United States

Real estate trends to watch for the remainder of 2017

INSIGHT ARTICLE  | 

The fundamental outlook for the housing sector remains strong even as gathering policy and cost headwinds imply rising risk and the residential investment recovery enters its eighth year.

According to the National Association of Realtors, there is general agreement that among those active in commercial real estate markets that continued economic growth will drive activity, at least domestically.[i]

Here are some trends to keep an eye on for the remainder of the year:

Economy

  • The Federal Reserve is expected to continue to raise interest rates, which could make buying a home difficult for some. But the uncertainty of the market and the lack of clarity regarding how significantly interest rates will rise are making the market more disciplined. Lenders are being more cautious, and borrowers, more conservative.[ii]
  • While financing conditions for commercial and residential real estate were essentially unchanged as of April, values were elevated for some sectors of the commercial market. A sharp decline in valuations, notes Business Insider, could mean risks for financial stability in the banking system.[iii]
  • Real estate funds, relatively flat for the past year, currently yield twice the rates of the Standard & Poor’s 500 index (S&P 500) and a 10-year Treasury note rate.[iv]
  • The rising cost structure due to policy changes anticipated to come out of Washington will generate headwinds for homebuilders and may require price increases of near 2 percent, with most of that cost passed through to consumers.

Tax reform

  • Private equity real estate funds and commercial real estate investors are anticipating sweeping changes to come out of Washington, particularly with tax reform. Investors in pass-through entities expect tax rates to come down, but at this point it’s difficult to predict if these changes will be the game-changer that the Tax Reform Act of 1986 was for the industry.[i] Both the White House and the House Republican leadership have stated they want to have tax reform legislation passed by August 2017.[ii]
  • The tax reform proposal put forth by Republican leadership in the House—and commonly referred to as the Blueprint—could make what some have called a radical change to the rules governing the computation of business or investment income. This would not only apply to assets with short- and medium-term lives, such as vehicles or factory equipment, but also to depreciable real estate, which is today generally treated as having a depreciable life of 30 to 40 years, depending on its use.

Global capital 

  • U.S. assets continue to become more attractive and valuable to global investors, despite uncertainty regarding the relatively new administration in Washington. China invested more than $16.5 billion into properties, overtaking Canada to become the leading foreign investor in U.S. commercial real estate.[i] Hotels and offices continue to be the most popular assets.[ii]
  • There is still a seemingly attractive spread between U.S. real estate and 10-year government bonds in many large and liquid global markets where Asian investors participate heavily. As long as this spread remains, it is likely that there will be an Asian institutional “bid” for quality U.S. real estate.
  • VUCA—a common acronym used to describe volatility, uncertainty, complexity and ambiguity— aptly describes the political, regulatory and economic landscape for 2017 to which businesses have to become accustomed. Industries, economies and governments are not immune from a VUCA world and the unpredictability it brings. As this trend is expected to continue, evaluating investment risk alongside the contributors to VUCA will bring relevance to the current investment mindset.

Investor-raised capital

  • The United States is attracting institutional investors both foreign and domestic that are looking for safe real estate investments with solid yields, primarily in New York City, Los Angeles and San Francisco.[iii] This isn’t new, but it’s resulting in too much available capital—or “dry powder” as it’s known in the industry—and not enough attractive real estate, a trend that has been with the industry for a few years. The influx of foreign investment is not expected to slow down anytime soon, making it a decidedly seller’s market.

The impact on sectors

  • Student housing: The student-housing sector continues to remain attractive to institutional investors due to the sector’s ability to achieve higher returns—largely driven by high demand—compared to conventional multifamily housing.[iv] According to a recent report by TH Real Estate, construction in the student housing market is expected to stay strong in the coming months. In addition to an uptick in millennial demand for college and post-graduate degrees, the report notes that state budget cuts to education may bolster the market as investors create housing stock on or near campus to serve institutions that lack the funding to provide it themselves.[v]
  • Senior housing:  Investor appetite for seniors housing and care real estate continues to grow, with the majority of investors who specialize in the sector planning to increase the size of their portfolios in 2017, according to CBRE’s U.S. Seniors Housing & Care Investor Survey report. Several factors, such as favorable investment yields, demand and an aging population, are driving investment into the sector.[vi] The sector has done extremely well for investors, historically outperforming other major property types over several periods.[vii]
  • Industrial: Repurposing real estate to accommodate the rising demand for one-day distribution is picking up in the United States. Vacant offices and even parking garages are being converted to meet consumer demand for faster product delivery. Demographics and the continuing rise of e-commerce account for the shift.[viii]
  • Retail:  Millennials prefer to do their buying online; more than half of their purchases are made on the internet. But they do still enjoy some real-world retail experiences and retailers are evolving to accommodate them. Malls that don’t see as many shoppers as they used to must be repositioned to attract visitors with new offerings―such as restaurants, cafes and bars―turning the mall into an “experiential” destination and driving up the value of logistics facilities.
  • Office: Co-working providers are now a force to be reckoned with. WeWork, the $17 billion startup, added hundreds of thousands of square feet worth of new Manhattan leases in 2016 and will soon be among the biggest lessees in the United States. This has spurred investment in office properties that appeal to co-working providers. The millennial-driven demand for open-plan, fully digital, creative office space is offering opportunities for some property investors but challenges for owners of aging, old-school office buildings from the suburbs and to Park Avenue.

Footnotes
[i] “Realtors® Have a Positive Outlook for Commercial Markets in 2017” news release (May 19, 2017)
[ii] Rothstein, E. “Widespread Uncertainty is Helping Commercial Real Estate” (May 25, 2017) Bisnow
[iii] Oyedele, A. “The Fed says it'll be appropriate to raise interest rates again 'soon'” (May 24, 2017) Business Insider
[iv] Waggoner, J. “3 Smart Investments When Interest Rates Are Rising” (May 25, 2017) Money
[v] Mattson, B. “A closer look: Real estate private equity funds brace for financial reforms and shifts in regulatory landscape” (May 1, 2017) Institutional Real Estate, Inc.
[vi] NAIOP, the Commercial Real Estate Development Association
[vii] China Spends $16.5B on US Commercial Real Estate in 12 Months to Claim Top Investor Spot” (May 24, 2017) Mingtiandi
[viii] Sheng, E. “Chinese Now The Largest Group Of Foreign Investors In U.S. Commercial Real Estate” (March 13, 2017) Forbes
[ix] Williams, C. “Here's Why Real Estate Funds Are Sitting On Billions Of Dollars” (May 8, 2017) Bisnow
[x] Marino, V. “A Rush to Meet Rising Demand, and Expectations, for Student Housing” (Feb. 28, 2017) The New York Times
[xi] Park, T. “Student housing – a sizeable and growing niche investment opportunity” (Mar. 28, 2017) TH Real Estate
[xii] Gerrity, M. “Investor Demand for Senior Housing Continues to Grow in U.S.” (Jun. 7, 2017) World Property Journal
[xiii] “Getting Better with Age: Investment Opportunities in Senior Housing” Harrison Street
[xiv] Gonzalez, T. “How North America’s Shifting Demographics Are Changing Industrial Real Estate Trends” (April 27, 2017) Bisnow

 

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