Tag: Commercial Real Estate

Will Cannabis Legalization Present CRE Investment Opportunities?

Posted on March 9, 2020March 9, 2020 | Leave a comment

No matter what your personal views on the matter, the cannabis legalization discussion is here to stay. As of the writing of this article, marijuana is fully legal in 11 states and legal for medical use in over half the states in the US. Those numbers are not expected to diminish, with additional states considering full or partial cannabis legalization. What has followed has been a growth in a previously non-existent industry that has affected both micro and macro economics in the US. The question we now ask is: will cannabis legalization change the commercial real estate market?

To answer this question, today we will explore the current state of marijuana legislature as well as future projections, the likelihood that cannabis will become fully legalized in the state of Pennsylvania, and discuss how federal and state legislation on cannabis has and will continue to impact the CRE industry.

The Latest on Cannabis Legalization

There is nothing clear about the current state of cannabis legalization. So let’s stick with the facts. First and foremost, the federal government considers marijuana a class 1 controlled substance. This puts marijuana at the same tier as LSD, heroin, ecstasy, peyote, and methaqualone. While legislation has been proposed, the nationwide legalization of marijuana is likely very far off.

11 states have fully decriminalized marijuana

It should be noted that although we consider these states part of a group, their individual laws on cannabis regulation vary dramatically. What remains constant is that users must be over the age of 21, and distribution is still highly regulated. The states that have legalized marijuana include Washington, California, Maine, Michigan, Alaska, Nevada, Colorado, Oregon, Illinois, Massachusetts, and Vermont.

33 states currently allow the legal use of marijuana for medical purposes

33 states plus the District of Columbia allow residents to own and use marijuana when it is prescribed by a physician. Pennsylvania is one of these states. These laws become even cloudier than the “fully legal” 11 states listed above, as the medical red tape can be quite complex.

Fully illegal vs. decriminalized and beyond

For the 39 states that have not legalized marijuana, there are varying degrees of criminality associated with possession and distribution charges. Some states including Delaware, Connecticut, Maine, and New York, have reduced cannabis charges, meaning previous punishments have been diminished for those.

Will Cannabis be Legalized in Pennsylvania?

Pennsylvania’s laws on cannabis allow for medical use only. Unlike some other states, Pennsylvania has not enacted laws to decriminalize marijuana possession or distribution charges. As we discuss the possibility of the marijuana business impacting commercial real estate in our region, the next logical question becomes: how likely is it that cannabis will become legal in Pennsylvania?

The answer is as complex as you might imagine. Politicians including Governor Tom Wolf and Lieutenant Governor John Fetterman have both gone on record stating that they would consider the legalization of marijuana in the future. In the case of Fetterman, he is openly in favor of full legalization on the state and federal level.

Recent polls suggest that 59 percent of Pennsylvanians support the recreational use of marijuana. This is in stark contrast to a similar poll in 2006, in which only 22 percent of registered voters were in favor of recreational marijuana use becoming legal. The biggest considerations continue to be:

Pennsylvania’s mix of conservative and liberal ideals clashing at the state levels and
Money. If other states see a windfall from marijuana legalization (including commercial real estate), the likelihood of full legalization grows.

How Cannabis Legalization Has Impacted the Commercial Real Estate Market

The legal marijuana industry has already eclipsed $10 billion in the US. The cannabis market is potentially the fastest growing industry in the nation. Commercial real estate investment is a huge part of that growth. Here are a few ways in which marijuana impacts local CRE markets:

The demand exists for large facilities. Cannabis production facilities are quite large, and often include both farming and processing capabilities.
Regulations are a blessing and a curse. CRE investors would be wise to understand state and local laws before entering the cannabis arena. Cannabis producers must jump through hoops at the state level to gain site approval before beginning any type of production.
Cannabis retail is big business. Of course, production is only one side of the equation. Marijuana has a strong retail presence which has injected life into a stagnant retail market.
Local and state economies have been boosted by legal marijuana. Even if you want nothing to do with the cannabis industry, there is now sufficient evidence to make the claim the legalizing pot boosts the economy at the micro and macro level. As we know, stronger economies often create stronger CRE markets.

