2020 Expectations and Market Realities in Real Estate 03-02-2020
2020 Expectations and Market Realities in Real Estate 03-02-2020
2020 Expectations and Market Realities in Real Estate 03-02-2020
FORGING
AHEAD
i
Expectations & Market Realities in Real Estate 2020
Forging Ahead
© 2020
Deloitte Development LLC
NATIONAL ASSOCIATION OF REALTORS®
RERC
SitusAMC
All Rights Reserved.
Disclaimer: This report is designed to provide general information in regard to the subject
matter covered. It is sold with the understanding that the authors of this report are not
engaged in rendering legal or accounting services. This report does not constitute an offer
to sell or a solicitation of an offer to buy any securities, and the authors of this report advise
that no statement in this report is to be construed as a recommendation to make any real
estate investment or to buy or sell any security or as investment advice. The examples
contained in the report are intended for use as background on the real estate industry as a
whole, not as support for any particular real estate investment or security. Neither Deloitte,
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directors, officers, and employees warrant as to the accuracy of or assume any liability for
the information contained herein.
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
TABLE OF CONTENTS
CHAPTER 1: INTRODUCTION
Forging Ahead.............................................................................................................................2
2019 Deloitte Dbriefs Poll Results...............................................................................................3
CRE Forges Ahead as a Preferred Asset Class..............................................................................4
The Interest Rate Environment.....................................................................................................5
Negative Interest Rates: From Odd to Ordinary............................................................................6
Risks in 2020.............................................................................................................................6
Technology and the CRE Investment Environment......................................................................10
The 2020 Deloitte Commercial Real Estate Outlook..................................................................10
Global Conditions.....................................................................................................................14
The U.S. Economy......................................................................................................................15
Employment and Income...........................................................................................................17
Housing....................................................................................................................................18
CHAPTER 5: OUTLOOK
Economy...................................................................................................................................52
Financial Markets......................................................................................................................53
RERC Research 10-year Treasury Forecast.................................................................................54
CRE Debt Market Outlook..........................................................................................................54
CRE Equity Market Outlook........................................................................................................54
RERC Research Total Return Forecasts.......................................................................................55
Property Type Outlooks..............................................................................................................56
Sponsoring Firms......................................................................................................................61
RERC........................................................................................................................................61
Deloitte.....................................................................................................................................62
NATIONAL ASSOCIATION OF REALTORS®.....................................................................................63
iii
ABOUT OUR CONTRIBUTORS
DELOITTE NATIONAL ASSOCIATION RERC AND SITUSAMC
OF REALTORS®
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
FOREWORD
Dear Readers,
This is good news for CRE transactions. While overall deal activity
was down in 2019, volume is picking up for particular property
types and markets as investors keep looking for deals this late in
the cycle. We expect CRE prices to stay at record highs as space
market fundamentals remain healthy; strong valuations will likely
support the high prices. We forecast CRE capital appreciation
returns to decline over the next year before moving up again late
in 2021. By the end of 2022, we may see income returns increase to
levels not seen since 2016.
v
ACKNOWLEDGMENTS
SPONSORING FIRMS & CHAIRS ASSOCIATES
Kenneth P. Riggs, Jr., CFA, CRE, MAI, FRICS, CCIM Charles Ellis
Vice Chairman Associate
RERC Research RERC Research
Alec Roth
Analyst
RERC Research
Jack Tolchin
Consultant
Deloitte Transactions and Business Analytics LLP
vi ©2020 Deloitte Development LLC, NATIONAL ASSOCIATION OF REALTORS®, RERC. All Rights Reserved.
EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
CHAPTER 1:
INTRODUCTION
CHAPTER 1 INTRODUCTION 1
INTRODUCTION
SEATTLE
2 ©2020 Deloitte Development LLC, NATIONAL ASSOCIATION OF REALTORS®, RERC. All Rights Reserved.
EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
2019 DELOITTE DBRIEFS POLL The number of responses for these survey would continue to grow in a slow to mod-
RESULTS: EXPECTATION AND MARKET questions ranged from 2,869 to 3,803. See est pace in 2019, down from 41.5% of the
REALITIES IN REAL ESTATE 2019 Exhibits 1-A through 1-E for charts of the poll respondents in 2018. There was an increase
results. in the percentage of respondents who said
Since 2011, the authors of this report have the economy would be weak with little or no
used the Deloitte Dbriefs platform to show- The 2019 Dbriefs poll participants showed growth without support from the Fed – 15.2%
case the results of our report. Each year, the less confidence in the state of the economy in 2019 compared to 2.0% in 2018.
webcast participants are polled to gauge and a more pessimistic view of the CRE
their sentiment about the market. Nearly market compared to 2018. Only 9.6% of the In terms of the CRE market, only 9.6% of the
5,000 people attended the 2019 webcast and respondents believed that the economy respondents believed that robust transac-
nearly 4,000 people participated in the poll, would hit on all cylinders in 2019, compared tion volume and price appreciation would
which was conducted on Feb. 5. to 20.5% in 2018. Additionally, 34.0% of the continue in 2019, compared to 19.5% in 2018.
respondents believed that the economy The highest number of respondents — 34.0%
EXHIBIT 1-A. DELOITTE Dbrief POLL RESULTS — WHAT IS YOUR VIEW OF THE STATE OF THE ECONOMY?
Finally Hitting on All Cylinders — Full Speed Ahead Touch and Go — Still Trying to Get Its Bearings Downturn Likely This Year
Continued Slow to Modest Growth Expected Weak — Would See Little/No Growth Without Federal Support Don’t Know/Not Applicable
60
50
40
Percent
30
20
10
0
2014 2015 2016 2017 2018 2019
Sources The Deloitte Dbriefs Real Estate Series, Expectations and Market Realities in Real Estate, February 2019.
EXHIBIT 1-B. DELOITTE Dbrief POLL RESULTS — WHAT IS YOUR VIEW OF THE CURRENT STATE OF CRE?
Robust Transaction Volume and Price Appreciation Continue Flattening or Sluggish Transaction Volume and Pricing Deceleration on the Way
Gradual Slowing of Deal Volume and Price Increase Uncertainty Not Sure
60
50
40
Percent
30
20
10
0
2011 2012 2013 2014 2015 2016 2017 2018 2019
Sources The Deloitte Dbriefs Real Estate Series, Expectations and Market Realities in Real Estate, February 2019.
CHAPTER 1 INTRODUCTION 3
EXHIBIT 1-C. DELOITTE Dbrief POLL RESULTS — TO WHAT EXTENT DO YOU EXPECT COMMERCIAL REAL ESTATE VALUES
TO CHANGE OVER THE NEXT 12 MONTHS?
More Stress -15% to -2% Moderate Improvement +2% to +5%
Minimal -2% to +2% Robust Strengthening +5% to +15% Not Sure
60
50
40
Percent
30
20
10
0
2012 2013 2014 2015 2016 2017 2018 2019
Sources The Deloitte Dbriefs Real Estate Series, Expectations and Market Realities in Real Estate, February 2019.
— believed that the CRE market was experi- generally increasing since 2012, except for and availability would remain the same in
encing a gradual slowing of deal volume and dips in 2016 and 2019. After ranking No. 3 2019, nearly identical to 30.6% in 2018. The
price increase, slightly less than 34.8% in the among the sectors from 2011 through 2016, percentage of respondents suggesting they
previous year. Only 4.3% of the respondents it surpassed office for No. 2 in 2017, and has would seek riskier positions declined from
believed that the CRE market would expe- remained there since. 24.8% in 2018 to 19.7% in 2019.
rience a deceleration in 2019, but that was
still higher than 2.7% in 2018. While respon- Since 2012, the office sector’s favorability has CRE FORGES AHEAD AS A PREFERRED
dents in 2018 were split between anticipating been in the 11%-16% range. The office prop- ASSET CLASS
minimal change (-2% to +2%) and moderate erty type was the most favorable investment
improvement (+2% to +5%) in CRE values opportunity for 13.3% of respondents in 2019, Since the GFC, CRE has been a preferred asset
over the next 12 months, respondents in 2019 down from 14.0% in 2018 but up from its low class, offering investors solid risk-adjusted
were more likely to expect minimal change point of 11.5% in 2017. Its peak was in the first returns. CRE is a tangible asset, offering rela-
(40.1%) than moderate improvement (28.3%). year of the survey, 2011, at 17.5%. tive safety during a downturn in the form of
income returns while offering higher yields
Slightly more than a third of the respondents The percentage of those favoring the retail compared to bonds. As we continue into the
said that multifamily assets had the most sector increased slightly from 7.1% in 2018 to long expansion cycle, we expect that uncer-
favorable investment opportunity in 2019 7.6% in 2019. Dating back to 2011, the retail tainty will continue to play a primary role in
based on recent performance of fundamen- sector has ranked as the second-least favor- investment decisions. Investors are likely to
tals. Multifamily respondents represented able sector. The percentage of respondents keep a risk-off approach, backing away from
the largest percentage at 35.3% among the who viewed retail as the most favorable high-risk assets such as stocks to retreat to
property types though it was down slightly investment opportunity generally fell every safe-harbor investments.
from 36.8% in 2018. This continued a down- year from 2011 through 2014, rose in 2015,
ward trend in opinions about the multifam- dropped again in 2016, and remained in the The relative performance of CRE compared to
ily sector. In 2017, 46.8% of respondents said 6% to 8% range the past three years. benchmark low-risk investments will drive
multifamily would offer the most favorable investment activity moving forward. With
investment opportunity; its favorability has Hotel was rated the least favorable invest- 10-year Treasury yields falling quarter over
been in the 35%-47% range since 2012. Mul- ment opportunity, with only 5.3% of the quarter (QOQ) and cap and discount rates
tifamily has ranked highest among all the respondents preferring the asset class. Hotel flat, spreads widened in 3Q 2019, according
property types since the poll began in 2011, has been the least-favorable sector in every to analysis from RERC Research, as they have
when 29.2% favored the sector. year of the polling. Nonetheless, 2019 repre- for three consecutive quarters, to reach the
sented an increase from 4.0% in 2018. largest in three years (see Exhibit 3-B). This
The industrial/warehouse sector was means that CRE investors are getting a higher
deemed favorable by 18.2% of respondents Dbriefs participants believed that capital risk premium despite no perceived risk
in 2019, down from 20.4% in 2018, but still availability for CRE in 2019 would remain increases in CRE. Cap rate spreads over the
higher than 2017, when the percentage was comparable to that of 2018. About 30% of 10-year Treasury are now above the three-
14.0%. The sector’s popularity has been the respondents believed that the standards year, five-year and 10-year averages. Moody’s
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
EXHIBIT 1-D. DELOITTE Dbrief POLL RESULTS — PROPERTY TYPE INVESTMENT OPPORTUNITY
WHICH PROPERTY TYPE DO YOU VIEW AS OFFERING THE MOST FAVORABLE INVESTMENT OPPORTUNITY BASED ON RECENT PERFORMANCE OF FUNDAMENTALS?
Office 17.5% 13.1% 12.3% 13.0% 16.0% 14.0% 11.5% 14.0% 13.3%
Industrial/Warehouse 11.9% 10.0% 11.1% 12.4% 12.8% 10.4% 14.0% 20.4% 18.2%
Multifamily 29.2% 45.8% 46.8% 45.5% 35.5% 40.7% 46.8% 36.8% 35.3%
Retail 9.4% 8.4% 8.4% 6.5% 8.3% 7.7% 6.8% 7.1% 7.6%
Hotel 4.7% 3.7% 3.2% 4.4% 6.0% 6.9% 3.8% 4.0% 5.3%
Not Sure 27.4% 19.1% 18.2% 18.2% 21.4% 20.3% 17.1% 17.7% 20.3%
Sources The Deloitte Dbriefs Real Estate Series, Expectations and Market Realities in Real Estate, February 2019.
EXHIBIT 1-E. DELOITTE Dbrief POLL RESULTS — HOW DO YOU VIEW THE OUTLOOK FOR CAPITAL AVAILABILITY FOR
COMMERCIAL REAL ESTATE IN 2020 VERSUS LAST YEAR?
Tighter standards and less availability Expanding capital reaching out to riskier positions
Same standards and availability Too much capital resulting in broad-market aggressive pricing Not Sure
60
50
40
Percent
30
20
10
0
2011 2012 2013 2014 2015 2016 2017 2018 2019
Sources The Deloitte Dbriefs Real Estate Series, Expectations and Market Realities in Real Estate, February 2019.
