As real estate becomes an investment staple, capital will continue to flow and demand is expected to persist.
NATIONAL RESEARCH DIRECTORS from major commercial real estate brokerage, data provider and investment firms gathered for their annual meeting sponsored by the NAIOP Research Foundation on September 17 to share their observations and outlook for the coming year. David Funk, Pasquinelli family chair in real estate at Roosevelt University, opened the session by providing preliminary data relating to his ongoing study, funded by the NAIOP Research Foundation, which involves mapping sources of capital flowing to real estate. He noted that over the past 30 years, targeted allocations to real estate from institutional investors such as pension funds, endowments and insurance companies have grown from 2 to 10 percent of total investable funds. He believes that real estate is well on its way to becoming a permanent fourth asset class — alongside stocks, bonds and cash — and that the net effect of this will be a tsunami of capital that will cause return expectations to reset downward, from a historical range of 8 to 10 percent to a new level of 6 to 8 percent.
Funk also noted that global capital continues to chase U.S. real estate over other investment destinations. He asked participants if they believed that appetite for U.S. real estate was due to familiarity with the U.S. markets among fund managers. Respondents commented that tremendous transparency and availability of market data in the U.S. contributes significantly to reduced risk, making the U.S. market more stable and therefore more attractive than others around the world. Rene Circ, director of research for CoStar Portfolio Strategy, stated that “… often, foreign investors seek U.S. investments to balance portfolios geographically, but also to hedge against currency fluctuations.”
Not surprisingly, technology surfaced as the No. 1 current driver of demand for office space in markets across the U.S. Participants agreed, however, that no good definition of “technology companies” or “technology jobs” exists, and that better definitions are needed so the effects of this sector can be more accurately tracked. They commented that tech companies are no longer clustered in just a few major hubs, such as San Francisco, Silicon Valley and Austin, Texas. Today, these firms can be found in numerous markets across North America.
Furthermore, technology is becoming deeply embedded within companies across all industries, as they automate more systems to communicate internally as well as with clients. The move toward “big data” will only intensify companies’ need for software, systems and database experts. In the health care industry, for example, individuals now have personal online medical records with virtually every doctor they visit; this means that hundreds of millions of records now need to be updated, corrected and protected. Keith DeCoster, director of U.S. real estate analytics for Savills Studley, who led the office discussion, noted that office-using employment has also increased in lower-cost markets such as Atlanta and Nashville, where educated and affordable labor pools are drawing employers.
When DeCoster asked the group to identify potential disruptors that will affect the office sector, respondents cited the following:
Office users are paying more attention to workplace strategies that enable them to identify and create the optimal “workplace environment” for their companies — and to lease as little space as possible.
Jim Costello, senior vice president, Real Capital Analytics, noted that many traditional shared office/executive suites facilities are tired and lack vibrancy, especially compared to well-designed and well-programmed coworking facilities.
Valuations for coworking center operators like WeWork appear to be out of whack; this will become evident when demand for office space contracts during the next downturn. Yet coworking centers are clearly filling a niche, occupying some of the Class B and C space once occupied by smaller companies and creating new demand for that space among even smaller companies and startups that may not have leased office space in the past.
DeCoster also presented the following list of the top concerns of U.S. business owners, compiled by Duke University and CFO magazine:
- Economic uncertainty.
- Cost of benefits.
- Recruiting/retaining qualified employees.
- Regulatory requirements.
- Government policy.
- Weak demand.
- Data security.
- Employee productivity.
- Access to capital.
- Employee morale.
Those concerns served as food for thought for participants as they contemplated and discussed future demand for office space.
Multifamily: Canada and Beyond
Ross Moore, director of research, Canada, for CBRE, provided a glimpse into the Canadian multifamily market, which is changing in ways Moore characterized as “dramatic” on the ownership front, as investors seek new opportunities. He indicated that much of the nation’s multifamily stock is old and not of institutional quality. It is locally controlled by families that hold onto the properties for generations because they are subject to huge capital gains taxes when the properties are sold. (There is no 1031 exchange equivalent in Canada.)
Moore said that Swedish investors, including Akelius and others, have recently entered the Toronto multifamily market in pursuit of value-add opportunities. New investors are taking a much more active role than those of the past, renovating apartment buildings and resetting rents from, for example, CA$800 to CA$1,200 per month, a 30 percent jump that is achievable because of very low vacancy rates, which historically have hovered around 2.5 percent. Asian money and pension funds are also getting in on the action, having registered a tremendous increase in the amount of capital invested in multifamily properties in Canada between 2014 and 2015. Asked why multifamily in Canada (and elsewhere) is gaining investor attention, Ross replied, “because investors have run out of things to buy.”
Moore added that Canada is moving to a European model of residential living, with immigrants, empty nesters and millennials becoming more comfortable with smaller spaces in vibrant urban neighborhoods.
During the retail discussion, participants talked about how millennials do much of their shopping online, predominately via their smartphones, making purchasing decisions based on ratings provided by sites like Yelp, and how they respond to terms like “authentic,” “natural,” “social” and “environmentally responsible.” Videos are a huge component of millennial purchases; according to CEL & Associates, Inc. roughly 70 percent of millennial shoppers view videos as part of their online shopping process.
Participants discussed how “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 are also generating demand. In short, personalized experiences that cannot be achieved online — at least not yet — are filling retail space.
The group also explored 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. Bennett Gray, senior director, national forums and NAIOP Research Foundation at NAIOP, mentioned the example of Capital One’s 360 Cafe in San Francisco, where anyone can work, socialize or relax in a large, two-story open space with tables, comfortable chairs and beanbag seating as well as free Wi-Fi and discounts on pastries and coffee for bank customers. Roaming bank employees help people conduct basic banking business. Capital One uses this welcoming approach — which it has expanded to 10 other cafes in seven cities — to introduce visitors to its brand, while staff “soft sell” banking services like loans and credit cards.
Despite all the talk about e-commerce and how it has driven retail sales during the current recovery, a study published by the National Bureau of Economic Research concluded that warehouse clubs and supercenters like Sam’s Club and Costco have played an even stronger role than e-commerce in shaping retail since 2000. The study 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.
Ray Wong, director of Americas Research Operations for CBRE, suggested that the big box format is appealing “because you never know what they will have; there is a surprise each time you visit.”
Finally, participants discussed the industrial sector. For an overview of that presentation, see “Five Trends That Will Shape the Industrial Sector in 2016,” by Aaron Ahlburn.