Going Forward

At the moment, legalized marijuana in Pennsylvania is all a hypothetical. The benefits of legalized marijuana for business and for commercial real estate are well documented. If and when our state (or the fed) chooses to adopt cannabis, there will certainly be an opportunity to pounce. The question going forward will become when that happens and what regulations will come along for the ride.

Construction Labor Shortage and Commercial Real Estate Projects

Posted on February 28, 2020March 9, 2020 | Leave a comment

Most commercial real estate professionals already know that there is a construction labor shortage in our country. This is true for major construction projects and renovations alike. There are a number of contributing factors which have caused this shortage which are likely to continue this shortage moving forward. As CRE professionals, this labor shortage has a material impact on construction deadlines, construction prices, and much more.

Today, we will explore this topic by identifying the current state of the construction labor shortage, discuss what factors are causing the labor shortage, and finally how the construction labor issues are impacting and will continue to impact commercial real estate construction.

The Current State of the Construction Labor Shortage

According to a new survey from the Associated General Contractors of America (AGC) and Autodesk, 80 percent of construction firms say they are having a hard time filling hourly and craft positions – which represent the bulk of the industry’s workforce. That same report suggests that labor shortages are the biggest threats to the construction industry. By extension, that’s a significant risk for the commercial real estate industry as well.

According to the US Bureau of Labor Statistics, there were 263,000 available jobs in the construction industry as of June 2018. The BLS predicts that the number of available jobs will increase over the next 10 years faster than average, with an above average median annual wage. Estimates place the total number of construction jobs at about 7.2 million.

Perhaps the most telling statistic is that 79 percent of construction companies are looking to hire new employees this year, but many are having a difficult time finding workers with the appropriate skills. To make matters worse, the disparity between the need for skilled construction workers and the availability of skilled construction workers is expected to increase moving forward.

What is Causing the Construction Labor Shortage?

The construction labor shortage would perhaps be more appropriately called a skilled construction labor shortage. Yet the reasons for the labor shortage are diverse. Some of the primary reasons for the current construction labor shortage include:

The industry is still recovering from 2008

The Great Recession of 2008 shook the commercial real estate world. A healthy construction industry in the early and mid 2000’s was suddenly placed into a depression where workers were laid off and construction projects were slowed or canceled altogether. The CRE industry has since recovered, but in the 10 plus years since 2008, the construction industry has been less appealing to prospective workers, leading to a shortage.

A decline in young workers with the necessary skills

A steady stream of young men and women graduated from technical schools and other training institutions ready to come into the construction workforce up until 2008. The Great Recession made construction a much less appealing option, which essentially slowed the flow of students and the flow of new employees needed for skilled positions.

The construction industry has grown and worker supply can’t catch up

Last but not least, it would have been difficult for construction companies to keep up with new hires even if there was the same level of skilled workers entering the workforce. Consider the labor statistics cited in the previous section regarding how many available jobs there are in construction.

How the Labor Shortage Impacts Commercial Real Estate Construction

Recent estimates suggest that ~70 percent of contractors are having difficulties meeting deadlines due to labor shortages. This simple fact causes a number of trickle down effects including:

Overall construction costs are increasing
Skilled laborers being asked to do more work
Investors are unhappy with contractors and construction crews
New projects are being rejected by construction crews
Many more

Labor costs make up about half of any building construction budget. Perhaps more importantly, no construction project can be completed on time and on budget without the appropriate construction crew. Construction labor shortages have a direct impact on the viability of commercial real estate construction projects for new construction and renovations alike.

One of the keys for CRE professionals in the current construction is being realistic about costs and timelines. Labor shortages are a bottleneck for any construction project. They are even more of a detriment for large scale, commercial real estate projects.

Going Forward

All of the available data points towards the construction labor shortage continuing in the immediate future. It is likely that the market will balance itself out as wages rise and skilled construction jobs become more appealing to younger generations. The question moving forward will become when the scales tip and the workforce begins to fill the available jobs. It is also worth noting that while many economists are predicting an imminent recession, most predictions also lean towards the next recession being much less impactful on the commercial real estate market.