Baa and Aaa yield rates also declined QOQ the Federal Open Market Committee (FOMC) trade negotiations and solid economic data,
in 3Q 2019, pushing cap rate spreads higher. decreased the target rate range for the first which pushed investors into riskier posi-
Cap rate spreads over both Moody’s Baa and time since 2008 in an attempt to keep the tions.13 Despite the upward trend in yield
Aaa have increased for three consecutive economy humming and followed up with late in the year, the 10-year Treasury rate
quarters and are the widest in almost seven identical quarter-point cuts in September and declined 77 bps between December 31, 2018
years. Cap rate spreads over both these bond October.12 The rate cuts undoubtedly helped and December 31, 2019.14
rates exceed the three-year, five-year and the overall economy, while the inflation rate
10-year averages. remained in the 2.0% range for the year. An We note that on January 31, 2020, the yield
accommodative FOMC will likely continue to curve between the 10-year and three-month
THE INTEREST RATE ENVIRONMENT keep short-term interest rates low in 2020. Treasurys (10y-3m curve) inverted. In 2019,
the 10y-3m curve was inverted for about 4½
The U.S. economy has appeared to reach The 10-year Treasury rate was volatile in months.15 Research from the Federal Reserve
a sweet spot where the economy has been 2019. After sharply declining through August of San Francisco found that the 10y-3mo
growing and the unemployment rate drop- 2019, the 10-year yield reversed course and spread had a predictive accuracy between
ping without sparking any appreciable increased 45 basis points (bps) by the end 85% and 89% for indicating recessions one
increase in the inflation rate. In July 2019, of the year. This followed advancements in year out.16 This has renewed investor concern
CHAPTER 1 INTRODUCTION 5
over a possible recession in 2021, though the was $12.6 trillion as of January 27, 2020, the of the U.S.22 A large portion of the holders of
extremely low rates over the past decade pos- highest level in two months but well below U.S. debt are retired or soon-to-be retirees
sibly makes drawing parallels to previous the historical high of $17 trillion set in who have their portfolios in risk-free U.S.
recessions possibly problematic. August 2019, according to Bloomberg.17 Still, Treasurys. Many federal programs, includ-
negative interest rates, which up until five ing Social Security, Medicare and Medicaid,
The impact of interest rates on CRE depends years ago seemed absurd, have now become are also heavily invested in Treasurys, mean-
on economic growth and spreads between almost commonplace. The European Central ing these public programs would most likely
cap and discount rates and interest rates. Bank (ECB) turned to negative interest rates lose money on the aggregate due to negative
RERC Research data show that cap rate com- in response to the region’s debt crisis and interest rates.
pression has stalled over the past couple of dangerously low inflation.18 Several other
years but remains at historically low levels, countries followed suit. As of November RISKS IN 2020
despite market participants’ concerns about 2019, the central banks of Sweden, Switzer-
a long-in-the-tooth expansion. Assuming land, Denmark, the Eurozone and Japan had GEOPOLITICS
economic fundamentals remain positive negative interest rates. The economies of
over the year, the low interest rates could these countries account for nearly 25% of the Geopolitical uncertainty makes it difficult
kick-start cap rate compression again. global economy.19 In December 2019, Sweden for investors to predict and/or adapt to eco-
increased its borrowing rate to zero, but it nomic shifts, or to financial or governmental
If capital flows continue to intensify due to remains to be seen if the change will impact policies and regulations. In 2019, many coun-
declining interest rates, CRE pricing will likely Sweden’s economy. The change is probably tries were rocked by street protests involving
increase; this makes rational underwriting moot for pension funds, as it does nothing to varying amounts of violence by either the
standards even more important. Remember encourage saving.20 protesters or law enforcement agencies sent
that a 50 bps decline in the cap rate translates to quell them. Among the places that faced
to a 10% increase in price. Historically low Could the U.S. adopt negative interest rates? protests were Hong Kong, Chile, Saudi Arabia,
short- and long-term interest rates have driven There is nothing stopping the U.S. from mov- India, Bolivia, Spain, Iraq, Iran, Russia and
a substantial across-the-board increase in ing into negative interest rates, but several Sudan.23 These violent clashes do not include
property prices in nominal and real (infla- issues would arise should the U.S. decide to the ongoing armed conflicts and civil wars
tion-adjusted) terms. But as long as funda- take that plunge. One of the biggest fears is throughout the Middle East, Africa and East-
mentals are strong, underlying values will that the FOMC would not have any tools left ern Europe and economic or government col-
support high prices. However, we are seeing to employ when the next downturn occurs.21 lapses in Venezuela, Lebanon and Moldova.24
an increasing bid-ask gap at such high prices. Global investors might lose faith in the safety With international geopolitical turmoil, the
Sellers are often taking deals off the market of U.S. government bonds as negative inter- U.S. has become a relatively attractive desti-
and instead refinancing at ultra-low rates. est rates and other forms of quantitative eas- nation for investment capital as investors flee
This has left buyers with few quality options. ing may be perceived as a sign of weaknesses to safety. Additionally, the resilient U.S. econ-
in the economy. In addition, the portfolios omy, combined with favorable interest rate
NEGATIVE INTEREST RATES: FROM of millions of U.S. investors would likely be differentials relative to the rest of the world,
ODD TO ORDINARY hurt. According to the Office of Management adds to the attractiveness of U.S. assets to for-
and Budget, $16.8 trillion of the govern- eign investors.
The total amount of negative yielding bonds ment’s $22.7 trillion debt is held by the public
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
BREXIT the Trump administration is setting its eyes on additional uncertainty for investors. While
a new trade deal with the UK.29 the final candidates will not be known until
British Prime Minister (PM) Boris Johnson, mid-2020, there are several policy proposals
who took office on July 24, 2019, called snap The U.S., for the first time in four years, does from Democratic primary candidates that
elections in December and built a large not have any openly outstanding issues with would likely affect investors. In addition to
majority (365 of 630 seats) in Parliament for any of its trade partners, but it’s unclear how these proposed policies, we discuss current
his Conservative Party. On January 9, the long this will last. Tensions remain between policies and regulations that are impacting
Parliament, on a 330 to 231 vote, formally the U.S. and France; the EU has condemned the capital markets in chapter 3.
approved Brexit, nearly three years after the the Phase One trade deal, and the EU might
nationwide referendum. Johnson’s plan is not take kindly to a trade deal between the They almost uniformly want to repeal all or
similar to one pushed by former PM Theresa U.S. and the UK. 30 ,31 most of the tax bill that Congress approved
May, but it adds a controversial customs bor- and President Trump signed into law at the
der in the Irish Sea between Northern Ireland Under the U.S.-China trade deal, China will end of 2017.37 This tax bill lowered the maxi-
and the rest of the UK. The UK officially left purchase an additional $200 billion in exports mum corporate income tax from 35% to 21%.
the EU on January 31, 2020.25 over two years from American farmers and Sens. Elizabeth Warren and Bernie Sand-
other exporters.32 The U.S., in turn, will can- ers and former Mayor Pete Buttgieg want to
The UK will remain under EU rules of trade cel tariffs on $156 billion in goods and cut restore the 35% rate; former Vice President
until December 31, 2020. Johnson has said the tariff rate on $120 billion in goods from Joe Biden supports a 28% top rate; and Sen.
he expects to strike a trade deal with the EU 15% to 7.5%.33 The financial markets have Amy Klobuchar favors a 25% rate.
by the end of the year, but European Com- responded well to the Phase One agreement,
mission President Ursula von der Leyen has but given that past deals have fallen through, The estate tax, which Republicans have
said that’s not enough time and she believes some investors are skeptical that Phase One been trying to eliminate for years, currently
the UK will leave without a new trade deal will come to fruition or that it will have much applies to individuals who inherit more than
in place.26 Brexit has already cost the UK impact in the long run.34 China agreed to $11.4 million with a top rate 40%.38 Sanders
roughly 130 billion pounds (US$170 billion), cut tariffs in half on about $75 billion of U.S. has proposed lowering the threshold to $3.5
and it’s expected to cost another 70 billion imports in response to the U.S. reducing tar- million. The tax rate would be 45% for those
pounds (US$91 billion) by the end of 2020.27 iffs on Chinese goods. Though the Phase One in the $3.5-10 million range; 50% for $10-50
deal is a step in the right direction, both sides million; 55% for $50 million to $1 billion; and
TRADE had to make compromises.35 A Phase Two U.S.- 77% for more than $1 billion. Warren pro-
China trade deal would likely lead to greater poses returning to the levels in place when
In the beginning of 2020, several positive economic growth for the U.S., but such a deal George W. Bush took office in 2001: a thresh-
advancements in trade negotiations increased is uncertain. Phase Two negotiations aren’t old of $675,000 and a maximum rate of 55%.39
investor optimism about global economic likely to start until after the U.S. elections, if
growth. The Phase One deal with China was at all.36 The major candidates are also pushing for
signed January 15, the same day that United changes in the treatment and rate of capi-
States-Mexico-Canada Agreement (USMCA) 2020 U.S. ELECTIONS tal gains taxes.40 Biden would eliminate the
was ratified by the U.S. Senate on an 89-10 step-up basis for inherited capital assets
vote.28 And now with Brexit officially in effect, The 2020 election season introduces and end favorable rates on capital gains for
DENVER
CHAPTER 1 INTRODUCTION 7
anyone making over $1 million. Warren, Government’s debt will double by 2023 and
among others, wants to tax capital gains at exceed spending on the U.S. military by
CHICAGO the same rate as ordinary income. 2024.”46 Lower demand for U.S. Treasurys
would lead to higher interest rates and down-
Housing affordability and availability are ward pressure on the dollar, further slowing
also top issues for the candidates.41 Sanders economic growth.47
announced a “Housing for All” plan, with
an emphasis on building more affordable Despite these trends, evidence suggests that
housing and combating gentrification. War- consumers may be showing debt restraint.
ren would expand the National Housing In November 2019, consumers reduced bal-
Trust Fund and provide $445 billion over 10 ances on credit cards and revolving debt by
years to build, preserve and operate rental $2.4 billion.48 This was the largest decline in
homes that are affordable for families with eight months.49
the greatest needs. Warren would also seek
to lower the cost of renting. Buttigieg’s Doug- SECULAR CHANGES
lass Plan is designed to end homelessness for
families with children, fund national invest- DEMOGRAPHICS
ments in affordable housing construction and
expand federal protections for tenants against The U.S. Census Bureau reported that U.S.
eviction. population grew by just 0.5% between 2018
and 2019.50 It was a lower growth rate than
U.S. DEBT during the Great Depression of the 1930s and
the lowest since the population dropped in
U.S. debt levels are at all-time highs. Total 1918 during WWI.51
public debt, which is the total of all govern-
ment borrowing, was approximately $23 tril- Several demographic changes are contrib-
lion at the end of 2020.42 Total public debt as uting to the decline. The number of births
a percent of GDP topped 100% in 4Q 2012 and fell in 2019 in 42 states and Washington,
stood at 105.5% as of 3Q 2019. According to D.C., likely because many millennials are
the Congressional Budget Office (CBO), high waiting to have children. 52,53 With a rapidly
and rising public debt could reduce national aging population, the natural increase in
saving and income, boost the government’s population (the difference between births
interest payments, limit lawmakers’ ability to and deaths) fell below 1 million for the first
respond to unforeseen events, and increase time in decades. Four states — Maine, New
the likelihood of a fiscal crisis.43 Hampshire, Vermont and West Virginia —
even had more deaths than births. The aging
The federal deficit in fiscal year (FY) 2020 is population is a concern in the U.S., with one
projected to be $1 trillion and average $1.3 in five residents projected to be over age 65 by
trillion between 2021 and 2030.44 This consti- 2030. By 2034, older people are expected to
tutes an increase in the deficit to GDP ratio outnumber children for the first time in U.S.
from 4.6% in 2020 to 5.4% in 2030. By com- history.54 With Americans living longer, pro-
parison, deficits have averaged 1.5% of GDP grams for the elderly such as Social Security
over the past 50 years. For FY 2020, net inter- and Medicare will be in a tenuous position as
est payments on current government debt fewer prime-age workers are available to pay
outstanding are projected to account for $479 taxes to support these programs.55
billion, slightly more than 10% of the total
U.S. budget.45 Immigration could offset the slowing natural
population growth; however, fewer immi-
The White House’s FY 2020 budget stated, grants are entering the U.S. An estimated
“If financial obligations continue to grow at 595,000 immigrants moved to the U.S. in
the current pace, the Nation’s creditors may 2019, down from the decade high of nearly 1.1
demand higher interest rates to compensate million in 2016. This number could further
[for the increased risk of default], potentially decline with the Supreme Court’s uphold-
leading to lower private investment and a ing of the Trump administration’s “public
smaller capital stock, harming both Amer- charge” regulation that would allow the
ican businesses and workers. If nothing is government to reject visas and green card
done, interest payments alone on the Federal applications, based on whether an applicant
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
needs or may need public assistance.56 company CFOs say they are feeling increasing
pressure from stakeholders to act on climate
The aging demographic shift and slowing change.61 These CFOs, however, say they lack a LOS ANGELES
U.S. population growth presents challenges thorough understanding of the issue and have
for the U.S. economy. A smaller working-age few plans in place to develop and implement
population means fewer people to drive the comprehensive climate strategies. As the per-
economy. In fact, economists at the Federal ceived threat of climate change has increased,
Reserve Board of San Francisco state that investors have substantially increased their
declining population was likely the main holdings in sustainable or green enterprises.
driver of the slow growth since the Great Climate change exposes companies to transi-
Recession.57 These economists also find that tion risks, including changes in technologies,
when the slowing productivity growth over markets and regulation that can increase
the past several decades is factored in, long- business costs, undermine the viability of
run economic growth is expected to be just existing products or services, or affect asset
1.5%-1.75%. values. RERC Research is noticing that many
investment firms have set up sustainability
CLIMATE CHANGE groups to investigate the financial risks asso-
ciated with climate change.
Climate change around the world is becom-
ing a challenge for investors in commercial The Los Angeles Times reports that one-fifth
and residential real estate – in obvious and of CalPERS’ $394 billion pension fund’s pub-
more subtle ways. lic market investments are in sectors with
high exposure to climate change, including
In the most obvious way, climate change energy, materials and buildings, transpor-
can damage or destroy investors’ properties. tation, and agriculture, food and forestry.62
Hurricanes, for example, are becoming more Climate change has direct financial implica-
destructive. The five most costly hurricanes tions stemming from rising sea levels, stron-
in U.S. history have all occurred since 2005, ger and more frequent storms and heat waves.
including three since 2012, and incurred Besides the challenges from climate change
about $497 billion in damages as of Septem- itself, regulations aimed at reducing carbon
ber 2019.58 emissions, lawsuits against polluters and
market trends like the fast-dropping price of
When Harvey struck the Houston area in renewables exacerbate financial risk for inves-
2017, almost three-quarters of the damaged tors. In September 2019, Gov. Gavin Newsome
homes were outside the Special Flood Haz- issued an executive order directing CalPERS
ard Area, leaving thousands of residents and and CalSTRS to decrease carbon emissions
commercial landowners uninsured. Areas and increase climate resiliency. CalPERS has
facing potentially severe damage (Category pledged to make its portfolio carbon-neutral
3 areas or higher) accounted for one-fifth of by 2050.
the U.S. assets at risk to hurricanes, with a
capital valuation of $16.6 billion.59 On the bright side for investors, the challenge
of climate change gives companies the oppor-
According to an MSCI report,real estate tunity to improve efficiency, spur innovation,
investors have three choices for dealing with and improve their supply chains by not rely-
property damage from climate change:60 ing as much on price-volatile fossil fuels. Most
companies are increasing energy efficiency
• Avoid high-risk areas. and using more climate-friendly equipment.
• Transfer the risk to insurance compa- They earn benefits from government incen-
nies and tenants. In many cases, however, tives and reduced costs.
insurance premiums will rise or become
unattainable. Microsoft pledged in January to be carbon
• Control the impact of these risks by work- negative by 2030 and to “remove from the
ing with regulators or implementing their environment all the carbon the company has
own plans. emitted either directly or by electrical con-
sumption since it was founded in 1975.”63 In
But the challenge goes beyond potential prop- addition, it plans to start a $1 billion climate
erty damage. According to a report by Deloitte, innovation fund.
