During a recent meeting with a large Canadian pension fund advisor, Kansas City—not normally identified with prime real estate investment—became the focal point of an “emerging markets” strategy the advisor was developing for a client from Singapore.
In retrospect, foreign capital interest in Kansas City is not surprising since yields in major global markets have largely converged at record low levels. Investors increasingly are testing new markets—and testing new lows on yield—simply to deploy capital. A large German investor is still actively deploying capital to the United States despite hedging costs that lowered its yield by up to 350 basis points annually. Extremely low yields plus super-expensive hedging costs mean we are in a new investment world where institutional investors are willing to accept more risk for less return.
In late-cycle environments, it’s not unusual to see capital shift to smaller secondary markets. What is unusual is that we have not seen cap rate convergence in primary and secondary markets, which often happens at the end of the cycle. This creates opportunity, as one of the most effective long-term investment strategies is to “lead” rather than “follow” the money. Leading the money means going into “emerging” U.S. markets like Seattle 20 years ago, Austin 15 years ago, Nashville seven years ago and maybe Tampa, Portland and Kansas City today. Leading the money may result in cap rate compression even in a rising interest rate environment like we have today. This doesn’t mean that investors should ignore the major markets like New York and Los Angeles, whose long-term growth prospects are buoyed by a critical mass of talent, capital and infrastructure.
Another compelling trend is the re-definition of what constitutes Class A space. Until recently, you could not find any Class A office space in the Arts District in L.A., Fulton Market in Chicago, Bakery Square in Pittsburgh and Midtown-South in Manhattan. Today, all of them have a ton of it and have attracted some of the top tech and blue- chip tenants in the market. This is because the definition of Class A is changing, with lots of adaptive re-use projects, local retail, great live-work-play environments and partnerships with local universities to attract and retain talent. In short, the scarcity of investors (yield) has now converged with the scarcity of occupiers (talent clusters) to drive Class A office space into the frontier of emerging markets that only a few years ago were laden with only Class B and C product.
Just as these new markets combine all elements of commercial real estate into one package, so too does this CBRE 2019 Market Outlook. Although we are late in the cycle, the outlook remains very good for each of the four major real estate asset types. Continued economic growth bodes well for the office, retail and industrial sectors, while less homebuilding is benefitting multifamily and lenders and developers have avoided the temptation to overbuild in this cycle. Some new opportunities have emerged, including multistory industrial, life-sciences/health-care facilities and workforce housing.
As always, CBRE combines its industry-leading research with industry-leading “facts on the ground” from our brokerage professionals to produce our forecast. Please reach out to your local research or transactional professional to learn more.
By Spencer Levy, Chairman & Senior Economic Advisor, Americas Research, CBRE.