It is likely that a long term, stable construction labor demand will sort itself out. In the meantime, construction crews and commercial real estate investors alike will do well to understand how the labor shortage will impact construction costs, construction timelines, etc.

The Reinvention of Retail and its Impact on CRE

Posted on February 26, 2020March 9, 2020 | Leave a comment

Ask around or cruise the internet and you are likely to find some pretty dire information on the retail industry. Yet you are also likely to find individuals and organizations that understand a simple fact: retail isn’t dead, it is just evolving. This is true for brick and mortar retail and e-commerce alike. With customers having more choice than ever, even disruptive companies like eBay are being disrupted by other innovators like Etsy.

For those of us in the CRE business, the question then becomes: “how does the reinvention of the retail industry impact commercial real estate?” Today, we will aim to answer that question by discussing how the retail industry has and is evolving, the types of CRE projects still paying dividends within the retail industry, and an outlook on commercial real estate in the retail sector.

How Modern Retail has Changed Over the Years

To understand how retail and CRE impact one another, we will start by understanding the current state of the retail industry. Due to major market shifts, the retail industry has undergone some key paradigm changes in recent years. These changes include:

Customers are more informed than ever. The old days of coming into a store knowing next to nothing are behind us. Any individual or organization with internet access can be nearly as knowledgeable as a salesperson before making a purchase.

Retailers know more about customers than ever. On the flipside, modern data collections and analytics also allow retailers to know more about customers before they ever set foot in a store.

Mobile devices drive in-store visits. The average consumer has internet access at all times. This means that the average consumer finds businesses through their mobile device a large percentage of the time. An example might be searching “Thai restaurants near me” to find a place to eat.

Reviews from critics and customers are available for all to see. Online reviews are a major disruptor of the retail industry. This can be both an opportunity and a threat to retailers.

How Retail Struggles Hurt Commercial Real Estate

There is little question that the struggles of the brick & mortar industry have had a negative impact on the retail commercial real estate industry. There are a few key ways in which the downturn of traditional retail business has hurt CRE:

The US is “over-retailed”. It is important to understand that the retail industry is still big business. As a recent article put it, “The problem with U.S. retail? There’s too much of it.” When we talk about CRE and retail, the primary issue is an overabundance of existing real estate with insufficient demand. The key will be re-positioning or removing this excess supply of space. Or as CBRE’s Jason Cannon humorously put it at last week’s NAIOP Pittsburgh chapter meeting, “The problem isn’t that we are overbuilt; it’s that we are under-demolished.”

Malls are dying. To illustrate this point, we need to look no further than the dying malls of America. The epicenters of American retails well into the 2000’s have since lost viability in the face of e-commerce. Retail CRE used to focus on megastructures and large retail presences, but will likely need to adapt to survive (more on this in the following section).

New construction for retail is on the downturn. As a result of items 1 and 2 alongside other key factors, new construction for retail real estate is down about 5% in 2019 year over year.

Retail Commercial Real Estate Adapts to Industry Change

Moving on to the question of the hour, how can the retail CRE industry adapt to a changing retail industry? While there is no one answer, there are several ways in which commercial real estate investors can remain competitive in the retail space.

Repurposing old retail spaces

Earlier we discussed how the US is “over-retailed”. This creates a supply and demand issue without question. It also creates an opportunity for investors to snap up undervalued retail real estate and repurpose those properties into money makers. This can include revamping dead malls, vacant spaces left by a dying big box industry (think Sears and JC Penney), and much more.

Investing in mixed-use properties

There are countless success stories of dead malls being turned into local community colleges, places of worship, or even bowling alleys. The point being, real estate is real estate. Retail spaces in good locations tend to be undervalued in today’s CRE environment. Turning these spaces into mixed-use properties which allow for retail, industrial, residential, and/or commercial properties is one way to adapt to a changing marketplace.

Going Forward

Retail is not a dead industry, it is merely one undergoing rapid change. Although we discussed some of the latest changes and retail industry problems, there will always be a sizable market for retail in the commercial real estate industry. For commercial real estate investors, the biggest takeaway might be that CRE must adapt as retail continues to adapt. Retail and e-commerce will continue to move forward as technology advances and customer behavior adapts.