CHAPTER 1 INTRODUCTION 9
DALLAS
Green tech offers investors a multitril- Nareit All Equity REITs Index, REITs deliv- transactions. Like most technologies in the
lion-dollar opportunity in the years ahead ered a 27.9% return through November 2019. financial sector, however, blockchain faces
in a variety of areas, including battery stor- With continued expected growth and low a serious lag between its development and
age, urban mobility, renewables, software vacancy rates, 2020 remains favorable for implementation.73 Even when blockchain is
and artificial intelligence to help under- REITs.68 fully developed, it will likely have to pass
stand climate data, the food production through the gauntlet of state and Securities
ecosystem, building construction and even The latest development in fintech for CRE is and Exchange Commission (SEC) regula-
fashion sustainability, because clothing has the introduction of REIT ETFs on no-com- tions before it can be implemented.
a life cycle of waste.64 Many of these areas mission websites and apps. Apps such as
are directly or at least indirectly related to Robinhood and websites such as Fidelity THE 2020 DELOITTE COMMERCIAL
CRE trends and performance. Investments, TD Ameritrade and Charles REAL ESTATE OUTLOOK74
Schwab are offering zero-commission trades
Nonetheless, many companies aren’t on REIT exchange-traded funds (ETFs).69 Digital technology and analytics are at the
involved in much long-term efforts or coor- These ETFs, including Vanguard’s Real forefront of CRE secular changes, accord-
dinating with other companies to act on cli- Estate ETF (VNQ) and Schwab’s U.S. REIT ing to the 750 CRE professionals surveyed
mate change. Companies need to not only ETF (SCHH), have expense ratios of less for the 2020 edition of Deloitte’s Commer-
measure their exposure to climate-related than 0.2%, which allows easier and cheaper cial Real Estate Outlook: Using digital and
risks and subsequently manage them, but investment in CRE than ever before.70 analytics to revolutionize tenant experience
also incorporate climate change in their report.
strategic plans. Failure to do so can under- Another fintech development that may
mine the sustainability of their businesses, impact CRE is the introduction of block- DIGITIZATION AND TENANT EXPERIENCE
according to Deloitte.65 chain. Not to be confused with cryptocur-
rencies, which will likely have no effect on Tenant experience needs to be a top prior-
TECHNOLOGY AND THE CRE CRE, blockchain is the underlying technol- ity for CRE professionals, and that requires
INVESTMENT ENVIRONMENT ogy of cryptocurrencies and could poten- companies to put tenants and end-user pref-
tially have a huge impact in every financial erences at the center of every business deci-
REITS AND FINTECH sector.71 sion. Creating superior experiences extends
beyond tenants; it requires extending ser-
Passive investing in CRE has been around An article by Nareit states that blockchain vices to day-to-day consumers of the space,
since President Dwight D. Eisenhower has the ability to completely transform CRE including retail shoppers, residents in mul-
signed Public Law 86-779, sometimes called by creating efficiencies in things like prop- tifamily properties, employees in office
the Cigar Excise Tax Extension of 1960. This erty and title searches, financing, leasing, space or manufacturers using warehouses.
act effectively created real estate investment purchasing and selling, due diligence, man-
trusts or REITs.66 REITs are considered the aging cash flows, payment management, The on-demand economy is reshaping
best route for people who want to be pas- and cross-border transactions.72 This would tenant expectations about how real estate is
sive investors in CRE. As of September 2019, reduce risks and costs in CRE transactions. consumed, and technology-enabled facili-
the REITs market owned $3 trillion in gross Blockchain is in its infancy, but it could ties and personalized experiences are trans-
real estate assets.67 According to the FTSE lead to cheaper and smoother real estate forming CRE. Environmental and security
10 ©2020 Deloitte Development LLC, NATIONAL ASSOCIATION OF REALTORS®, RERC. All Rights Reserved.
EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
technological investments will improve the as more tenants seek flexible leases rather
experience for tenants, who are expecting than traditional leases based on a specific
these features in smart or Internet of Things time period. AI can significantly increase NEW YORK CITY
(IoT)-enabled buildings. Luxury retail the speed and accuracy of mundane tasks in
brands have embraced sensor-enabled tech- lease administration – and more accurately
nologies, such as smart mirrors in fitting detect duplication and fraud while helping
rooms that use smart lighting to help cus- to evaluate potential earnings for new ten-
tomers see outfits in different lighting. ants and existing lease renewals. In the pro-
cess, AI can be used to help generate new
Tenants are willing to pay a premium to live revenue sources, for example, by collecting
or work in smart buildings. Smartphones data about people’s movements within a
and tablets can provide security features building that can be sold to advertisers or
such as app-based entry into buildings and urban planners.
property management or emergency contact
information, building information, includ- DIGITAL REALITY
ing maintenance updates and sustainabil-
ity efforts, and advice about local points Digital reality (DR), which includes aug-
of interest. For CRE organizations, mobile mented reality (AR), virtual reality (VR),
apps can provide notifications about events, mixed reality (MR), 360-degree videos and
tenant handbooks and newsletters, and immersive technologies, is not limited to the
contact information. entertainment industry. DR is being used in
CRE. Residential brokers first used VR to
THE GROWING IMPORTANCE OF DATA offer property tours 24-7, and now it is being
used similarly to sell office, industrial and
Adoption of mobile apps from tenants and restaurant properties. It can help customize
occupiers can give insightful data about ten- properties to each tenant’s preference. DR
ants’ experiences. This allows CRE owners can increase worker precision at job sites
and operators to improve predictive capabil- and supervisors can get 360-degree views
ities and offer unique experiences to every of a site.
user. CRE companies need to develop plat-
forms, processes and a governance struc- DATA SECURITY
ture that enable data discovery, availability,
management and usability. Data analytics Smart buildings can collect reams of data
can use the information to enhance deci- and personal information about tenants,
sion-making and improve operating perfor- employees and customers, which increases
mance. Data ownership should be outlined the risk of exposure to cyberattacks. Per-
at the start of a service contract to avoid con- petrators can also attack building systems
fusion on usage. such as security, life safety, heating, venti-
lation and air conditioning. Governments
ARTIFICIAL INTELLIGENCE (AI) and regulators around the world are intro-
TECHNOLOGY USE WITH CRE ducing stricter rules to protect personal data
and privacy. As a result, CRE leaders need to
AI technologies can evaluate sets of tradi- work continuously to improve cybersecurity
tional and alternative data quickly and accu- and increase privacy.
rately. AI’s predictive ability can improve
profitability and returns and automate
redundant tasks while improving tenant-re-
lated decisions, modernizing leases and
helping create new revenue sources. It also
can evaluate trends and patterns to pre-
dict tenant behavior and turnover and help
make informed decisions about selecting
tenants. In the process of all this, however,
companies may need to hire employees with
specialized AI skills.
Another opportunity is automating lease
administration. This is especially important
CHAPTER 1 INTRODUCTION 11
SOURCES
1
Merriam-Webster, “forge,” accessed Feb. 11, 2020.
2
Bureau of Economic Analysis, “Gross Domestic Product, Fourth Quarter and Year 2019 (Advance Estimate),” Jan. 30, 2020.
3
U.S. Bureau of Labor Statistics, “Databases, Tables & Calculators by Subject,” accessed Feb. 7, 2020.
4
The Conference Board, “Consumer Confidence Survey,” Jan. 28, 2020.
5
Federal Reserve Bank of St. Louis, “Personal Income,” December 2019, updated Jan. 31, 2020.
6
Bureau of Economic Analysis, “National Data,” accessed Feb. 10, 2020.
7
Ibid.
8
U.S. Bureau of Labor Statistics, “Real Earnings — December 2019,” Jan. 14, 2020.
9
Institute for Supply Management, “January 2020 Manufacturing ISM Report on Business,” Feb. 3, 2020.
10
RCA, 3Q 2019.
11
CRE fundamentals data are provided by CoStar Market Analytics (www.costar.com), 3Q 2019. The information is provided “As Is” and without any representations, warrantees or guarantees.
12
Jeanna Smialek, The New York Times, “Federal Reserve Cuts Interest Rates for Third Time in 2019,” Oct. 30, 2019.
13
Federal Reserve Bank of St. Louis, “10-Year Constant Maturity Rate,” Feb. 6, 2020.
14
U.S. Department of the Treasury, “Daily Treasury Yield Curve Rates,” accessed Feb. 11, 2020.
15
Chuck Jones, Forbes, “Recession Signal Is Raising Its Ugly Head Again,” Feb. 1, 2020.
16
Michael D. Bauer and Thomas M. Mertens, Federal Reserve Bank of San Francisco, “Information in the Yield Curve about Future Recessions,” Aug. 27, 2018.
17
Sam Potter and John Ainger, Bloomberg, “World’s Pile of Negative Debt Surges by the Most Since 2016,” Jan. 27, 2020.
18
Jana Randow and Yuko Takeo, Bloomberg, “Negative Interest Rates,” Nov. 1, 2019.
19
Ibid.
20
Rafaela Lindeberg, Bloomberg, “A $100 Billion Fund Manager Lists His Fears as Sweden Hits Zero,” Jan. 1, 2020.
21
Yahoo! Finance, “Yahoo! Finance Features Marcus & Millichap’s President and CEO Hessam Nadji Stocks vs. Real Estate: 2020 Investment Strategy,” Jan. 29, 2020.
22
Federal Reserve Bank of St. Louis, “Federal Debt Held by the Public,” Dec. 11, 2019.
23
Declan Walsh and Max Fisher, The New York Times, “From Chile to Lebanon, Protests Flare Over Wallet Issues,” Oct. 23, 2019.
24
Council on Foreign Relations, “Global Conflict Tracker,” Feb. 7, 2020.
25
House of Commons Library, “Brexit and the Northern Ireland Border,” Jan. 14, 2020.
26
Phil Serafino, Bloomberg, “Von Der Leyen Says Brexit Transition May Not Happen by End 2020,” Dec. 27, 2019.
27
Ben Winck, Markets Insider, “Brexit Cost for UK Will Soar to $260 Billion This Year: Study,” Jan. 10, 2020.
28
Eric Wasson, Bloomberg, “Senate Passes USMCA, Giving Trump a Win Before Impeachment Trial,” Jan. 16, 2020.
29
Shawn Donnan and Jenny Leonard, Bloomberg, “With Brexit Done, Trump Sets Himself Up to Be Disruptor Again,” Feb. 3, 2020.
30
Jonathan Stearns, Bloomberg, “Europe Threatens Legal Challenge to U.S.-China Trade Pact at WTO,” Jan. 16, 2020.
31
Shawn Donnan and Jenny Leonard, Bloomberg, “With Brexit Done, Trump Sets Himself Up to Be Disruptor Again,” Feb. 3, 2020.
32
William Mauldin, Lingling Wei and Alex Leary, The Wall Street Journal, “U.S., China Agree to Limited Deal to Halt Trade War,” Dec. 14, 2019.
33
Ibid.
34
Bloomberg, “China to Cut Tariffs 50% on U.S. Goods Spelled Out in Deal,” Feb. 5, 2020, updated on Feb. 6, 2020.
35
Bob Davis and Lingling Wei, The Wall Street Journal, “How the U.S. and China Settled on a Trade Deal Neither Wanted,” Jan. 13, 2020.
36
Ibid.
37
Andersen, “2020 Presidential Candidates’ Tax Proposals — Business,” Dec. 5, 2019.
38
Carmin Chappell, CNBC, “Bernie Sanders Proposes a Big Hike in the Estate Tax, Including a 77% Rate for Over $1 Billion,” Jan. 31, 2019.
39
Allison Bell, ThinkAdvisor, “Warren Kicks Off Presidential Campaign, Offers Estate Tax Proposal,” Jan. 7, 2019.
40
Rocky Mengle, Kiplinger, “New Hampshire Primary: Tax Plans for All 11 Democratic Presidential Candidates,” June 25, 2019, updated Feb. 7, 2020.
41
Julia Falcon, Housing Wire, “Here are the 2020 Presidential Candidates’ Plans for Affordable Housing,” Jan. 13, 2020.
42
Federal Reserve Bank of St. Louis, “Federal; Debt” Total Public Debt,” Dec. 11, 2019.
43
Congressional Budget Office, “The Budget and Economic Outlook: 2020 to 2030,” Jan. 28, 2020.
44
Ibid.
45
White House, “A Budget for a Better America,” Fiscal Year 2020 Budget for the U.S. Government, accessed Feb. 12, 2020.
46
Ibid.
47
Kimberly Amadeo, the balance, “The US Debt and How It Got So Big,” Dec. 14, 2019.
48
Vince Golle, Bloomberg, “U.S. Consumer Borrowing Cools on Drop in Credit-Card Balances,” Jan. 8, 2020.
49
Ibid.
50
United States Census, “2019 U.S. Population Estimates Continue to Show the Nation’s Growth is Slowing,” Dec. 30, 2019.
51
David Welna, NPR, “U.S. Population Growth In 2019 is Slowest In A Century,” Dec. 31, 2019.
52
United States Census, “2019 U.S. Population Estimates Continue to Show the Nation’s Growth is Slowing,” Dec. 30, 2019.
53
Neil Vigdor, The New York Times, “U.S. Population Makes Fewest Gains in Decades, Census Bureau Says,” Dec. 30, 2019.
54
United States Census, “Older People Projected to Outnumber Children for First Time in U.S. History,” March 13, 2018.
55
Joseph Zeballos-Roig, Markets Insider, “US Population Growth is the Lowest It’s Been Since 1918. Here’s Why That’s Terrible News for the Economy,” Jan. 11, 2020.
56
Camilo Montoya-Galvez, CBS News, “Supreme Court Greenlights Trump’s ‘Public Charge’ Rule to Restrict Legal Immigration,” Jan. 27, 2020.
57
John Fernald and Huiyu Li, FRBSF Economic Letter, “Is Slow Still the New Normal for GDP Growth?” June 24, 2019.
58
Gillian Mollod, Will Robson, MSCI, “Climate Risk in Private Real Estate Portfolios: What’s the Exposure?” Oct. 2019.
59
Ibid.
60
Ibid.
61
Dr. Michela Coppola, Thomas Krick and Dr. Julian Blohmke, Deloitte Insights, “Feeling the Heat? Companies are Under Pressure to Act on Climate Change and Need to Do More,” May 2019.
62
Julia Rosen, Los Angeles Times, “Climate Change Threatens Billions in CalPERS Pension Fund,” Dec. 19, 2019.
