Will rising interest rates lead to higher capitalization rates or will the record levels of private capital support current commercial real estate valuations? What will be the strongest real estate sectors? And how will a potential economic slowdown affect the commercial real estate market?
These are common questions in real estate today, but they speak to the same bottom line: How should investors adjust their private real estate strategy for 2019 in light of new threats and opportunities? While many experts are predicting a market correction after years of low-interest rates and steady growth, we still see opportunities to invest in commercial real estate—if we understand the following trends that will change the property landscape this year.
10. Money will be tighter. The Fed’s bond buying after the recession increased the money supply in the market and buoyed the economy, driving investors to commercial real estate and other higher-yield assets. Now, by selling government bonds, central bankers are taking cash out of circulation and making bank credit less available. The Federal Reserve still holds nearly $3.8 trillion in Treasury and mortgage backed securities—a portfolio built up during the financial crisis of a decade ago. Now the government is unwinding its portfolio, which was well over $4 trillion until this past September, by selling bonds at attractive rates. With treasury bonds looking better, money will be less available for other investments, including real estate.
9. Rent growth will moderate. The global and U.S. GDP growth rate outlook has been lowered, due to tightening of monetary policy and concerns about trade and immigration. Lower growth produces less demand for commercial real estate. But rental demand will still come in below new supply levels, spurring a modest upward climb for vacancy rates and moderating rent growth through 2019, explains Freddie Mac.
8. Real estate funds will step up. A record $180 billion in global capital is flowing to real estate private equity, according to Preqin, a leading industry source of real estate data. If real estate prices begin to fall, real estate funds will be in position to pick up the slack and fund more commercial real estate transactions.
7. Interest rates will level out. Economists expect fewer rate increases in 2019. We predict that the Fed’s quarterly rate resets most likely will end this summer, and the yield on 10-year Treasury notes will settle in their current range between 2.7 percent and 3.3 percent. Yields on core real estate assets, which closely follow 10-year Treasuries, will remain within 5% of their current levels today.
6. Commercial real estate is due for a correction. Commercial real estate prices are at record highs, prompting Bloomberg to quip that prices are “frothy.” If the market were to decline, new buyers will emerge, including real estate private equity funds, institutions and family offices. The depth of this buyer pool will buoy the market, likely limiting any drop in property values to 5 to 10 percent.
5. Multifamily housing will maintain strong demand. The millennial population is still increasing, but their homeownership rate, at 32 percent for 25-29 year-olds and 46 percent for 30-34 year-olds in 2017, is still well below the national average of 64 percent, CBRE research notes. Gen Z is also just entering the rental market right behind millennials, at many downsizing Baby Boomers are opting to rent.
4. Millennials will discover suburbia. Young workers with growing families are following the pattern of their parents, looking for value outside the central city. However, the Urban Land Institute’s emerging trends report says this generation now demands walkable access to mass transit, shopping and entertainment. As a result, suburban rental rates will outperform in Charlotte, Denver and other markets where light rail connects multifamily housing to downtown amenities.
3. Secondary markets will shine. Commercial real estate’s global gateway cities no longer have an exclusive claim to cultural institutions, research universities, sports teams or fine dining. As a result, Southern and inland regional with strong market fundamentals will outperform traditional East and West Coast gateways. Real estate market trends make Atlanta, Dallas and Houston among the best places for real estate private equity investment in 2019
Watch Origin Principal Dave Scherer discuss the attributes emerging markets exhibit which make them ideal environments for potential real estate investments.
2. Data centers will draw institutional investors. Pension and sovereign wealth funds have adopted an asset class once dominated by real estate investment trust and venture capital, according to Cushman & Wakefield. A 2018 Georgia tax exemption brings added interest to this industrial real estate segment, which thrives in Chicago, Dallas, Phoenix and other technology hubs. Institutions also represent a higher proportion of self-storage transactions tracked by Marcus & Millichap.
1. Qualified Opportunity Zone (QOZ) funds must move quickly. Real estate funds must move quickly to make the most of a tax incentive provided in the Tax Cuts and Jobs Act of 2017. Qualified Opportunity Zones allow investors in state-designated redevelopment areas to defer or eliminate capital gains taxes. And they are attracting substantial capital from investors. But it is not easy to find viable projects, especially given the current economic climate. The race is on to invest in development sites in the more than 8,700 census tracts certified as QOZs, according to Real Capital Analytics. Funds that succeed with QOZs will have the local expertise necessary to identify and control the properties with the highest potential.
Taken together, these trends substantiate the principal prediction the Urban Land Institute made in its 2019 Emerging Trends Report: the only certainty for the coming year is uncertainty. But whatever the real estate market trends, disciplined investing provides a foundation for superior results.