For all the doom and gloom, there are still 65.9 million square feet of real estate under active construction in the US. Americans still shop at traditional retail centers in huge numbers. What remains to be seen is how both the retail and CRE industries adapt to new technologies moving forward.

Fundamental Factors that Drive Commercial Real Estate Markets

Posted on February 14, 2020March 9, 2020 | Leave a comment

While most of you reading this come from the commercial real estate industry, it can be useful to brush up on the fundamentals. With this in mind, here are some of the fundamental factors that drive the commercial real estate market.

The Local, State, and Federal Economy

Without a doubt, the state of the economy is a primary mover of the real estate market. Understanding exactly how the economy impacts commercial real estate is more complex. First, we must measure the health of the economy using metrics including gross domestic product, gross national product, productivity, spending, unemployment, and much more. Ask ten economists which metrics matter most, how to properly measure them, and what trends will impact commercial real estate most, and you are likely to get ten different answers.

It is not vital for commercial real estate professionals to understand the intricacies of the economy. It is more important for CRE professionals to keep an eye out for dramatic economic shifts like the next recession.

Interest Rates – CRE Loan Rates

Another key factor in CRE health are the past, current, and future interest rates. Similar to an individual seeking a mortgage for a home, investors looking into commercial real estate properties seeking a loan must consider interest rates for their loans. When interest rates rise, demand for properties is generally lowered. Conversely, lower interest rates frequently spur new investments/restructuring for commercial real estate loans. The factors that determine interest rates are many, but essentially boil down to lenders covering their costs and risks of loaning money.

Unlike mortgages for residential properties, commercial real estate loan rates can vary from 3.5 to 20 percent. This wide range of rates stem from the different property types, investment types, loan types, and details of the individual/group seeking the loan. Because there is such a gap between different CRE loans, it is prudent to understand one’s unique situation before assuming a range of rates.

Regional Population Demographics and Behaviors

The national landscape of commercial real estate might not extend to your region. A simple example would be state population increases and decreases within certain demographics. If your state is experiencing a large influx of young professionals, the commercial real estate market is likely to experience a boost. Yet the CRE environment is not a 1-1 relationship with population alone. In our Western PA region, we are simultaneously seeing a growing demand for convenient housing for young professionals in urban areas and a growing need for senior citizen housing and resources such as medical facilities.

Demographics that influence commercial real estate also stem from shifts in demographic behavior. Where Baby Boomers were reliable home owners for many decades, they have recently begun a shift towards renting their homes for financial and convenience reasons. For this and many other reasons, “there are more of group x moving to our area” is not a slam dunk when it comes to CRE forecasting.

Governmental Policies on Commercial Real Estate

Buying, renting, and selling properties all involve government regulation. These regulations have always existed, but have increased in the years following the Great Recession of 2007-2009. Because the recession was tied into the lending crisis, federal and state regulations on real estate loans and transactions become stricter and more invasive. The commercial real estate industry is built to adapt to these changes. It has been argued that one of the major reasons why CRE bounced back faster than other real estate industries in the wake of the Great Recession is that adaptability to changing government regulation.

CRE professionals might want to stay abreast to the changing regulations through the Code of Federal Regulations (CFR). “CFR stands for Code of Federal Regulations. The CFR is the codification of the general and permanent rules and regulations published in the Federal Register by the executive departments and agencies of the federal government of the United States. This codification of what is sometimes called “administrative law” has been published annually since 1938. The CFR is divided into 50 “titles” that are meant to cover broad areas such as Commerce and Foreign Trade, Federal Elections, Employees’ Benefits, Internal Revenue, and Education, just to name a few.”

Going Forward

The current outlook of the commercial real estate market in Western PA and across America remains cautiously optimistic. The US economy has been relatively strong over the past few years, with a few cracks starting to form in recent months. Loan rates remain appealing for commercial real estate investors, and the overall trend for real estate has continued to rise. However, many of the industry drivers we listed here today are beginning to flatten or even regress. This, and many other complex factors, have led economists to predict a looming recession in America. Recessions are an unavoidable part of a free economy, and we are overdue based on historical precedence.