63
Kara Swisher, New York Times “When Will Companies Finally Step Up to Fight Climate Change?” Jan. 23, 2020.
64
Ibid.
65
Dr. Michela Coppola, Thomas Krick and Dr. Julian Blohmke, Deloitte Insights, “Feeling the Heat? Companies are Under Pressure to Act on Climate Change and Need to Do More,” May 2019.
66
Bloomberg, “Money Stuff: Carlos Ghosn Is Looking for a Judge,” Jan. 8, 2020.
67
Nareit, “REITs by the Numbers,” accessed Feb, 12, 2020.
68
Nareit, “Nareit’s 2020 REIT and Economic Outlook,” accessed Feb. 12, 2020.
69
James Royal, Bankrate, “In the Race to Zero-fee Broker Commissions, Here’s Who the Big Winner Is,” Oct. 4, 2019.
70
ETFDB, ”Real Estate ETFs,” Feb. 6, 2020.
71
Nathaniel Popper, The New York Times, “What is the Blockchain? Explaining the Tech Behind Cryptocurrencies,” June 27, 2018.
72
Clay Risher, Nareit, “How Blockchain Could Transform Real Estate,” Oct. 24, 2018.
73
Ibid.
74
This section provides a summary of the 2020 Deloitte Commercial Real Estate Outlook report. To download the full report, visit https://www2.deloitte.com/us/en/insights/industry/financial-services/
commercial-real-estate-outlook.html
12 ©2020 Deloitte Development LLC, NATIONAL ASSOCIATION OF REALTORS®, RERC. All Rights Reserved.
EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
CHAPTER 2:
THE ECONOMY
Percent
national Monetary Fund (IMF) projected
world output to expand at a slower pace of 2
3% in 2019, its lowest level since 2008-2009,
from 3.6% in 2018.1 The OECD also expected 1
global GDP growth to slow to 2.9% in 2019,
down from 3.5% in 2018.2 Meanwhile, the 0
World Trade Organization (WTO) expected 2017 2018 2019
world trade to expand at a slower pace of Note G20: GDP Constant Prices (SA, QOQ Change)
2.6% in 2019 from 3% in 2018.3 GDP for the Source OECD, 2Q 2019.
G20 is found in Exhibit 2-A.
China was expected to grow at subdued ($1.15 trillion). 4 China.7 The Section 301 tariffs are on top of
pace of 6.1% in 2019 (6.6% in 2018), with the 25% tariff on imports of steel and alu-
growth continuing to decelerate to 5.8% in Trade tensions simmered down on Decem- minum authorized from all countries under
2020, according to IMF estimates. China’s ber 13, 2019, when the U.S. and China set- Section 232 of the Trade Expansion Act of
economic growth started easing in 2015 in tled on an agreement in which the U.S. 1962, which took effect on March 23, 2018.
the wake of regulatory reforms to curb debt suspended the additional 15% duty on The tariffs for imports from Mexico and
accumulation — a positive step toward a Annex C of about $160 billion of imports.5 Canada were removed in May.8 China has
stronger financial system and economy, but This included imports of cellphones and imposed retaliatory tariffs on about $185
one that has slowed down growth from the computers under Tranche 4, which was billion of imports from the U.S.9
torrid 10% expansion during 2001-2010. The scheduled to take effect on December 15,
U.S.-China trade tensions created another 2019, in exchange for at least $200 billion in The reduction in global trade has impacted
headwind for the economy. According to U.S. goods and services exports to China.6 export-dependent economies such as Ger-
China’s State Administration of Foreign As of October 1, 2019, the U.S. had already many, which narrowly escaped a recession
Exchange, China imported 5% less ($928 imposed 30% tariffs on $250 billion of Chi- in the first three quarters of 2019, managing
billion) in goods in the first half of 2019 on nese imports under Section 301 of The Trade to eke out 0.1% growth in 3Q.10 The German
a YOY basis, while it exported just 1% more Act of 1974, nearly half of U.S. imports from government has cited the negative impact
LONDON
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
HONG KONG
of the U.S.-China trade war on its economy, expanding, but the October 1, 2019, increase with the EU takes firmer shape.
particularly on the car industry and the net- in the consumption tax might may rein in
work of suppliers that account for about 14% consumer spending in 2020, so growth is According to IMF estimates, Latin America
of the German economy.11,12 expected to slow to 0.5% in 2020. and Caribbean economies were expected
to show little growth – 0.2% in 2019 (1% in
In Canada, growth slowed to 1.5% in 2019 In Europe, an accommodating monetary 2018) amid the continued collapse of the
(from 1.9% in 2018), with growth expected to policy has propped up economic growth. Venezuelan economy and weaker invest-
improve slightly to 1.7% in 2020, according to In 2016, the ECB further loosened monetary ment spending.19 Investors are assessing
the Bank of Canada.13 Canada’s economy is policy, bringing the interest rate down to 0% the economic policy changes arising from
heavily tied to the oil and gas industry, which, on its refinancing operations that provide the new leadership in Mexico, Argentina and
in turn, is highly dependent on the U.S. econ- main source of liquidity to the banking sys- Brazil. Brazil, which relies heavily on Chi-
omy, which takes in 96% of Canada’s oil tem on top of the negative rate it imposed on nese imports of soybean, fuels and iron ore,
exports.14 In the first three quarters of 2019, bank deposits (currently at -0.5%) in 2016 to is expected to post a modest growth rate of
U.S. crude imports from Canada fell 10% YOY. encourage bank lending.17 The IMF projected 0.9% in 2019.20
the euro area to expand at a slower pace of
The IMF expected Japan’s economy to grow 1.2% in 2019 (1.9% in 2018), with growth THE U.S. ECONOMY
modestly by 0.9% in 2019, due to weaker slightly improving to 1.4% in 2020.18 The
exports to the U.S., China and Europe, UK economy is expected to grow 1.2%, with GDP
especially of autos and electronics.15,16 Con- growth improving slightly to 1.4% in 2020 as
sumer and investment spending are still the outlook for the terms of Britain’s exit deal Amid global tensions, an inversion of the
EXHIBIT 2-B. PERSONAL CONSUMPTION EXPENDITURES AND PRIVATE NONRESIDENTIAL FIXED INVESTMENT
Real Personal Consumption Expenditures (%Chg) Real Private Nonresidential Fixed Investment (%Chg)
15
10
0
Percent
-5
-10
-15
-20
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019*
Millions
Percent
130 6
With a supporting monetary policy that 5
kept up job growth, consumer spending 120 4
3
outweighed the contraction in investment
110 2
spending that occurred for the second 1
consecutive quarter. The FOMC paused on 100 0
2001 2003 2005 2007 2009 2011 2013 2015 2017 2019
increasing its policy rates in the first half of
2019 and lowered policy rates three times Source BLS, November 2019.
in the second half (July 31, September 18,
and October 30), reducing the federal funds
rate by a total of 75 basis points, to a range EXHIBIT 2-D. ANNUAL PRIVATE PAYROLL EMPLOYMENT
of 1.5% to 1.75%. This was the first time the Retail trade
Utilities
FOMC lowered policy rates since 2008.
Mining and logging
Information services
Gross private fixed investment contracted Management of companies
Finance & insurance
for two straight quarters as non-residential Wholesale Trade
investment spending contracted to an annual Real estate rental and leasing
rate of -2.3% in the third quarter. Investment Arts, ent., rec
Manufacturing
spending for structures contracted for two Other services
straight quarters to an annual rate of -9% in Transportation and warehousing
Adm & waste services
3Q 2019. Business spending for equipment Educational services
also contracted to an annual rate of -3.8% in Construction
3Q 2019. In contrast, residential investment Professional and tech services
Accommodation & food
spending rose at an annual rate of 4.6% in Health care
3Q 2019 as declining mortgage rates led to a -100 0 100 200 300 400 500 600
Thousands
recovery in home sales (see Housing section Source BLS, November 2019.
in this chapter).
While businesses cut back on spending, EXHIBIT 2-E. ANNUAL PERCENT CHANGE IN PAYROLL EMPLOYMENT GROWTH
consumers continued to spend at a healthy YOY change
pace, as employment rose and wage growth
3.22 0.03
outpaced inflation. Personal consumption
expenditures, which typically accounts for
roughly 70% of GDP, increased at an annual
rate of 3.2% in 3Q 2019 (see Exhibit 2-B).
Consumer spending for all items increased
except for clothing and shoes and gasoline
and fuel. Spending on durable consumer
goods rose a hefty 8.1%, bolstered by spend-
ing for recreational vehicles (17.0%) and
household furnishings and durable house-
hold equipment (6.0%).
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
5
Millions
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
6
Southern states led by Utah (3.2%), Nevada
4
(3.1%), Washington (2.7%), Florida (2.7%),
2
Arizona (2.6%), Texas (2.5%), New Mexico
0
(2.2%), South Dakota (2.2%), Colorado (2%)
-2
and Alabama (2%).
-4
2012 2013 2014 2015 2016 2017 2018 2019
HOUSING
Source NATIONAL ASSOCIATION OF REALTORS®, October 2019.
After the FOMC paused on increasing the
federal funds rate in 2019, existing home
sales measured on a seasonally adjusted
annual rate started to pick up in May 2019,
according to the NATIONAL ASSOCIATION
OF REALTORS® (see Exhibit 2-F). Existing
home sales on a seasonally adjusted annual
rate (SAAR) started off slowly at 4.93 million
in January 2019, but picked up steam during
the year, hitting an annual rate of 5.46
million by October 2019. The U.S. Census
Bureau also reported that single-family new
home sales rose to a seasonally adjusted
annual rate of 733,000 units as of October
2019 from 557,000 one year ago.
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
behind by about 7 million units relative to EXHIBIT 2-J. RENTAL VACANCY RATES IN 2019
demand based on household formation alone Rental Vacancy Rate
as of September 2019. 11.8 2.1
OF REALTORS® (Exhibit 2-I). Strong price There is a lack of rental housing as well, using growth is up by at least 5% from one year
gains were registered in areas such as Spo- rental vacancy rates as an indicator. Nation- ago as of November 2019 in areas such as
kane, Washington (12.6%); Salt Lake City, ally, the rental vacancy rate stood at 6.8% as Phoenix (7.7%), Los Angeles (5.4%), River-
Utah; (12%); Boise City, Idaho (10.3%); of 3Q 2019, according to U.S. Census Bureau side-San Bernardino (4.8%), Minneapolis
Albuquerque, New Mexico (9.6%); Grand data. Rental vacancy rates are below 5% in (4.8%), Tampa-St. Petersburg (4.6%), and
Rapids-Wyoming, Michigan (9.1%); Indi- states such as Minnesota (2.1%), Utah (3%), Atlanta (4.6%). Annual rent growth for
anapolis-Carmel, Indiana (9.5%); Char- Montana (3.4%), Massachusetts (4.2%), Cal- other metros is found in Exhibit 2-K. Nearly
lotte-Concord-Gastonia, North Caroli- ifornia (4.3%), Washington (4.4%), Colorado 50% of renters spend at least 30% of their
na-South Carolina (8.7%); Columbus, Ohio (4.6%), and New Jersey (4.7%). See Exhibit 2-J income on gross rent in 2018, according to
(7.4%); Nashville-Davidson-Murfreesboro, for rental vacancy rates. NATIONAL ASSOCIATION OF REALTORS®’s
Tennessee (6.5%); and Las Vegas-Hender- analysis of the 2018 American Community
son, Nevada (6.3%). Given the tight rental vacancy rates, rent Survey data.
ATLANTA
20 ©2020 Deloitte Development LLC, NATIONAL ASSOCIATION OF REALTORS®, RERC. All Rights Reserved.
EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
SOURCES
1
International Monetary Fund, Table 1.1, “World Economic Outlook, October 2019,” October 2019.
2O
OECDiLibrary, “OECD Economic Outlook, Volume 2019 Issue 2,” accessed February 7, 2020. Note: The members of the G20 are Argentina, Australia, Brazil, Canada, China, France, Germany, India,
Indonesia, Italy, Japan, Republic of Korea, Mexico, Russia, Saudi Arabia, South Africa, Turkey, the United Kingdom, the United States and the European Union.
3
World Trade Organization, “Global trade growth loses momentum as trade tensions persist,” April 2, 2019. Note: As of 2018, the World Trade Organization reported China as the second world’s largest
importer, importing $2.1 trillion worth of goods, or nearly 11% of total world imports, next to the United States that imported $2.6 trillion, or 13% of world imports.
4
State Administration of Foreign Exchange, “International Trade in Goods and Services of China Updated to December 2019,” Feb. 3, 2020.
5
Federal Register, “Notice of Modification of Section 301 Action: China’s Acts, Policies, and Practices Related to Technology Transfer, Intellectual Property, and Innovation,” Dec. 18, 2019.
6
Ibid.
7
Federal Register, “Notice of Modification of Section 301 Action: China’s Acts, Policies, and Practices Related to Technology Transfer, Intellectual Property, and Innovation,” Aug. 30, 2019. Note: The
Section 301 tariffs were issued under three tranches or lists: 25% tariff on $34 billion Tranche 1 issued in March 2018 that took effect June 2018; 25% tariff on $16 billion Tranche 2 issued in June
2018 that took effect August 2018; 25% on $200 billion Tranche 3 (10% tariff issued on July 2018 and raised to 30% on September 2018 that took effect May 2019). The tariffs on Tranche 1, 2, and 3
increased to 30% on October 1. In August 2019, the U.S. Trade Representative imposed a 10% additional duty (from 25%) on $300 billion of Chinese goods separated in List 1 of Annex A of the August
2019 notice to take effect on September 1, 2019 and List 2 of Annex C to take effect on December 15, 2019. The 10% tariff on List 2 was later increased to 15%.
8
U.S. Customs and Border Protection, “Section 232 Trade Remedies on Aluminum and Steel,” Sept. 3, 2019.
9
China Briefing, “The US-China Trade War: A Timeline,” Nov. 11, 2019.
10
Trading Economics, “Germany GDP Growth Rate,” accessed Feb. 12, 2020.
11
Paul Carrel, Reuters, “German industrial output drop fuels recession risk,” Sept. 6, 2019.
12
Ashoka Mody, Market Watch, “Opinion: Germany is a diminished giant, and that spells trouble for Europe,” Jan. 29, 2019.
13
Bank of Canada, “Monetary Policy Report – October 2019,” Oct. 30, 2019.
