Mega Trends: Preparing for the Future of CRE

The economy is generally looking strong, but there are cracks in the veneer, said Suzanne Mulvee, director of research with CoStar Group, at Commercial Real Estate Conference 2016. From the market cycle to foreign investment to opportunities for commercial real estate, Mulvee touched on mega trends, which she describes as things that are shifting demand and allowing the economy to grow outside what is expected.

The economy. Right now, we’re on a familiar trajectory: employment, wages and jobs are on the rise, default risks are low, credit is expanding and there’s been solid business investment – until now. Corporate profits are falling along with business investment. Will that lead to a decline in hiring? And what will be the Fed’s impact with an expected rise in interest rates?

Labor market. Job openings are at a record high, which means businesses still want to hire despite sliding corporate profits. Employees are getting raises – of the top 75 percent of workers, wages are rising in double-digits. This is a mega trend: value-add workers are in high-demand, and they’re being paid well.

Corporate profits vs. employment. Five quarters of profit decline but no decline in employment hasn’t been seen since 1987 when the markets crashed. In 1998, we saw this too, when profits were essentially put to the side as the nation focused on growing the tech industry, which came back to haunt the economy in 2001. How long will shareholders accept this decline in profits before they demand cost-cutting?

The clock is ticking on this cycle. CoStar data projects a 60 percent chance of a recession by 2018, which they believe will more closely reflect the recession of 2001 vs. 2007. That is good news.

Demographics. There’s a slowdown of working age individuals coming into the job market. Two million individuals have been added to the workforce yearly for the last few decades but that number drops to a half-million in the years ahead. This means fewer bodies are coming in, demanding CRE – will that propagate slow growth? Hotter markets capitalizing on these shifts –  Orlando, Austin, Ft. Lauderdale, Charlotte – are boosted by single family home construction, low business costs and a low cost of living, and there’s a migration from the Northeast into the South.

Sluggish growth. CRE developers are searching for exceptions to that smaller growth by capitalizing on the mega trends shaping the industry, and therefore looking at secondary and tertiary markets for opportunity. A lack of construction may be setting up a different kind of cycle. Will renovation be a stronger opportunity for office than new development?

Where to live? Knowledge workers are choosing urban locations including New York, San Francisco, Boston and Chicago, and the median household incomes there are strong. Not so much in the suburbs, where median household incomes are declining.

Liquidity. Record high amounts of cash is coming into CRE across all sectors, despite a blip at the start of 2016.

Retail outlook. Supply, demand and vacancies strongly vary from high quality to lower quality locations. Rent growth has just picked up in the last two years in high quality locations. Retailers are closing stores in weaker locations and opening stores in stronger ones, and density is proving to be one of the strongest combatants to the e-commerce shift.

Industrial is strong. Demand is growing at 50 percent higher than expected, based on the rate of economic demand. Growth in warehouse demand remained robust despite GDP’s softening, and the demand for goods by e-commerce consumers is spurring the opening of space close to high population centers. Industrial vacancy is the tightest it’s been in two cycles and rent growth has spiked. Strong and growing markets are Dallas, Inland Empire, Houston and Phoenix – all national distribution hubs – followed by Chicago, Atlanta, Columbus and Memphis.

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