The silver lining in these predictions is that the Great Recession of some 12 years ago has left the commercial real estate industry more hardened against economic downturn. Remember that economic strength is only one of the driving forces of CRE markets. Understanding the bigger picture allows us to accurately predict what we can expect going forward.

Increased Senior Housing Needs’ Impact on Commercial Real Estate

Posted on February 4, 2020March 9, 2020 | Leave a comment

It is no great secret that our country is aging. In fact, recent estimates provided by the US Census Bureau project that “older people (are) projected to outnumber children for the first time in US history” within the next 10 years. Not only will this put an economic strain on our nation, but it will also challenge our existing resources and infrastructure. An example of this strain is the existing problem of demand for senior housing outpacing our current supply. This dynamic is likely to impact the landscape of commercial real estate for years to come, but how?

Today, we will review the current reality of seniors’ housing needs, what those needs are likely to look like in the near future, and how these shifting realities will impact the CRE industry today and moving forward.

Senior Citizen Demographics by the Numbers in 2020 and Beyond

To understand senior housing, we must first understand the senior citizen demographic in the US. Here are some fast facts on senior citizens in America:

Over 50 million Americans are aged 65 or older. It should be noted that this estimate is on the conservative side based on available Census data.

The population of senior citizens isn’t just projected to rise, it is expected to explode. Where 2018 statistics put the number of Americans aged 65 plus at 52 millions, that number will be approximately 95 million by the year 2060.
Older Americans are also getting more diverse over time. Today, approximately 77 percent of Americans 65 plus are white. That number is expected to fall to 55 percent by 2060. Despite this increase in diversity, older generations will continue to lag behind younger generations in terms of ethnic diversity.

Additional facts about senior citizens that remain relevant to our conversation about housing and CRE include: aging generations having higher levels of education, longer life expectancies, and significantly lower poverty rates.

Low Affordable Housing Supply May Price Seniors Out of Their Communities

While senior citizens are in better shape than ever before in American in terms of wealth and education, they are still vulnerable to rising real estate costs. For extremely low-income renter households, only 35 rental homes are available for every 100 families in need. This is an example of a problem for senior citizens: they are particularly susceptible to being priced out of their own neighborhoods. Coupled with a national housing shortage and a rapidly aging population, rising real estate costs are a very real problem for seniors.

In Pittsburgh, we can see this in neighborhoods like Lawrenceville. From the years 2010 to 2017, the median home sales price jumped from $95k to $237k. That is nearly a 150% increase in less than a decade. Many working class families who have been living in Lawrenceville for decades have been forced to look elsewhere for affordable housing options. Again, senior citizens find themselves being hit the hardest.

How America’s Aging Population will Impact Commercial Real Estate

The Baby Boomer generation is in prime retirement age in the US. With that paradigm shift, the commercial real estate market is looking to adjust. Baby Boomers have been driving the residential real estate market for 20 plus years. Now they are about to drive the rental and commercial real estate markets in a new way.

Baby Boomer retirement likely to increase demand for multifamily housing

Retiring adults have been showing more inclination towards “downsizing” as they approach retirement age. This means that the Baby Boomer generation is going to be predominantly looking for affordable housing and/or rental opportunities for the first time in many years. This change in desired housing will likely come with a higher demand for multi-family housing, including:

Apartment complexes aimed toward senior citizen needs
Gated townhome communities
Any residential plans which take care of lawn care, home maintenance, etc.
Convenient living with senior-friendly amenities such as ramps, elevators, etc.

Another key factor to remember is that many senior citizens desire to stay local as they downsize. This means that these amenities are going to be desired in their current suburban/urban neighborhoods for affordable rates. This creates a potentially lucrative opportunity for commercial real estate developers and/or investors to get ahead of a rapidly aging US population.