14
Natural Resources Canada, “Crude Oil Facts,” Aug. 9, 2019.
15
International Monetary Fund, Table 1.1, “World Economic Outlook,” October 2019.
16
Ben Dooley, The New York Times, “Japan Posts Surprising Growth but Economic Threats Loom,” August 8, 2019.
17
European Central Bank, “Key ECB interest rates,” accessed Feb. 12, 2020.
18
International Monetary Fund, Table 1.1, “World Economic Outlook,” October 2019.
19
Ibid.
20
Pedro Rafael Vilela, Agencia Brasil, “Brazil plans to export goods with higher value-added to China,” May 2019.
21
Bureau of Labor Statistics, “Job Openings and Labor Turnover Survey,” November 2019.
CHAPTER 3:
THE CAPITAL
MARKETS
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
CHARLOTTE
on a case-by-case basis, and sometimes a funds questions. U.S. real estate. This has been seen in other
unit-by-unit basis. The fear is that regulated industries that decreased market frictions
stock will deteriorate and tenants will move In response to FIRPTA, there has been sig- by implementing, for example, zero-com-
to market-rate projects that continue to nificant pressure to decrease the scope of mission brokerage accounts for the investor
maintain their properties. the law and ultimately repeal it. In Octo- and have grown in the last four to five years.
ber 2017, the House Ways and Means Com- These other industries have grown in the
FIRPTA UPDATES mittee asked the Treasury Department to last four to five years. By decreasing finan-
repeal IRS Notice 2007-55, which imposes cial market frictions, CRE could potentially
The Foreign Investment in Real Property FIRPTA on foreign owners of a domestically see an uptick in growth more comparable to
Tax Act of 1980 (FIRPTA) imposes a capital controlled REIT when the REIT liquidates.10 that in the equity markets. In addition, the
gains tax on foreign investors in U.S. real potential increase in foreign investment from
estate.4 This tax does not occur in any other The Notice has arguably increased the cost a repeal of FIRPTA would have the combined
asset class and is considered discriminatory of investing in U.S. real estate and decreased result of driving new investment, economic
against foreign investors.5 FIRPTA is argued foreign investment in CRE. In April 2019, Rep. development, construction and job growth in
to have discouraged capital investment that John Larson, D-CT, and Kenny Marchant, communities across the country.
could be used to create jobs and improve U.S. R-TX, introduced the Invest in America Act
real estate and infrastructure.6 RERC Research (H.R. 2210), which would repeal FIRPTA.11 CECL STANDARD
posits that the law as it stands currently hin- According to the Real Estate Roundtable, the
ders foreign investors and deters the growth law would remove an outdated tax regime Beginning in January 2020, a new account-
of CRE markets. The Real Estate Roundtable that discriminates against foreign investment ing standard, the current expected credit
argues that to repeal FIRPTA would attract as and constrains the ability to mobilize private losses methodology (CECL), took effect for
much as $125 billion in global investments.7 capital for job-creating new investments.12 In public companies that are U.S. GAAP con-
December 2019, 11 senators sent a bipartisan forming.15 CECL replaces the allowance for
In 2015, FIRPTA was modified to exempt letter to the Treasury Department seeking loan and lease losses (ALLL). The CECL
foreign pension funds and double the repeal of Section 2 of IRS Notice 2007-55.13 Sec- standard is relatively unique because its
amount foreign investors may invest in a tion 2 applies U.S. capital gains tax to certain implementation has not been a finance-only
U.S. REIT. These reforms in 2015 increased types of real estate transactions that were not effort. In order for successful implementa-
foreign investment in U.S. real estate by treated as taxable by FIRPTA before.14 The tion, there must be changes to governance,
33%.8 In 2018, Congress passed clarifica- repeal of this section would decrease the cost modeling, credit analysis, information tech-
tions for FIRPTA involving foreign pension of investing in U.S. real estate and in theory nology and financial reporting.16 According
funds. The technical corrections state that increase investment in U.S. real estate; specif- to the Federal Reserve, CECL requires that
a wide variety of pension funds qualify for ically, it would increase investment in REITs. expected losses be estimated over the life of
the exemption.9 Following a clarification in a loan, whereas ALLL required losses to be
June 2019, the U.S. Treasury Department RERC Research believes that the repeal of stated when they are incurred.17 CECL affects
released proposed regulations that should FIRPTA would decrease financial market entities holding loans, debt securities, trade
solve most, if not all, of the foreign pension frictions, thus increasing investment in receivables and off-balance-sheet credit
NAREIT Index (Equity REITS)2 28.49% 20.70% 9.03% 11.07% 13.59% 9.37%
Dow Jones Industrial Average2 18.43% 3.84% 16.30% 12.23% 13.51% 9.48%
26 ©2020 Deloitte Development LLC, NATIONAL ASSOCIATION OF REALTORS®, RERC. All Rights Reserved.
EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
September, and October meetings. At the EXHIBIT 3-B. RERC RESEARCH HISTORICAL CAP RATES
end of October, the target range was 1.5% to IRR vs. 10-Year Treasury Yield Going-In vs. 10-Year Treasury Yield
800
1.75%. The FOMC cited slowing global eco-
nomic growth and geopolitical uncertainty, 700
especially the U.S. trade war with China, 600
as the causes of the more aggressive policy
INVESTMENT ALTERNATIVES 2
1
According to RERC research, the preference
for CRE declined QOQ from 5.9 to 5.7 (on a 0
scale of 1 to 10, with 10 being excellent) in 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
3Q 2019 (Exhibit 3-E). However, the rating Source Federal Reserve Board, December 2019.
is still one of the highest over the past two
years and remains the top investment alter-
native – as it has been for the past three
quarters. With 3Q 2019 Treasury yields at
the lowest in three years, the preference
for bonds fell from 4.3 to 3.6 and was rated EXHIBIT 3-D. CONSUMER PRICE INDEX (CPI)
as the least preferred investment alterna- Core CPI CPI All Items
tive compared to other asset classes. QOQ, 6
the preference for cash also declined. The 5
RERC Research CRE Attractiveness Index 4
increased slightly from 111 in 2Q 2019 to 114 3
in 3Q 2019. Other than 4Q 2018, the Index
2
Percent
Rating
capital availability had been on a generally 5
upward trend since 4Q 2016. Capital avail-
ability may rise in the coming months as an
4
effect of the Fed’s short-term rate cuts and
the prolonged low 10-year Treasury rate.
3
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Discipline of capital decreased slightly QOQ
(from 6.6 to 6.4) and was slightly lower Source RERC Research, 3Q 2019.
than the 6.5 rating in 3Q 2018. As availabil-
ity of capital has generally increased over
the past few years, discipline has followed decreased considerably, from 7.8 to 7.3; how- continues to grow.
the same general upward trend, indicating ever, it remained the same YOY. Following
that underwriting standards are rational — the same trend as availability, equity dis- CRE DEBT MARKETS
unlike what happened just prior to the GFC. ciplined declined QOQ, but remained the
The 3Q 2019 RERC Research Underwriting same YOY. Throughout the first three quar- According to RCA, the LTV ratio for the
Index, which examines the extent to which ters of 2019, equity availability and disci- apartment sector rose from 66% in the
the availability of capital and discipline of pline were the closest in alignment since beginning of the year to 69% by August
underwriting standards are aligned, indi- RERC Research began collecting these data. 2019. On the other hand, there was more
cates that availability of capital is exceeding fluctuation in the LTV ratio for commercial
discipline. However, the value of the index The availability of debt capital declined (office, industrial and retail) with a range of
remains relatively low compared to histori- slightly in 3Q 2019 but remained the same 51% to 63% during the first three quarters of
cal data; underwriting standards are keep- YOY. The 3Q 2019 debt availability rating 2019, reaching 62% in August 2019.
ing the high capital availability in check. remained among the highest in four years.
Debt discipline was the same QOQ and Data on debt yield ratios were provided by
For the past five years, RERC Research has down only slightly YOY. Debt discipline RCA. Debt yield ratios increased slowly from
been analyzing separately the availability was slightly above the five-year average. 10.8% in January 2019 to 11.1% in August
and discipline of capital for debt and equity. Broadly speaking, underwriters have main- 2019 for the commercial sector. Debt yield
tained their level of discipline over the past ratios for the apartment sector hovered
In 3Q 2019, the availability of equity capital few years, even as debt capital availability around 8.6% during the year, but fell to
PHOENIX
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
8.3% in August 2019. Debt yield ratios were EXHIBIT 3-F. COMMERCIAL REAL ESTATE DEBT UNIVERSE
below the high of 15% in 2010 for the com- 7% 49% U.S.-Chartered Depository Institutions
mercial sector and the high of 10.5% for the
apartment sector recorded in 2004. 13%
CMBS, CDO and other ABS
RCA provided trends analysis regarding the 2%
debt service coverage ratio (DSCR). Accord- Life Insurance Companies
ing to RCA’s methodology, DSCR is provided
through commercial mortgage-backed secu-
Foreign Banking Offices in U.S.
12%
rities (CMBS) tapes and only includes ratios
Government-Sponsored Entities (GSEs)
between 1 and 2.5. The commercial DSCR
was volatile during 2019 — starting the year
17% Other
at 2.15, sliding to 1.84 in April but climbing
back to 2.01 in August. The apartment sec-
tor was slightly more stable, with the DSCR
at 1.46 in January, falling 1.41 in May and Source Federal Reserve Board, compiled by RERC Research, 3Q 2019.
climbing to 1.53 in August. The volatility in
the ratio could be, in part, due to trade war
tensions rising in May 2019 and investors remained relatively flat in 3Q 2019, with investments. For commercial and multifam-
having concerns about the ability to service only 0.03% of the balance of commercial ily mortgage debt investments combined,
the high leverage moving forward. and multifamily mortgages held by life banks and thrifts registered the largest
insurance companies and only 0.04% of the increase in their holdings — $24.9 billion
According to Commercial Mortgage Alert balance of multifamily mortgages held by or 3.5%. The same report stated that total
(CMA), spreads tightened in 2019.27 As of Freddie Mac being delinquent.28 The delin- CMBS outstanding was $514.2 billion as of
December 20, spreads on AAA conduits quency rate for CMBS was 2.29% in 3Q 2019. 3Q 2019.
were S+87, below the 52-week average of
89. Spreads of BBB conduits were S+285, MBA reported that commercial and mul- According to MBA, originations grew
lower than the 52-week average of 303. tifamily mortgage debt outstanding roughly 24% in 3Q 2019 YOY.30 Commercial
The decreasing spreads were ascribed to increased by $75.7 billion in 3Q 2019.29 The and multifamily mortgage loan originations
an increase in demand due to end-of-the- total commercial and multifamily debt out- rose 9% in 3Q 2019 QOQ. Originations rose
year portfolio adjustments and an influx of standing stood at $3.59 trillion at the end for health care, industrial, office and mul-
investors unable to find enough subordinate of 3Q 2019, with multifamily mortgage debt tifamily properties, while retail properties
paper in the primary market. outstanding at $1.5 trillion — an increase of and hotel originations fell YOY.
$40.6 billion or 2.8% from the second quar-
The Mortgage Bankers Association (MBA) ter. The increase was backed by agency and RERC Research estimates the composi-
reported that delinquency rates for com- government-sponsored entity (GSE) portfo- tion of the CRE debt universe, as seen in
mercial and multifamily mortgage loans lios and mortgage-backed securities (MBS) Exhibit 3-F. Key investors in the debt market
DETROIT
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
investment in the U.S. in 2019. The decrease EXHIBIT 3-H. COMMERCIAL REAL ESTATE NET ACQUISITIONS
Cross-Border Inst’l/Eq Fund Listed/REITs Private User/Other Unknown
is attributed to more stringent Chinese cap- 35
ital controls that have been implemented
over recent quarters. Investment from Ger- 25
many increased 198% YOY, allowing it to 15
become the second largest foreign investor.
5
$ Billions
Per RCA, the biggest changes in investor com- -5
position were evident in a 52% pullback of
-15
capital by foreign investors in the first three
quarters of 2019 versus the first three quar- -25
ters of 2018. Through the first three quarters -35
of 2019, institutional investors increased 2018 2019
acquisitions by nearly 13% YOY along with Note Data reflect first three quarters of each year.
private investors who increased acquisitions Source RCA, 3Q 2019.
by 4.5% YOY compared to the first three quar-
ters of 2018. A list of major transactions, as
reported by RCA, can be found in Exhibit 3-I. EXHIBIT 3-I. REAL ESTATE TRANSACTIONS
Since the recovery began, private CRE prices, NAME: 30 Hudson Yards PLACE: New York, NY
as measured by the RCA Commercial Prop-
BUYER: Related Companies JV Alliance SF/UNITS: 1,463,234 OFFICE
erty Price Index (CPPI), have exceeded their
pre-recession peaks for all property types, SELLER: WarnerMedia
except retail (Exhibit 3-J). But are property
valuations in line with these price increases?
According to RERC Research, solid property
fundamentals are underlying strong valua-
tions, and these valuations are supporting NAME: Coca-Cola Building PLACE: New York, NY
the high prices. Favorable economic condi-
BUYER: SHVO JC Bilgili Holding SF/UNITS: 354,000 OFFICE
tions, including historic employment gains,
are expected to allow further room for rent SELLER: Nightingale Properties JV Wafra
growth. The RCA CPPI National All-Property
Index rose 2.1% QOQ in 3Q 2019. The index
was up 6.4% YOY in 3Q 2019.
According to transaction data from RCA, NAME: Waldorf Astoria Boca Raton PLACE: Boca Raton, FL
overall volume for the first three quarters BUYER: MSD Capital SF/UNITS: 1,047
of 2019 was down 1.6% from the first three HOTEL
quarters of 2018 (see Exhibit 3-K). Total office SELLER: Blackstone
volume decreased 5.5% YOY in 2019, with the
majority of the transacted volume in the sub-
urban office sector, which was on par with
suburban office volume one year ago. Central
business district (CBD) office, on the other NAME: Lord & Taylor (Manhattan) PLACE: New York, NY
hand, increased 13.4% YOY as of 3Q 2019, BUYER: Rhone Group JV The We Company SF/UNITS: 667,350 RETAIL
but made up only 40% of total transaction
SELLER: Hudson’s Bay Company
volume. Medical office volume was down
13.1% YOY. Cap rates for the overall office sec-
tor reached their pre-GFC low of 6.5% in 2016
and have increased only slightly in recent
quarters to 6.7% in 3Q 2019 (see Exhibit 3-L
NAME: Levi’s Plaza PLACE: San Francisco, CA
for cap rates by property type).
