United States

Real estate industry outlook

Real estate sectors need supply to keep up with demand


Key takeaways from the Fall 2019 Real Estate Industry Outlook

  • Foreign investment in U.S. real estate declined sharply in the first half of 2019.
  • In the retail sector, overall demand may offset store closings and bring vacancies down below rates not seen since 2007.
  • Industrial real estate remains one of the hottest subsectors in the market, but supply is not keeping up with demand.
  • Multifamily landlords are riding a wave of high demand driven by the influx of millennials.
  • Companies continue to locate to highly populated areas to attract talent, suggesting that new construction will be needed to meet office demand.


As ongoing signs of a slowing global economy percolate, foreign investment in U.S. real estate has been sharply declining. In the first half of 2019, foreign investment fell to $16.9 billion, a 48% decrease from the first half of 2018. Canada, Israel and Germany made up almost 50% of all inbound capital, while China fell 95% from its five-year average of $3.8 billion. Gateway markets such as San Francisco, Boston and Seattle, and industrial hubs that include the so-called Inland Empire in Southern California, are driving most of the growth in international investments.

Sovereign wealth funds, insurance companies and pension funds accounted for 30% of inbound volume in primary areas such as New York and Los Angeles, but only 3% in secondary markets in their search for tried-and-true markets. By comparison, equity funds almost doubled their share of inbound capital into secondary markets in their search for opportunities to meet yield targets in an environment of compressing cap rates.

Total outbound real estate investments in the first half of 2019 fell to $18.6 billion, down 17% from the prior year. The United Kingdom was the top destination of outbound capital from the United States. Despite investors’ concerns about Britain’s impending withdrawal from the European Union, U.K. property values have risen, and the purchasing power of the U.S. dollar remains attractive compared to the falling U.K. pound.

Office properties remain the top asset for U.S. investments abroad, but industrial and multifamily investments are on the rise, growing to 31.6% of outbound activity from just 9.5% between 2004 and 2008. This trend mirrors the domestic market, where the industrial and multifamily sectors have generally been seen as more favorable than office space.


E-commerce currently accounts for 10% of retail sales and 43% of total growth. Traditional brickand-mortar retailers who have not embraced e-commerce or developed a multichannel distribution strategy are shutting their doors. Last year, 5,854 stores went dark, which represented a record 155 million square feet. Coresight Research predicts that the number of store closings in 2019 could exceed 12,000, and UBS is predicting 75,000 additional store closings by 2026.

There is hope, however, for retail landlords. Supply has declined as developers recognize that U.S. retail overdeveloped in the 1980s and 1990s with the proliferation of malls. New supply has remained muted, averaging just below 14 million square feet per quarter since 2010, with the third quarter of 2019 projected to only 4.8 million square feet. This slowdown has allowed overall demand to offset store closings and shrink vacancies to 4.5%, below the 7.4% vacancy rate of 2010.

A steady absorption has allowed for forecasts of about 2% rent growth and national rates at $21.50 per square foot—still three times greater than industrial rental rates. Growth has been led by markets such as Orlando, Tampa Bay, Seattle and Charlotte—which have all seen rental growth rates above 5%—while markets such as New York City, Cincinnati, Chicago and Milwaukee are declining. Northern New Jersey, which has a significant concentration of retail, has suffered the most, with rents declining 2.9% year over year.

The other trend helping retailers has been the strength of entertainment-focused retail. The U.S. consumer has driven gross domestic product growth late into the current cycle, demonstrating strong spending and confidence, amid low unemployment and signs of wage growth finally reaching the labor force. These factors—combined with millennials reaching prime buying ages and their proclivity toward experiential entertainment—have prompted landlords to establish entertainment-anchored retail. Information technology now accounts for 3.7% of mall space, up from 2.7% in 2010.

Movie theaters have taken the lead in entertainment retail, accounting for 8 million square feet of growth since 2010, followed by arcades, bowling and dining. But these are not the movie theaters and arcades of the 1980s, which focused on teenagers. Instead, they cater to shoppers who want gourmet food and craft beer options to go with their favorite arcade games and La-Z-Boy recliners to enjoy the latest Disney reboot with their children.

MIDDLE MARKET INSIGHT The U.S. retail market continues to evolve, with stalwarts like Macy’s and Sears shuttering stores to make way for highly engaging and entertaining retail experiences. Landlords will remain focused on redesigning and reimagining dated strip centers and malls, while offering new supply, albeit at a sedate pace.


A volatile stock market left investors looking for a safe haven, with many allocating dollars to real estate fund managers. However, real estate funds have not yet deployed that capital, in part, due to escalating property values—no one wants to pay top dollar for real estate. As a result, real-estate-focused private equity funds are sitting on record amounts of dry powder. According to Preqin, that amount reached $345.2 billion in the United States through August 2019, the highest level since the research firm first began tracking the data in 2000.

Decreasing bond yields, including inversion of the closely watched yield curve, indicate that record-long U.S. economic growth may be coming to an end. The influx of capital into the real estate market is causing greater competition, as funds bid property values higher. Cap rates across the four major property sectors—industrial, multifamily, retail and office—have continued to decline and flatten out.

Real estate fund managers are having difficulty deploying capital at price points that can achieve desired returns, so they continue to sit on the sidelines.

MIDDLE MARKET INSIGHT In the face of a potential recession, real estate fund managers are in a position to show their worth. If they choose to buy assets now, it is vital to test the assumptions in their models to make sure properties can remain successful in a down economy. The other option is to wait for the real estate price roller coaster to start its ascent back to more desirable yields.