Going Forward

All signs point to senior citizens moving away from their single family homes into smaller single family homes, multi-family homes, or other senior-friendly accomodations. This is nothing new. What is new is that the population of Americans aged 65 plus is expected to nearly double over the next 40 years. As life expectancy continues to climb, older generations will be looking for affordable and convenient housing options in record numbers. From the perspective of the commercial real estate professional, the question becomes how our industry will adapt to this change.

Western Pennsylvania has already had an upturn in new construction for senior citizen centers, medical facilities, and other infrastructure to accommodate an aging population. Yet housing shortages and other factors will continue to create a situation where senior citizen demand for affordable and convenient housing will likely outpace the supply.

How the Housing Shortage Impacts Commercial Real Estate

Posted on January 24, 2020March 9, 2020 | Leave a comment

It doesn’t take a real estate expert to see that housing prices have been accelerating in recent years. Ten plus years after the Great Recession of 2007-09, residential real estate prices have more than recovered in most areas across the country. In its place, a housing shortage has created a situation where many Americans struggle to afford their rent, let alone to own a home. In fact, a significant portion of the current generation of young Americans have more or less resigned themselves to the fact that home ownership is unrealistic.

What is less obvious is how this residential real estate trend has and will continue to impact commercial real estate. It is unlikely that new home construction will be able to keep up with housing demands. Will these developments help or hurt the health of the CRE industry?

The Current State of Housing in the US

Let’s first establish a few key facts. There are approximately 138 million housing units in the United States. About 80 million of these units are occupied by their owners and 43 million are occupied by renters. By most estimations, the US actually has a very healthy ratio of available housing units to individuals or families in need of residence. So what is the problem exactly?

The answer lies in the fact that key markets such as California and Austin are being crushed by demand with a limited supply. The problem is that the current supply of housing units does not align with demand when it comes to price or location. This issue is particularly bad for more affordable homes, which cost between $100k-$250k, depending on the market. This creates heightened competition for more affordable homes, which drives up prices and makes these housing units less affordable to buyers and renters.

Ironically, as young adults flee from traditional markets like NYC and San Francisco and turn to hot markets like Pittsburgh and Kansas City, they are bringing big city housing shortage problems with them. For example, Pittsburgh experienced a 16 percent drop in relative housing availability in 2019 vs. 2018.

How Residential and Commercial Real Estate Interact

Based on these trends, one might assume that the commercial real estate rental market would be booming in response. This is not entirely the case. Despite housing prices rising to near-emergency levels, rental rates in 2020 are expected to remain relatively flat. The latest year-over-year numbers put rental rate growth at approximately 1.4 percent nationwide. Again, this is somewhat misleading as some regions have experienced explosive rental hikes while others have actually seen rental rates diminish.

Another key factor in this equation is the decision making process of young renters. Millennials and the generations who are growing up behind them have shown a tendency to choose convenience and amenities over square footage and perceived value. This is due to a number of reasons, including their desire to use public transportation and a preference for urban living.

These trends have been favorable for commercial real estate rental units which are focused on offering convenience first and foremost. Well equipped rental units in urban or even “urban suburb” locations continue to see high occupancy rates in 2020. As young adults continue to struggle to afford their own homes, rental properties should remain a safe bet.

Commercial Real Estate Projections in the Coming Years

By all current metrics, our nation’s housing shortage looks to only worsen in the coming years. This is especially true in mid-major markets experiencing a tech boom including Pittsburgh. As for commercial real estate investors in the area, that means that there will be an opportunity to deliver high quality housing at premium prices for young adults who are willing to pay for high level amenities.

For example, young renters are more likely to pay a premium for rental units in so-called “smart buildings”. These types of commercial real estate units are constructed or retrofitted to accommodate desirable features like ultra high speed internet and even 5G when that is released to the public. This is in step with the advantage that CRE has over traditional residential real estate: it can adapt more quickly on a larger scale to new technologies.

The housing market may be in a strange place, but that offers an opportunity to savvy commercial real estate investors. Understanding what young renters want will allow larger rental investments to continue to be profitable for years to come.