BUYER: Jamestown SF/UNITS: 931,160 OFFICE
Overall industrial transaction volume in SELLER: Gerson Bakar & Associates JV Interland Corp
3Q 2019 increased by 63% from 3Q 2018,
and ramped up from the prior quarter by
over 108%, according to RCA. Warehouse Source RCA, 3Q2019.
160
140
120
100
$ Billions
80
60
40
20
0
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Source RCA, 3Q 2019.
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
rating remained slightly overpriced QOQ at EXHIBIT 3-L. COMMERCIAL PROPERTY CAP RATES
4.8, but was closer to equilibrium than a year Retail Office Industrial Apartment
ago, when it was 4.5. After trending down- 10
ward between 2014 and 2017, the rating has
been less predictable over the past two years
as investors note the extreme bifurcation in 8
the sector. Investors are finding it extremely
Percent
difficult to sell any mall below prime Class A,
according to RERC Research.
6
MILWAUKEE
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
CHAPTER 4:
THE PROPERTY
MARKETS
40
Percent
0
20
0 -5
-20
-10
-40
-60 -15
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Source CoStar Market Analytics (www.costar.com),3Q 2019. The information is provided “As Is” and without any representations, warranties or guarantees.
50
to 49.6 million, a 9% drop YOY. Office funda-
40
mentals can be found in Exhibit 4-A.
30
The office sector is highly sensitive to eco- 20
nomic conditions. During the GFC, the sector 10
experienced negative net absorption, which 0
increased the vacancy rate to 13% in 2010, 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
according to CoStar market data. Source RCA, 3Q 2019.
36 ©2020 Deloitte Development LLC, NATIONAL ASSOCIATION OF REALTORS®, RERC. All Rights Reserved.
EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
other New York City boroughs where office EXHIBIT 4-C. OFFICE AVERAGE PRICE PER SQUARE FOOT
space is much cheaper. Office space in North- CBD Suburban All
ern New Jersey, at $158 per SF, is about one 600
sixth of the price in Manhattan.
500
Among markets with at least $1 billion in sales
during the first three quarters of 2019, the 400
PPSF ($)
largest increases in office sales volume were
in metros with a booming technology indus- 300
try: San Francisco ($8.7 billion; 149.4% YOY);
Boston ($6.5 billion; 54.6% YOY), Seattle ($6.1 200
billion; 34.7% YOY), San Jose ($5.6 billion;
71% YOY), Washington, D.C. ($3.2 billion; 100
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
11.6% YOY), Austin ($2.5 billion; 112% YOY),
East Bay ($2.0 billion; 8% YOY), Charlotte Source RCA, 3Q 2019.
($1.2 billion; 27% YOY) and Nashville ($1 bil-
lion; 30% YOY).
EXHIBIT 4-D. OFFICE AVERAGE CAP RATE
10-Year Treasury Yield Average Cap Rate
For transactions of at least $2.5 million, the 10
average price per SF for commercial office
space rose to $315 in 3Q 2019, a 15% gain YOY 8
(see Exhibit 4-C). Price per SF in CBD rose a
hefty 62% to $539 per SF, while suburban 6
office space price per SF rose at a much more
Percent
120
Cap rates fell to a low of 6.4% in 2016 and
moved up only slowly to 6.7% in 3Q 2019 (see 100
Exhibit 4-D). The gap between cap rates and
SIOR CRE Index
80
the 10-year Treasury bond widened to about
4.9 percentage points, from 3.6 percentage 60
points in 4Q 2018. The wider gap reflects the 40
higher uncertainty and risk outlook of inves-
tors compared to one year ago. 20
0
Members of the Society of Industrial and 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Office REALTORS® (SIOR) reported that office Source Society of Industrial and Office REALTORS®, NATIONAL ASSOCIATION OF REALTORS®, 3Q 2019.
market activity and market conditions were
still broadly strong in 3Q 2019 compared to
one year ago. The SIOR CRE Index-Office year ago. 2019 Q3 Commercial Real Estate Quarterly
was at 116.5 (Exhibit 4-E). However, the index Market Survey. The sales and leasing diffu-
has been trending downward since 1Q 2018, REALTORS® who typically do business in sion indices for office properties were above
indicating weakening growth. The index is the small CRE market where transactions 50, which means more respondents reported
based on 10 indicators of development activ- are typically below $2.5 million reported that an increase than a decrease in transactions
ity, sales/acquisitions and leasing. An index the office market was still broadly strong in in 3Q 2019 compared to one year ago. The dif-
above 100 means that the office market was 3Q 2019 from one year ago, according to the fusion indices were highest in the apartment
broadly “strong” in 3Q 2019 compared to one NATIONAL ASSOCIATION OF REALTORS® and industrial markets.
100 4
Percent
0 2
0
-100
-2
-200 -4
-300 -6
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Source CoStar Market Analytics (www.costar.com),3Q 2019. The information is provided “As Is” and without any representations, warranties or guarantees.
$ Billions
Percent
6
a 41% drop from 3Q 2018, according to data 80
from CoStar (see Exhibit 4-F).3 However, net 4 60
completions were still up 9%, with 227 mil- 40
2
lion SF of space completed YOY in 3Q 2019. 20
The increase in net completions indicates that 0 0
investors remain bullish about the industrial 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
market’s medium- to long-term prospects. Source Census Bureau, 3Q 2019.
With completions outpacing absorption, the
vacancy rate edged up slightly from 4.7% to
5.1% one year ago. Despite the slight uptick, a higher return compared to office property million or more.
the vacancy rate is about half that of the office acquisitions, which had a total return of 7.5%.
sector. Rent growth for industrial space moderated to Industrial properties sales transactions
5.1% in 3Q 2019 from 6.4% one year ago. increased in both the six major markets (New
The demand for industrial space is driven York City metro, Boston, Washington, D.C.,
heavily by e-commerce sales, which has expe- SALES TRANSACTIONS metro, Chicago, San Francisco metro, and
rienced explosive growth. As of 3Q 2019, the Los Angeles metro) as well as the non-major
Census Bureau reported e-commerce retail In the first three quarters of 2019, sales trans- markets. The six major markets took in $27.7
sales of $145.7 billion, or 10.5% of the $1.3 actions totaled $77.7 billion, an 18% increase billion of investments, while the other metro
trillion total retail sales (see Exhibit 4-G). In YOY, based on data from RCA (see Exhibit areas got the bulk of investments, $49.9 bil-
2000, retail e-commerce was less than 1% of 4-H). Driving the expansion was warehouse lion. In the first three quarters of 2019, Los
retail trade. transactions, which totaled nearly $63.7 bil- Angeles had the largest volume of industrial
lion (82% of total industrial transactions vol- property acquisitions ($4.4 billion; 30%
Investors on average had a total return on ume). Warehouse sales transactions were up YOY). Chicago was the second top destination
their industrial property investment of 10.8% 26% YOY in the first three quarters of 3Q 2019. although it garnered fewer acquisitions com-
in 3Q 2019, with the bulk due to an income While sales volume for warehouses rose, sales pared to one year ago ($4.0 billion: -11% YOY).
return of 6.7% and 4.1% from price appre- volume for flex office space decreased slightly The metro areas with at least $1 billion in sales
ciation, based on CoStar market data. The to $13.9 billion, a 7% decline YOY. The total volume and that increased in transactions vol-
return on industrial property investments has dollar volume of industrial transactions has ume YOY were: Inland Empire ($3.4 billion,
moderated from about 15% in 2015, but indus- grown phenomenally in the past two decades 11% YOY), Northern New Jersey ($2.7 billion,
trial property investments are still yielding from $16 billion in 2001 for transactions of $2.5 28% YOY), Orange County ($2.4 billion, 76%
38 ©2020 Deloitte Development LLC, NATIONAL ASSOCIATION OF REALTORS®, RERC. All Rights Reserved.
EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
YOY), New York City boroughs ($2.1 billion, EXHIBIT 4-H. INDUSTRIAL ACQUISITIONS
50% YOY), Seattle ($2 billion, 19% YOY) and Flex Warehouse All
East Bay ($2 billion, 39% YOY). 45
40
The average price per SF for industrial space 35
rose to an average of $110 as of 3Q 2019, up 30
Volume ($ Billions)
16% YOY (see Exhibit 4-I). Flex space aver-
25
aged $165 per SF, up 11%, while warehouse
20
space averaged $98 per SF, up 17%. In the
six major metro areas, the price per SF rose 15
to $170, up 12% from one year ago. Price per 10
SF in the non-major metro markets are about 5
half the cost, at $85 per SF, with prices rising 0
at a stronger pace of 18%. The top five most 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
expensive areas industrial spaces in price Source RCA, 3Q 2019.
per SF were Manhattan ($1,379), San Fran-
cisco ($515), San Jose ($295), Washington, D.C.
($288) and Los Angeles ($223). Compared to EXHIBIT 4-I. INDUSTRIAL AVERAGE PRICE PER SQUARE FOOT
these metro areas, the price for an industrial Flex Warehouse All
property are a bargain in Chicago ($78) Dallas 180
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
Dive article, the most sought-after markets for EXHIBIT 4-L. RETAIL (SHOPS AND STRIP CENTERS) VOLUME AND PRICING
e-retailer pop-up locations are New York, Los Shops Volume Centers Volume Shops Price Centers Price
500
Angeles and Toronto, while the most desired 35
Volume ($ Billions)
Percent
7
5
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
experienced a high mark, where the average the market compared to the last five years,
price per SF for 3Q 2019 of $226 and $258, as private investors have once again
respectively, is the greatest reported in over become the biggest player in the market.
a decade. This is the first time that average Institutional/fund investors have slightly
price per SF for the retail market as a whole increased their share of the buyer pool, from
has been greater than $200 per SF since 3Q 11% in 2018 to 12% YTD as of 3Q 2019. REITs
2016, which may have investors looking opti- position in the pool has fluctuated over the
mistically toward the future. past five years, ranging from18% in 2015 to
4% in 2018, according to RCA. As of 3Q 2019,
AVERAGE RETAIL REITs made up 11% of the buyer pool, which
PROPERTY CAP RATES represents a 61% increase YOY, while user/
other investors remain consistent with only
Average cap rates are slowly increasing, 4% of the buyer pool. Cross-border investors
rising 10 bps YOY since 3Q 2018, according have dramatically decreased their involve-
to RCA, which shows cap rates climbing ment in the market by 86% YOY, making up
slightly from 6.5% at the start of 2018 to 6.6% 5% of the buyer pool as of 3Q 2019, down
in 2019, with a spread of 489 bps over the from 34% in 2018.
10-year Treasury (see Exhibit 4-M).16 Within
the subcategories, cap rates were mostly The lender pool proportions appear largely
stable in 2019 compared to 2018, except for the same as years prior, with the exception
two subcategories. A 70-basis point increase of a change in the largest player between
occurred in the big box submarket since the 2018 and 2019, according to RCA. Regional/
start of 2018, with the cap rate starting at local banks make up the largest share of the
6.7% and sitting at 7.4% as of 3Q 2019. Cap lender pool at 27%, passing CMBS, which
rates declined from 8.9% in 4Q 2017 to 5.0% make up 18% of the lender pool. This rep-
in 4Q 2018 but increased 240 bps to 7.4% by resents a low point for CMBS over the past
3Q 2019. This significant fluctuation in the five years, with their share of the market
submarket could suggest instability. How- decreasing from a high of 33% in 2018.
ever, the cap rate for the mall subcategory Financial/fund institutions have had the
decreased 110 bps from 6.8% in 1Q 2018 to most significant increase in their presence
5.7% in 3Q 2019. With the large fluctuation in the market, making up 19% of the lender
of sales in the mall submarket, these cap pool, up from 7% in 2018. Additionally,
rate changes are not surprising. these lenders account for 54% of the lender
pool for malls, as they attempt to help out
INVESTOR COMPOSITION the struggling submarket. National banks
and insurance agencies have remained sta-
According to RCA, private investors ble, making up 15% and 12% of the pool,
increased their share of the buyer pool YTD respectively, with international banks and
in 3Q 2019 to own the majority at 64% as of private/other agencies combined compris-
3Q 2019. This has essentially normalized ing the remaining 10% of the lender pool.
42 ©2020 Deloitte Development LLC, NATIONAL ASSOCIATION OF REALTORS®, RERC. All Rights Reserved.
EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
6
200
4
150
Millions of SF
Percent
100 0
-2
50
-4
0 -6
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
The information provided is “As Is” and without any representations, warranties or guarantees.
Source CoStar Market Analytics, 3Q 2019.
Volume ($ Billions)
120
tor, including changes to the U.S. economy,
30 100
housing affordability, employment trends
80
and changes in the views of many toward 20
60
homeownership. As some investors prepare
10 40
for a potential recession, apartments are also 20
considered attractive given the low ratio of 0 0
capex costs to net operating income (NOI) 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
relative to other property types as noted by Source RCA, 3Q 2019.
RCA.18
A total of $129.9 billion of significant apart- EXHIBIT 4-P. AVERAGE APARTMENT CAP RATES
ment properties was sold in the first three 8
quarters of 2019, resulting in a YOY increase
of 6.4%, based on RCA data (see Exhibit 4-O).
7
This increase is just over half of the increase
from the same period in the prior year, but it
Percent
44 ©2020 Deloitte Development LLC, NATIONAL ASSOCIATION OF REALTORS®, RERC. All Rights Reserved.
EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
EXHIBIT 4-Q. APARTMENT MARKET VACANCY AND EFFECTIVE RENTAL GROWTH RATE
Completions Net Absorption Vacancy Rate Effective Rent Growth
300 6
250 5
200 4
Thousands of Units
Percent
150 3
100 2
50 1
0 0
2014 2015 2016 2017 2018 2019 2020 2021 2022 2023
Shaded area indicates forecast.
Source Moody’s Analytics REIS, 3Q 2019.
included Boston, Baltimore, Tampa and Las peak in 2019, thereafter gradually declining 2009, the vacancy rate fell in each year
Vegas. to 84,246 units in 2023. The total apartment through 2016 – from 8.0% to 4.2% (see
stock as of 3Q 2019 was approximately 11.3 Exhibit 4-Q). Since then, the vacancy rate
A diminishing supply of apartment proper- million units. has inched back up slightly and was at 4.7%
ties, strong sector fundamentals and intense as of 3Q 2019. The vacancy rate is expected to
competition have led to a significant pipeline APARTMENT PROPERTY remain in the 5% range over the next several
of new apartment projects, as developers look FUNDAMENTALS years, per Moody’s Analytics REIS .
to capitalize on the tight market conditions.