Industrial real estate continues to be one of the hottest subsectors in the market. With e-commerce making up 22% of retail sales and the expectation of quicker delivery times, last-mile warehouse facilities are experiencing sustained success. Cap rates are currently at 6.7%, after remaining flat for the past couple of years and at their lowest since 2000 (when CoStar began to track the data). Market rents have also hit a new peak at $8.78 per square foot.

But with such strong demand, supply has had trouble keeping up, due to limited land availability, long entitlement processes and rising construction costs. Despite the new development of about 250 million square feet in 2019, warehouse vacancy is expected to remain low, especially near high-population cities. Companies are getting more creative with their space. Prologis, a multinational logistics real estate investment trust, recently opened its first multistory warehouse near Seattle as a way to overcome capacity challenges. Amazon and Home Depot have signed on as major tenants.

Cold storage is also receiving a lot of attention in the industrial subsector. A recent report from CBRE Group, Inc. estimates that the United States could need an additional 100 million square feet in cold storage to meet demand from online grocery sales and food products with a short shelf life. This would mark a nearly 50% increase over the current market size of 214 million square feet. Cold storage facilities may triple construction costs, so spec development is rare, and demand has been slow to be fulfilled.


Multifamily landlords have been riding a wave of high demand driven by the influx of millennials, a cohort of 75.4 million people who surpassed boomers as the largest generation in 2016, according to the Pew Research Center. Demand for new construction is stymied, however, by the fact that millennials still only have a 36% homeownership rate, nearly 8% behind where Generation X was at the same age. This lag in homeownership by the largest generation in America is dragging overall homeownership down to 64%, well below the 69% rate seen in the early 2000s. These factors have translated to a feeding frenzy by multifamily developers and landlords as they chase record growth and cap rates.

The second quarter of 2019 saw more than 100,000 units absorbed, while an additional 78,000 came on the market. This level of demand is expected to continue to keep cap rates at a 10-year low of 5.8%. With the cost of acquiring prime assets at record highs, players in the multifamily rental space are looking at development as an entry point.

The top markets seeing apartment unit construction remain in coastal cities with strong technology-focused economies. Washington, D.C., fueled by the prospects of Amazon HQ2’s arrival, has nearly 35,000 units under construction; while Seattle and Boston each boast more than 20,000 units. However, multifamily growth is not limited to technology hubs, as cities such as Salt Lake City, Miami and Charlotte are seeing units under construction, as a percentage of current inventory, exceed 8%. Boston also leads this list with more than 10% of its current inventory under development.

The high demand outpacing supply has translated into national rental growth rates of 3.2%, with national average rents topping $1,358 per unit. Migration to the desert has driven 7.5% year-overyear growth rates in Las Vegas and Phoenix, while Albuquerque rounds out the top three at 6%. Even major markets with what can be considered weak performance have seen solid growth, with Houston trending at 1.1%, and cities like San Jose, Columbus and Pittsburgh still trending at 2.1%.

But the tide may be turning. Mortgage rates continue to remain at record lows and homebuilders, after nearly two decades focusing on high-end development, have begun to shift to more affordable entry-level homes, which, on average, have dropped to $312,000 per unit. Homeownership will likely be boosted by millennials beginning to see wage growth at 3.7%.

MIDDLE MARKET INSIGHT If millennials are finally headed toward homeownership, landlords banking on Generation Z will be left wanting, as the total for that cohort is 16% less than millennials. Demand is expected to continue into 2020; growth, however, is unlikely to continue much beyond that.


As the second-longest expansion extends, homebuilders are receiving mixed signals regarding their future growth. Political uncertainty and weakening job growth are causing concerns, while wage growth, younger demographics and low interest rates give hope for a brighter future. Given this uncertainty, homebuilders slowed housing starts to 876,000 in August, down 1.5% from a year earlier, as they work through old inventory.


In addition, there has been a notable shift in pricing: July 2019 new home median prices fell 4.5%, year over year, to $312,800. This decrease results from a right sizing of new home premiums. Historically, new homes have been able to command a 19% premium over existing inventory, but during most of this cycle, premiums have been over 30%.

While homebuilders are appropriately adjusting their portfolios and prices are softening, there are signals that better times are ahead. Wage growth has finally begun to trend up, and the U.S. consumer continues to be a beacon of optimism driving the economy. Additional wages and declining costs are translating into an increase in buyer traffic, which, in turn, has homebuilder confidence trending up for the end of 2019.


Fundamentals are favorable in the office market. Unemployment remains near 50-year lows, and companies continue to locate to highly populated areas to attract talent.

In the gateway markets, where new construction areas may be harder to find, developers are becoming more creative and disrupting the traditional central business district, exemplified by projects such as Hudson Yards in New York City and the Old Post Office in Chicago. Vacancies are at an 18-year low and rents are continuing to grow—suggesting that new construction will be needed to meet office demand. Tech cities are showing the largest amounts of rental growth; Austin, San Jose, San Francisco and Seattle lead the way with over 6% growth year over year.

MIDDLE MARKET INSIGHT Long-term lease payments with short-term rental income may lead to smaller operators being unable to function in a recession, and consolidation is a likely result. Larger coworking companies will be able to lower their cost basis by renegotiating their existing leases to offset any recession risks.

With WeWork so frequently in the news, it is difficult to look at the office subsector without talking about flexible office space. While currently accounting for just under 2% of total U.S. office inventory, flex space could rise to 13% by 2030, according to CBRE. There are significant concerns, however, about the viability of coworking firms in a downturn economy.


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