Going Forward

It may be a running gag that millennials can’t afford to buy homes, but that reality is no joke. The wealth of our country might be held disproportionately by older generations, but younger working generations are the key to future CRE success. Where traditional thinking has valued square footage and price first and foremost, young adults today are shifting their focus towards amenities and convenience. This, coupled with the ongoing housing crisis, creates a scenario where well positioned rental properties can dominate the market.

Commercial Real Estate and US Economic Trends Going into 2020

Posted on January 13, 2020March 9, 2020 | Leave a comment

As with most investor markets and economic issues, commercial real estate is an ever-changing reality. What might look like a safe bet today could lead to huge losses tomorrow. Government regulations, environmental factors, and a looming recession are just a few of the ways that the commercial real estate landscape can change at any moment. Yet seasoned real estate veterans understand that these changes are just a surface disruption of CRE wisdom which generally holds true over time.

With all of this in mind, here is a brief report on the current realities of commercial real estate in the US as well as some insights into the near future.

2019 Commercial Real Estate by the Numbers

The commercial real estate market is currently valued in the ballpark of $1.1 trillion. To put that in perspective, if a trillion dollars represented $10,000, a billion dollars would be $10. Needless to say, there are massive amounts of revenue being generated in the CRE market in 2019. Here are a few other statistics to give a clearer picture of the current state of CRE:

The commercial real estate industry experienced an estimated growth of 2.2 percent in 2019. This is down from an average of ~4 percent annual growth in the CRE industry over the past five years.
Commercial real estate growth has outpaced overall real estate growth, rental rate growth, and leasing growth in 2019.
Seasonalized annual construction values from Q2 2019 are down by about five (5) percent compared to similar estimates from 2018. Newly constructed commercial structures saw the largest value losses over this time period.
Commercial property valuations are on a steady rise beginning with the recovery period in 2009-2010. During this time period, prices have risen the most in the Western United States with the Midwest lagging behind.
Rental rates have flattened to a relatively low 1.4 percent year over year growth from 2018 to 2019. This trend is expected to continue with many market indicators pointing towards a stagnant apartment market overall.

The State of the US Economy Looking to 2020 and Beyond

Before we stare into the proverbial crystal ball, we should first state the obvious: nothing is guaranteed. That being said, here are some likely events in the US economy over the next several years.

A recession is all but unavoidable in the next few years

As of the writing of this article, the latest news is that doom and gloom predictions about the next US recession may have been exaggerated. Despite this sudden onset of optimism, the plain truth is that recessions are a part of modern free markets. The most optimistic, realistic view of the situation is that our next recession may not take place in 2020 but in the years to come. Whether the next economic downturn occurs in 2020, 2021, or beyond, it will almost certainly have a material impact on commercial real estate just as it did during the Great Recession of 2008.

Climate change will continue to be a major player for the economy and for CRE

Recent scientific studies have predicted that extreme weather events in the United States will rise by approximately 50% by the end of the 21st century. This continues the already observable trend of extreme weather patterns like more frequent and stronger tornadoes, hurricanes, floods, and other natural disasters. This will impact both the overall economy and commercial real estate industries for obvious reasons. Building codes are likely to be updated, insurance costs will rise, and other incidental expenses will almost certainly take a hit. Economists warn that climate change will likely cost the US economy 100’s of billions of dollars by the year 2090.

Young adults will continue to struggle financially

Last but not least, the population of adults who should be representing the largest buyers in the US economy will continue to be hit by crippling debt, healthcare costs, and stagnant wages. Barring an unlikely dramatic shift in the political and/or economic landscape, the US Debt Crisis will be a huge factor in the economy for the foreseeable future. This has already played a role in lagging rental rates, home ownership, and spending habits. It is difficult to predict how this situation will play out, but younger generations have proven that they are willing to cut costs, something that is not a great sign for economic health.

Going Forward

The commercial real estate sector has been reliably strong for nearly 10 years now. After a two year dip in 2008-09, investors have enjoyed solid returns and steady growth. While it is reasonable to expect another downturn at some point in the next few years, it is also reasonable to believe that the US economy will bounce back and investments will continue to pay dividends. It will continue to be important for investors to keep up with the latest CRE trends such as co-working, energy construction projects, infrastructure construction, and much more. The commercial real estate world’s evolution is ongoing, and the only certainty moving forward is change.