According to Moody’s Analytics REIS’ base- According to Moody’s Analytics REIS, annual According to forecast information from
line forecast, 265,199 apartment units were effective rent change was 5.0% in 2018, and Moody’s Analytics REIS for the top 50 mar-
expected to be delivered in 2019, followed by based on YTD information it is forecast to be kets, Chicago, Raleigh-Durham, Denver,
232,522 and 172,221 in 2020 and 2021, respec- 4.2% in 2019.20 Based on Moody’s Analytics Phoenix and Charleston are expected to have
tively.19 A new supply of apartment units has REIS’ baseline forecast, the annual effec- the highest cumulative effective rent change
increased in every year since 2011 — from just tive rent change is projected to continue to by the end of 2023. Of the top 50 markets, the
42,255 units in that year to 264,544 in 2018. decline steadily through 2023 to 2.5%. lowest performing markets are expected to
Based on the projection data from Moody’s be Sacramento, Philadelphia and Hartford.
Analytics REIS, this trend is expected to Since the apartment recovery began in late
Volume ($ Billions)
rates experienced within the last five years.21 20 200
New rooms are still projected to be added in 15 150
the coming year and above the long-term
10 100
average, but fewer will be added than in
2019. Additionally, demand growth trends 5 50
show signs of moderation and are below the
0 0
long-term average. By and large, supply and 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
demand are forecast to remain in equilibrium Source RCA, 3Q 2019.
through 2020 with occupancy and ADR grow-
ing slightly, but in step.22
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
Trades Report show cross-border foreign cap- EXHIBIT 4-T. HOTEL NET ACQUISTIONS BY INVESTOR TYPE
ital investment in the hotel sector increased Cross-Border Inst’l/Eq Fund Listed/REITs Private User/Other Unknown
from $6.5 billion to $10.3 billion YOY, as 20
shown in Exhibit 4-T.30 Cross-border inves- 15
tors completed 11.7% of all hotel acquisitions.
10
Cross-border transactions had an average of
$283K per key, which was down 29.9% YOY. 5
$ Billions
The average cap rate on cross-border transac- 0
tions was 8.4%.31 -5
-10
FUNDAMENTALS
-15
Occupancy was strong yet again in the lodg- -20
ing industry at 66.1%, well above the long-run 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 YTD 2019
average of 62.5%, although early signs point Source RCA, 3Q 2019.
to moderating growth in the upcoming year.32
Similarly, while ADR remains strong, YOY
increases are forecast to be below inflation.33 In EXHIBIT 4-U. HOTEL ADR AND OCCUPANCY
the latest Cushman and Wakefield U.S. Lodg- Occupancy ADR
ing Industry Overview, Smith Travel observed 68 160
48 ©2020 Deloitte Development LLC, NATIONAL ASSOCIATION OF REALTORS®, RERC. All Rights Reserved.
EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
SOURCES
1
CRE fundamentals data are provided by CoStar Market Analytics (www.costar.com), 3Q 2019. The information is provided “As Is” and without any representations, warrantees or guarantees.
2
RCA, 3Q 2019.
3
CRE fundamentals data are provided by CoStar Market Analytics (www.costar.com), 3Q 2019. The information is provided “As Is” and without any representations, warrantees or guarantees.
4
Dr. Lawrence Yun and Gay Cororaton, NATIONAL ASSOCIATION OF REALTORS®, “SIOR Index Shows Continued Weakening in Industrial and Office Markets in 2019 Q3,” 3Q 2019.
5
U.S. Census Bureau, “Advanced Monthly Annual Retail Trade Report,” November 2019.
6
Business Insider, “Latest Characteristics, Research, and Facts,” accessed Feb. 20, 2020.
7
James Savard, Chain Store Age, “Four Tends That Will Dominate Retail Real Estate in 2020,” Jan. 2, 2020.
8
Retail Dive, “Digitally Native Brands Set to Open 850 Stores in 5 Years,” Oct. 10, 2018.
9
Alby Gallun, Crain’s Chicago Business, “Now Even Healthy Malls Struggle to Find Financing,” Nov. 8, 2019.
10
Ibid.
11
Akerman, “Retail Resilience: Adaptation Nation,” Dec. 4, 2019.
12
Colleen Egan, Town Square, “The State of Malls in America,” accessed February 10, 2019.
13
Alby Gallun, Crain’s Chicago Business, “Now Even Healthy Malls Struggle to Find Financing,” Nov. 8, 2019.
14
Retail Dive, “10 Retail Trends to Watch in 2020,” Jan. 6, 2020.
15
RCA, 3Q 2019.
16
Ibid.
17
CRE fundamentals data are provided by CoStar Market Analytics (www.costar.com), 3Q 2019. The information is provided “As Is” and without any representations, warrantees or guarantees.
18
RCA, 3Q 2019.
19
Moody’s Analytics REIS, 3Q 2019.
20
Ibid.
21
CBRE Hotels Research, “Hotel Horizons, December 2019 – February 2020,” Dec. 2019.
22
Ibid.
23
Rodney G. Clough, HVS, “2020 United States Hotel Industry Outlook,” Dec. 18, 2019.
24
RCA, “TrendTracker,” Jan. 2, 2020.
25
RCA, “Trends & Trades,” Dec. 19, 2019.
26
Cushman & Wakefield, “U.S. Lodging Industry Overview,” Mid-Year 2019.
27
RCA, “Trends & Trades,” Dec. 19, 2019.
28
RCA, “RCA Capital Trends Hotel Report,” Dec. 18, 2019.
29
Korpacz/PwC, “National Full-Service Lodging Segment Q3 2019,” Dec. 10, 2019.
30
RCA, “Trends & Trades,” Dec. 19, 2019.
31
RCA “TrendTracker,” Dec. 12, 18, 2019.
32
CBRE Hotels Research, “Hotel Horizons, December 2019 – February 2020,” Dec. 2019.
33
Ibid.
34
Cushman & Wakefield, “U.S. Lodging Industry Overview,” Mid-Year 2019.
35
CBRE, “Q3 2019 U.S. Hotel Figures,” Q3 2019.
36
Cushman & Wakefield, “U.S. Lodging Industry Overview,” Mid-Year 2019.
37
Ibid.
38
Cushman & Wakefield, “U.S. Lodging Industry Overview,” Mid-Year 2019.
CHAPTER 5:
OUTLOOK
CHAPTER 5 OUTLOOK 51
OUTLOOK
ECONOMY EXHIBIT 5-A. 2020 GDP GROWTH SCENARIOS
Lower Case Baseline Upper Case
3.5
MACROECONOMIC OUTLOOK
3.0
The U.S. economy appears set to continue to
2.5
grow in 2020. Global economic conditions are
showing some signs of improvement, while 2.0
Percent
the U.S.-China Phase One trade deal has
1.5
reduced policy uncertainty. Monetary policy
will continue to support growth in 2020. The 1.0
FOMC will likely maintain the federal funds
0.5
rate at the current range of 1.5% to 1.75% to
sustain the U.S. economy given the risks that 0.0
2017 2018 2019 2020
might arise from slower-than-anticipated
global economic growth. Source NATIONAL ASSOCIATION OF REALTORS®, November 2019.
LAS VEGAS
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
however, are being addressed, albeit mod- EXHIBIT 5-B. U.S. ECONOMIC OUTLOOK (BASELINE)
estly, through innovations in housing design
(e.g., micro-apartments, manufactured hous- ACTUAL FORECAST
ing) and some easing of zoning regulations by
local and state governments such as in Cali- 2017 2018 2019 2020
fornia, which has allowed the construction of
accessory dwelling units, and in Oregon and Economic Indicators (Annual Growth Rate*)
Minneapolis, where duplexes and triplexes Real GDP 2.4 2.9 2.1 2.4
can be built in single-family zoned areas.
Nonfarm Payroll Employment 1.6 1.7 1.3 1.2
If housing starts are sustained at a level of 1.36 Annual Change in Non-farm Employment ('000s) 2,272 2,450 2,256 1,854
million in 2020, existing and new-home sales
are likely to surpass 6.3 million (5.56 million Consumer Prices 2.1 2.4 2.0 1.9
of existing home sales and 750,000 of 1-unit Percent
new home sales). With housing starts a little
Unemployment 4.4 3.9 3.7 3.6
above the household formation rate of 1.2 mil-
lion but still short of the 1.6 million needed to Fed Funds Rate 1.0 1.8 2.3 1.7
meet both household formation and replace-
30-Year Fixed Rate 4.0 4.5 4.0 3.8
ment, housing prices are expected to increase
at a modest pace. The median existing-homes
Housing Indicators (Thousands)
sales price is projected to rise by 3.6% to
$280,200 and the median new-homes sales Existing Home Sales** 5510 5340 5362 5560
price is expected to increase by less than 1%
New Single-Family Sales 613 617 678 750
to $314,200.
Housing Starts 1209 1250 1255 1362
CAPITAL MARKETS
Single-Family Units 855 876 870 942
The outlook for the stock market in 2020 is Median Home Prices
positive. Trade tensions seem to be easing;
Thousands of Dollars
the U.S. and China signed Phase One of
their trade deal and the U.S. Senate passed Existing Home Prices 247.2 259.3 270.4 280.2
the United States-Mexico-Canada Agree-
New Home Prices 323.1 326.4 313.5 314.2
ment (USMCA) in January 2020.6 Trade
was one of the top concerns for investors Percent Change — One Year Ago
and corporations in 2019, so the signing of
Existing Home Prices 5.7 4.9 4.3 3.6
these deals should bring stability and lead
to financial market growth in the near term. New Home Prices 5.0 1.0 -4.0 0.2
In Europe, Bloomberg analysts suggest
*Quarterly figures are seasonally adjusted annual rates.
that Brexit might make EU economic con- **Existing home sales of single-family homes and condo/co-ops.
ditions stronger. Meanwhile, Greece seems Source NATIONAL ASSOCIATION OF REALTORS®, November 2019.
to have turned a corner with its economic
hardships. These two trends should bring
more economic stability to the region.7 The
prospect of higher economic stability and
growth in Europe has investors excited to NEW ORLEANS
see how 2020 plays out.
CHAPTER 5 OUTLOOK 53
RERC RESEARCH 10-YEAR TREASURY EXHIBIT 5-C. GDP GROWTH OUTLOOK (BASELINE)
FORECAST ACTUAL FORECAST
RERC Research forecasts the 10-year Treasury 2017 2018 2019 2020
under three different scenarios.9 Historical
Real GDP 2.4 2.9 2.1 2.4
and forecast rates are found in Exhibit 5-D. In
3Q 2019, the 10-year Treasury rate was 1.8%, Personal Consumption 2.6 3.0 2.8 2.9
continuing a downward trend in rates since
Private Investment 4.4 5.1 -0.6 2.1
November 2018. Since third quarter’s end,
however, the rally in the bond market has Nonresidential 4.4 6.4 -0.5 1.4
subsided; the 10-year Treasury rate increased
about 25 bps in the six weeks ending on Residential 3.5 -1.5 -1.0 4.8
November 8. Exports 3.5 3.0 -0.2 0.6
The base case scenario assumes the most Imports 4.7 4.4 0.1 2.2
probable economic situation over the next Government 0.7 1.7 2.9 2.1
two years, with Treasury rates increasing in
2020 and 2021. This scenario assumes that Federal 0.8 2.9 4.2 3.0
unemployment remains at record lows, infla- State and Local 0.6 1.0 2.1 1.5
tion remains near the target rate, and the Fed
Note Figures represent annual growth rate
holds off on any rate changes over the next Source NATIONAL ASSOCIATION OF REALTORS®, November 2019.
year. The base case scenario sees the 10-year
Treasury rate ending 2020 around 2.0% and
increasing to 2.4% by 3Q 2021. EXHIBIT 5-D. RERC RESEARCH’S 10-YEAR TREASURY FORECAST
Lower Case 10-Year Treasury Yield Base Case Upper Case
5
The higher case scenario reflects stronger
economic growth but has a lower proba-
bility of occurrence compared to the base 4
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
returns of CRE and demand for the asset class EXHIBIT 5-E. RERC RESEARCH TOTAL RETURN FORECAST (BASE CASE SCENARIO)
is expected to stay strong. Cash Flow Rate CapEx Appreciation Total
14
Percent
including historically low unemployment,
6
are expected to allow further room for rent
growth in many property types. Though cap- 4
ital is readily available, high prices and lack
2
of quality deals will likely result in positive,
but moderating, overall CRE volume growth 0
in 2020. 2013 2014 2015 2016 2017 2018 2019 2020 2021
The total return forecast is RERC Research’s proprietary model based on RERC Research data and data from NPI-ODCE and is for
unleveraged, institutional-grade properties. Total returns are derived from an income component and a capital appreciation/depreciation
Deloitte’s 2020 Commercial Real Estate Out- component. Shaded area reflects RERC Research’s outlook for the base case scenario for 2020, 2021 and 2022.
look report states that 65% of respondents Sources RERC Research, NCREIF, 3Q 2019.
believe rental growth will continue to grow
and 73% of respondents see transaction activ-
ities increasing in the next 18 months.12 among these (and other) metrics. Therefore, case scenario calls for FCFY to be 2.60% at the
any changes in one metric would affect the end of 2020 and increase to 2.70% in 2021.
