply facilities."

11. Investors To Continue Flocking To Secondary, Tertiary Markets For Yield

Commercial property investors on the hunt for solid risk-adjusted returns continue to skip gateway markets to gamble on assets in burgeoning markets that are secondary, as well as the trend is very likely to continue in 2019.

"Because of the high rates and restricted opportunities in main U.S. metros, investors are continuing to concentrate more on secondary markets, that are enjoying double-digit increase in investment activity and also substantially more powerful price increases than at the primary (largely coastal) subway markets," Colliers' Nelson said. "But, those trends are likely to undo if/when we see the economic downturn, and investors find the security of larger, more liquid markets"

This behavior is typical at a late-stage cycle such as this, CBRE Chairman of Americas Research Spencer Levy stated.

"The downside of the coin is it's standard of late-cycle investment activity that you find a change from primary to secondary in search of returns. What's new is we've not seen a compression of returns that would be typical in late-market action," he explained. "What occurs is cap levels in primaries and secondaries converge; we have not seen that in retail and office, but we have seen that in multifamily. The issue is, is that this tendency durable during a recession that will occur in the next few years?"

12. Construction Industry To Keep on Grappling With High Costs, Labor Shortage

Rising construction costs were the No. 1 property and development concern for respondents that participated in ULI's Emerging Trends in Real Estate 2019 surveys. On a scale of one to five, five being of the best importance, construction prices ranked 4.59, together with land prices and housing costs and availability following close behind at 4.14 and 4, ULI reports.

"Growing construction costs could possibly be the most understood narrative of 2018 that has to become a material narrative in 2019," CCIM's Conway stated. Conway identified a variety of factors exacerbating price and labour challenges in the construction business, such as a decline in immigrant construction laborers after the financial crisis, loony superstorms as a consequence of climate change that has led to enormous rebuilding efforts across the nation, and tariffs and the transaction war.

"Key materials like steel,... toilet fixtures from China, timber from Canada, etc., are affected. Pay attention to the quarterly revenue reports from building materials companies regarding the kind of input cost increases being experienced. Caterpillar, by way of example, reported strong earnings in Q3 2018, however, a sizable rise in substance inputs like steel. The result is rising pressure on margins.

"This is the important takeaway regarding construction labor and material costs increases -- margins are going to be squeezed, cost overruns incurred, and values under stress unless rents and [internet operating income] can be raised to cover the increasing costs of new building," Conway said.

13. U.S. Office Real Estate Markets To Remain Stable, Though Demand May Slow

CBRE said in its 2019 U.S. Outlook report which office net absorption is predicted to reach 37M SF in 2019, representing the sector's 10th consecutive year of positive absorption. Should the nation continue to experience strong office-using job growth in the new year, it might cause strong absorption rates and renewed attention from investors.

"One portion of office property growth is the requirement for more office space near amusement venues and other comforts. These office buildings are relying on smaller, flexible workspaces. Working spaces also are becoming more prevalent as professionals select other working methods," Green informed Bisnow.

That said, Colliers' Nelson expects office demand will taper off in reaction to a downturn in job creation and robust supply amounts.

"Demand for office space will medium in response to slower job development, just as a significant volume of projects already under construction starts to enter the market," Nelson stated. "So vacancy will trend upward and rent growth will ease as market conditions become more aggressive for landlords."

14. Retail Bankruptcies To Slow, Retailer Earnings To Stabilize

"The real estate industry has undergone significant change in recent decades, and the transformation is deep and will continue throughout 2019. The convergence of brick-and-mortar and online retail will continue to create major seismic changes in the industry," TD Bank Head of Commercial Real Estate Gregg Gerken told Bishop.

Though a wave of merchants filed for bankruptcy and shuttered shops this season -- including Sears, Mattress Company, Nine West and Claire's -- the circumstances surrounding most store closures next year ought to be enormously different, CBRE's Cordero explained.

"I feel that the general industry sentiment is that 2017 was likely the summit [for retail closures]. I believe there'll continue to become closers in 2019 -- it's difficult to say whether we will have more or less -- but I would say a great deal of the closures that we will find in 2019 will be more about what we predict portfolio rationalization or optimization than they're about retailers that are failing.

"Retailers in many cases do need to close stores to reorient their portfolios -- therefore I do anticipate closures at 2019, but I do not actually [connect ] a lot of these closures as dying or failing retail, it is more of morphing and adapting retail," Cordero said.

15. Multistory Warehouse Development From The U.S. To Accelerate

Conditions have ripened for multistory warehouse development from the U.S., and this trend will continue into 2019. Facilities are underway or have already delivered in Seattle, San Francisco, New York, Miami and Chicago. Even though multistory warehouses are nothing new in Europe and Asia, the U.S. is in the beginning phases of developing these types of facilities today that building prices are not as cheap and there is less accessible land than in the past, CBRE's Levy said. Unprecedented demand for logistics and warehouse area now has changed this dynamic.

"The rents which are being achieved in these multistory industrial [centers ] may be just two or three times what you are seeing in conventional industrial. We think this specific tendency is only at the start in the United States," Levy explained.

Although the bumps in rent are significant, CBRE Head of Industrial Research David Egan said these multistory facilities can also present operational challenges for consumers.

"The users are going to have to change how they function in such buildings to make it work effectively," he explained. "The operational problems are not small -- to alter the way that they move stock in and outside of those buildings is not a tiny little tweak."

16. Grocery Chains To Move Additional Online Expand Their Online Offerings With The Assistance Of Tech

Up to now, delivering fresh groceries to consumers' doors has been a fairly nascent notion -- and it's no simple job. Grocers already battle low profit margins because of progressively declining food prices and new low-cost competitions like Aldi entering the market. The challenges, coupled with expensive online delivery expenses, has kept online grocery delivery in its infancy. However, CBRE's Cordero sees that tendency shifting in 2019.

"Grocery is probably, one of all the retail classes, one of the lowest for online penetration. We think because of a mixture of technological advancement, investment on the part of retailers and consumer demand, that we're going to find a pretty important shift next year at grocery going online and retailers offering more to customers in that domain," she explained.

17. Economic Development Teams Round the Nation Continue To Feel The Impact Of HQ2 Competition

"An open contest such as the Amazon HQ2 search is an opportunity for communities to redefine their own legacy image and showcase what is different in their market today versus 10, 20 or 30 years back. The 238 communities that competed for the Amazon HQ2 are decreasing economic development consequently," CCIM's Conway said.

"Amazon is using the data to site select new fulfillment centers in places like Tucson, Arizona, and Birmingham, Alabama. Other significant transportation and e-commerce companies, such as Norfolk Southern Railroad, have used the data to make a relocation choice (in Norfolk Southern's instance, to Atlanta, which was one of the 20 finalist cities for Amazon HQ2). In other words, the Amazon HQ2 search was to economic growth precisely what the census is to demographics"

18. U.S. Hotel Occupancy To Split Records In 2019

The hotel sector is expected to undergo a record-breaking year of occupancy levels in 2019, according to a forecast from CBRE Hotels America Research. Occupancy levels are predicted to surge to 66.2% following year, the 10th consecutive year of expansion. This growth will be driven by a 2.1% growth in demand to offset incoming supply.

That strong demand may not be felt equally across markets, Quadrum Hospitality Group President Foiz Ahmed said.

"Although the hospitality industry continues to grow, the economies in which Quadrum is busy will remain relatively flat given their higher-than-national average occupancy prices. While average daily rates are rising nationwide, the business will likely face some challenges as a result of rapid adoption of programs that provide discounted prices."