How a Recession Would Impact Commercial Real Estate

Posted on December 23, 2019March 9, 2020 | Leave a comment

When it comes to recessions, it is not a matter of if, but a matter of when. The average American tends to view recessions as massive periods of history such as The Great Depression. In reality, recessions are quite frequent with varying degrees of impact on the individual and on different industries. Based on historical precedence, the US is due for another recession in the coming years. What is more difficult to calculate is the severity and duration of the next recession.

As real estate investors, recession can be viewed as both a scary proposition and also as an opportunity. Today, we will examine past recessions to better understand how investors can prepare for the impact of a future recession on commercial real estate.

The Inevitability of the Next US Recession

While nothing is inevitable beyond death and taxes, a recession is pretty damn close. Beyond the conceptual inevitability of economic ebbs and flows, recent recession indicators have shown that the US is due in coming years. Examples include:

Inverted yield curve: In a healthy economy, a long term, 10-year yield is expected to outperform a short term, 3-month treasury rate. In 2019, the 10-year yield dipped below the 3-month yield for the first time in 12 years. The last time this occurred, the 2008 financial crisis was looming around the corner.

Unemployment rates belie the reality: One of the strongest pillars of the current US economy is historically low unemployment rates. This is a great sign of stability of the nation’s economy. However, a worrying trend is that 2019 saw huge cuts to employee hours. This is often the first step towards higher unemployment rates, as employers tend to cut hours first, before ultimately having to downsize.

New York Federal Reserve recession probability model: The New York Federal Reserve puts out one of the most comprehensive and respected predictive models when it comes to future recessions. According to this model, the likelihood of a recession has approached 40 percent for the first time since 2009. Previous predictions have been accurate with a nearly perfect track record.

2008 Great Recession’s Impact on Commercial Real Estate

The residential real estate market gets most of the attention when it comes to the Great Recession of 2008-2009, and for good reason. Foreclosures and purchasing habits took a massive hit during the following years. However, the commercial real estate industry was hit nearly as hard. In fact, the average price of office space has been slower to recover than average rental rates. While office prices in 2017 had recovered to 30 percent above their 2007 highs, rental rates were performing at 60 percent above their 2007 highs.

Another grim aspect of the 2008 financial crisis was the impact it had on vacancy rates within commercial real estate. 2010 saw peak vacancy rates at 17.4 percent for office space, 10.1 percent for industrial space, and 10.8 percent for retail space. It is important to note that the impact on CRE markets seems to have been a bit more delayed than within the residential market, potentially accounting for some of the slower recovery noted above.

From the years 2007 to 2009, total investments in real estate went from $460 billion to $70 billion. This is one straightforward trend which will likely translate for commercial investment in any coming recessions. The impact may not be so severe, but total investments will almost certainly slow when a future recession hits.

How CRE Investors Can Prepare for a Recession

With all of this in mind, how exactly can commercial real estate investors prepare for this inevitability? While predicting the future is obviously a fool’s errand, there are two primary strategies that CRE investors can use to stay ahead of the curve.

Liquidate assets now to turn investments into cash

The signs of recession are certainly there. Some investors who have seen solid returns on their current CRE investments might want to take a turn-to-cash approach. This essentially takes your skin out of the game until the economy is back on the rise. The fringe benefit of turning current investments into cash is that savvy CRE investors can once again get back into the real estate market when property values hit their lowest points.

Retain real estate assets and weather the storm

Recessions are scary, but as all things, they too will pass in time. Most long-term investors understand that half the battle is staying in the game. All of the figures we have quoted earlier show horrible downturns and also eventual recoveries. In fact, one of the “bad” statistics for CRE was a mere 30% increase in value over a 10 year period.

Going Forward

Recessions are as American as apple pie. They are not to be feared, but they certainly call for some preparation and smart decision making. Commercial real estate is every bit as susceptible to an economy in recession as residential real estate or any other forms of investment. Smart investors will view coming economic downturns as just a part of the greater picture. Just as the CRE market recovered from 2008, so too will it recover from the next recession.