The expected rental growth and transaction other forecasts.
activities could bolster CRE performance over NCREIF implied cap rates can be interpreted
the next year. However, with prices at all-time In addition, all the returns are projected out as the current quarter NOI divided by the cur-
highs in most property types, CRE returns are in three possible scenarios — base case, lower rent quarter-ending market value. This result
expected to be driven primarily by income case and higher case. The base case is the is then multiplied by 4 to get an annual rate. In
instead of capital appreciation.13 Steady cash most probable scenario. The higher case sce- 4Q 2018, the national NCREIF implied cap rate
flow growth is still available in most markets, nario assumes stronger fundamentals and fell to a historic low of 4.21%. RERC Research’s
but at a slower rate than in previous years. capital appreciation, but is less likely to occur base case scenario predicts the NCREIF
Still rising construction costs, capital expen- than the base case scenario. The lower case implied cap rate will be 4.44% at the end of
ditures and tenant improvements (Tis) remain scenario assumes weaker fundamentals and 2020 and to 4.55% in 2021.
a concern for investors. capital appreciation and is also less likely to
occur than the base case scenario. CRE value can be described in terms of a price
RERC RESEARCH TOTAL RETURN change, which combines capital expenditures
FORECASTS Per NCREIF, the free cash flow yield (FCFY) and capital returns, or capital appreciation
is the quarterly net operating income (NOI) only. RERC Research’s capital appreciation
RERC Research forecasts total returns for the minus ordinary or routine capital expenses, forecast provides an alternative way to exam-
NPI-ODCE as well as the income components divided by the beginning market value in the ine prices, because a significant portion of the
and capital components of total returns (see quarter. It focuses on quarterly net cash flow run-up in CRE prices is due to capital improve-
Exhibit 5-E). All of RERC Research’s forecasts from operations, which accounts for ordinary ment projects (including leasing activity).
incorporate data from the NPI-ODCE and are or routine capital expenditures. This measure Capital returns have drastically declined
for unleveraged, institutional-grade proper- represents additional income beyond rent that since 2015. RERC Research forecasts that
ties. Although we provide individual forecasts investors can expect to receive from investing appreciation will be 0.33% at the end of 2020
for each of these components, it is import- in the properties at a particular time and is before increasing to 0.73% in 2021.
ant to note that RERC Research’s forecast for comparable to a stock dividend yield after cap-
NPI-ODCE returns assumes interdependency ital expenditures have been paid. Our base Although national NPI-ODCE total returns
MIAMI
CHAPTER 5 OUTLOOK 55
have been strong in recent years, it is import- spaces that promote a healthy work-life bal- INDUSTRIAL MARKET OUTLOOK
ant to note that annual returns continue to ance (e.g., exercise areas, lounging areas),
decrease from their 2015 highs. After a sharp and flexible offices with state-of-the-art tech- Driven by the robust growth of e-commerce
decrease from 2015 to 2016, declines for the nology and fully furnished spaces. Driving retail sales, the industrial market should
NPI-ODCE total return have been less dra- the demand for these office features is the continue to have the strongest underlying
matic. RERC Research’s base case scenario growth of technology jobs and 24/7 online market fundamentals among the property
predicts the NPI-ODCE annual total return connectivity. The BLS projects computer and types. E-commerce is likely to keep growing
will be 4.83% at the end of 2020. In 2021, total information technology occupations to be the as younger generations join the workforce and
returns are expected to increase to 5.33% by fastest-growing industry from 2018 to 2028, increase the consumer base.
the end of the year. Income returns will con- adding about 546,200 new jobs in work areas
tinue to drive the majority of total returns. such as cloud computing, collecting and stor- According to CoStar, vacancy rates are
ing big data, and information security.14 expected to increase from 3.5% in 2019 to 4%
CRE appreciation is expected to decline over in 2020, causing rent growth to fall from 5.1%
the next year before picking up steam at the Metropolitan areas that are able to create in 2019 to 3.7% in 2020, but vacancy rates could
end of 2020 as both income returns and capital jobs and that provide affordable housing fall further if the trade environment further
appreciation begin to grow. By the end of 2021, and office rent will likely have an advantage improves as subsequent phases of the Phase
income returns are expected to increase to lev- in attracting and retaining new businesses One trade deal take shape during the year.
els not seen since 2016, supported by strong and workers. These metros include Dallas;
growth in cash flow. For RERC Research’s total Atlanta; the suburbs of Virginia and Mary- Manufacturing and retail firms will seek to
return forecasts by property type, please refer land around Washington, D.C.; Northern minimize the total cost of warehouse space
to Exhibits 5-F through 5-I. New Jersey; Phoenix; Raleigh-Durham, and transportation, especially for last-mile
North Carolina; Nashville, Tennessee; transportation, to reduce delivery time. Last-
PROPERTY TYPES Columbus, Ohio; and Chicago. These areas mile transportation — delivering orders right
have affordable office rent and well-known to the doorstep of customers — is expensive,
OFFICE MARKET OUTLOOK universities and have a greater potential for so firms may accept higher warehouse rents if
office space development compared to other that means spending less on last-mile trans-
The demand and supply imbalance in the major metropolitan areas, such as New York, portation. The demand for warehouse space
office property market should continue to Boston, Washington, D.C., Los Angeles and near urbanized centers will still likely increase
improve as unused space is absorbed by San Francisco, where office rents are pricier. as warehouse occupiers seek to satisfy con-
demand for office space, with 1.8 million new sumer demand for faster delivery time, with
jobs expected. Vacancy rates will continue to The invigoration of space research and the one-day delivery as the gold standard.
fall, although slowly, due to low demand for increasing commercialization of the space
old vacant office properties. industry in rocket development, space Not many companies have the financial where-
equipment manufacturing, remote sens- withal of Amazon or Walmart, among others,
According to CoStar, the vacancy rate is ing and planetary prospecting, and crew to set up the chain of logistics from warehous-
expected to fall slightly to about 9.7% and transportation to and from Earth and the ing, to distribution and last-mile delivery, so
office rent will likely grow about 2%, about the International Space Station is an emerging retailers will continue to turn to third-party
same as in 2019, but there is an upside poten- development.15 This will have an increasing logistics (3PL) providers and co-warehousing
tial with the recent improvement of trade rela- impact on land and office development in facilities for storage and delivery services.
tions between the U.S. and China after they suburban areas that are homes to NASA’s Co-warehousing facilities also provide short-
signed the Phase One trade deal. With steady space centers such as Cape Canaveral, Flor- term space during peak times for inventory
rent growth, CoStar projects cap rates to aver- ida (Kennedy Space Center); Huntsville, overflows even for the big companies that have
age about 6.7% in 2020. Alabama (Marshall Space Flight Center); their own distribution networks.
Cleveland, Ohio (Glenn Research Center);
Class A or B office buildings will likely be more New Mexico (Spaceport America); and the The demand for industrial properties is driven
in demand than older office stock, given the suburbs of Virginia and Maryland (NASA by e-commerce sales, which in turn depends
preference for improved energy efficiency, headquarters). on a growing consumer population. Metro
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
EXHIBIT 5-F. RERC RESEARCH TOTAL RETURN FORECAST — OFFICE (BASE CASE SCENARIO)
Income Capital Total
30
20
10
Percent
-10
-20
-30
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
Sources RERC Research, NPI-ODCE, 3Q 2019.
EXHIBIT 5-G. RERC RESEARCH TOTAL RETURN FORECAST — INDUSTRIAL (BASE CASE SCENARIO)
Income Capital Total
20
10
0
Percent
-10
-20
-30
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
Sources RERC Research, NPI-ODCE, 3Q 2019.
HONOLULU
CHAPTER 5 OUTLOOK 57
areas with growing population will likely be well below the most recent high of over 69% in
the most attractive for development of indus- 2004, but it shows a notable shift from a nearly
FORT WORTH trial warehouse facilities, such as Dallas; 15-year downward trend.
Houston; Atlanta; Las Vegas; Minneapolis;
Columbus, Ohio; Tampa, Florida; Charlotte, Given trends in fundamentals, the apartment
North Carolina; and Nashville, Tennessee. sector may be moderating after a long and sus-
tained period of growth. However, relative to
RETAIL MARKET OUTLOOK the other major property types, apartments
still appear to be an attractive choice for inves-
A prominent trend in retail real estate, which tors, particularly given a potential economic
could also be the key to continued success in slowdown on the horizon.
the market, is taking action to adjust a retail-
er’s footprint to match today’s omnichannel HOTEL MARKET OUTLOOK
marketplace, according to Chain Store Age.16
For many department stores or big-box con- CBRE forecasts annual U.S. lodging ADR at
cepts, this could mean introducing small- $131.08 for 2019, which is 90 bps higher than
er-format stores that either carry less inven- the 2018 average of $129.97, while RevPAR had
tory in general or carry inventory considered a projected increase of 70 cents from $85.95 to
specifically relevant for the market, re-brand- $86.65.17 CBRE projects that over the next four
ing to fit the desire for experiential shopping, quarters, occupancy will decrease by 40 bps
or shuttering underperforming locations to 65.8%, ADR growth will decrease by 30
altogether, according to Retail Dive’s arti- bps to 0.9%, RevPAR growth will fall 100 bps
cle 10 retail trends to watch in 2020. Mean- to 0.3%, and demand growth will decrease
while, for many e-retailers, this could mean 70 bps to 1.4%.18
stepping into the brick-and-mortar space by
opening a built-out flagship location in one CBRE’s December 2019-February 2020 Hotel
of the prime markets in the country or con- Horizons report predicts a RevPAR increase
tinuing to grow their portfolio by obtaining of 0.8% for the year. Through 2022, CBRE
more storefront space across urban and sub- projects ADR growth of less than 1.5% annu-
urban areas. The industry is bracing itself for ally. Alongside low ADR growth projections,
the next large disruption in the market — per- RevPAR growth is forecast below 1.0% until
haps additional store closures or bankruptcy 2021. Due to this, it will likely be difficult to
announcements, or maybe the emergence of achieve consistent profitability in the lodg-
a new technology that will shift how Gen Z ing industry.19
and their fellow consumers prefer to shop,
or even an economic recession. In the mean- From a supply and demand perspective,
time, retail property owners will need to con- Cushman & Wakefield’s Lodging Industry
tinue to adapt their properties, and retailers Overview expects a decrease in new con-
will re-examine their business models to struction caused by the stabilization in
strategically participate in the omnichan- demand due to slowing revenue growth and
nel market at their full potential and realize an expected increase in construction costs.20
growth in the year ahead.
After nearly a decade of straight growth, it
APARTMENT MARKET OUTLOOK should be of no surprise that investors and
owners are practicing caution with regard
The outlook for the apartment market appears to the lodging market going forward. How-
to be positive in the short term, with continued ever, while it is likely wise for investors and
investor appetite in this sector and increasing owners to be skeptical of the market’s ability
property values. to continue its historic run, there have been
few true causes for concerns or indications
According to 3Q 2019 U.S. Census Bureau of a substantial downswing. It is expected
data, the homeownership rate, which had that hotel investors will be monitoring GDP
been in sharp decline throughout the current growth and consumer confidence, while still
real estate cycle and a major driver behind the cautiously pursuing acquisition opportuni-
strength of the apartment market, bottomed ties and taking advantage of market funda-
out at just under 63% in 2016 and has since mentals and pricing to the extent that buy-
increased to 64.8% in 3Q 2019. This is still sell assumptions converge.
58 ©2020 Deloitte Development LLC, NATIONAL ASSOCIATION OF REALTORS®, RERC. All Rights Reserved.
EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
EXHIBIT 5-H. RERC RESEARCH TOTAL RETURN FORECAST — RETAIL (BASE CASE SCENARIO)
Income Capital Total
20
15
10
0
Percent
-5
-10
-15
-20
-25
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
Sources RERC Research, NPI-ODCE, 3Q 2019.
EXHIBIT 5-I RERC RESEARCH TOTAL RETURN FORECAST — APARTMENT (BASE CASE SCENARIO)
Income Capital Total
25
20
15
10
5
Percent
-5
-10
-15
-20
-25
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
Sources RERC Research, NPI-ODCE, 3Q 2019.
SAN DIEGO
CHAPTER 5 OUTLOOK 59
SOURCES
1
NATIONAL ASSOCIATION OF REALTORS, “NAR Real Estate Forecast Summit: Consensus Forecast,” Dec. 11, 2019. Note: Real Estate Consensus Forecast Summit held on Dec. 11, 2019. Fifteen residen-
tial and commercial real estate economists participated in the consensus forecast.
2
Ibid.
3
Haver Analytics, “FRB Excess Bond Premium Implied Recession Risk over the Next 12 Months,” November 2019.
4
Freddie Mac, “Mortgage Rates Tick Up Slightly,” Feb. 6, 2020.
5
National Association of Home Builders, “Builder Confidence Hits 20-Month High,” accessed Feb. 13, 2020.
6
Erica Werner and Rachel Siegel, The Washington Post, “Senate Approves New North American Trade Deal with Canada and Mexico,” Jan. 16, 2020.
7
James Stavridis, Bloomberg, “Europe Will Rise in 2020 as the World Melts,” Jan. 2, 2020.
8
Federal Reserve Bank of St. Louis, “CBOE Volatility Index: VIX,” Feb. 7, 2020.
9
Note: Predicting rates is a difficult endeavor under any circumstance. The above scenarios are RERC Research’s best estimates of inflection points for expected rates. The RERC Research 10-year Trea-
sury Forecast produces similar results to other third-party consensus forecasts and models, including analyses from Moody’s, Kiplinger and The Wall Street Journal.
10
MBA, “Commercial Real Estate Finance (CREF) Outlook Survey, 2020,” accessed Feb. 11, 2020.
11
Ibid.
12
Deloitte, “2020 Deloitte Commercial Real Estate Outlook,” accessed Oct. 7, 2019.
13
RCA, 3Q 2019.
14
U.S. Bureau of Labor Statistics, “Occupational Outlook Handbook: Computer and Information Technology Occupations,” Sept. 4, 2019.
15
Alexander MacDonald, “Emerging Space: The Emerging Landscape of American 21st Century Spaceflight,” April 2014.
16
James Savard, Chain Store Age, “Four Trends that Will Dominate Retail Real Estate in 2020,” Jan. 2, 2020.
17
CBRE Hotels Research, “Hotel Horizons, December 2019 – February 2020,” Dec. 2019.
18
Ibid.
19
Ibid.
20
Cushman & Wakefield, “Capital Markets – Hospitality,” Mid-Year 2019.
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
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Sources Builder Online 2018, NAREIT (9/18), P&I (May-December 2018), PERE Fifty (2018), Fortune 500 (2018), NREI (November 2017, April-November
2018), Commercial Mortgage Alert (6/18), NREI (4/18-11/18), ENR (5/18)
*Investment banking products and services within the United States are offered exclusively through Deloitte Corporate Finance LLC (“DCF”), an SEC
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This document contains general information only and Deloitte is not, by means of this document, rendering accounting, business, financial, investment,
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basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should
consult a qualified professional advisor. Deloitte shall not be responsible for any loss sustained by any person who relies on this document.
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EXPECTATIONS & MARKET REALITIES IN REAL ESTATE 2020 / Forging Ahead
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