2020 could be a pivotal year for the U.S. commercial real estate industry, with geopolitical, economic and local regulatory issues in keen focus.
As I turn 50 years old next year, I well remember that we’ve driven the same bumpy roads before. I think back to my formative years in the 1970s when big events like the end of the Vietnam War, the Iranian hostage crisis, the Cold War and an oil embargo that led to maddening gasoline shortages for American motorists had huge impacts on our economy. The bumps may be different today, but the roads are the same 50 years later. The problem is that our approach to underwriting commercial real estate risks is also the same and needs to adjust to the times.
Our industry in the 1970s was characterized by a slow-and-steady mentality, with long-term leases offering a good hedge against the volatility of the broader market. High inflation led to a nasty recession, making commercial real estate a good inflationary hedge. But the 2010s are the exact opposite, with low inflation and steady job growth leading to a historic economic expansion. The rise of coworking and material increases in license and short-term lease agreements have made the office and retail sector less predictable. The tech disruption of retail is increasingly encroaching on other asset types, including Airbnb’s effect on the multifamily and hotel sectors. As inflation and interest rates ticked down, so did cap rates, yet we still underwrite with a 1970s “fear-of-inflation” rule of 50 to 100 basis points added to exit cap rates.
Despite these transformational changes to our business, CBRE’s 2020 U.S. Outlook predicts a very good year for commercial real estate. And it can be even better if we help dispel some 1970s thinking, particularly around the fear of inflation. Transaction volume and cap rates are expected to remain largely stable, though we likely will see more fundamental/secular-driven cap rate compression in multifamily and industrial and, due to declining inflation and massive liquidity, some downward pressure on cap rates for other CRE sectors.
2020 will not be without its challenges. We expect some risk of oversupply in industrial and Class A multifamily, but secular shifts that have heightened demand far in excess of historic norms should mitigate material impact on fundamentals, which are expected to stay strong. While retail’s overall troubles are well reported, the sector is expected to show good rent growth as it becomes more experiential with limited new construction.
Though business confidence has weakened and business spending has slowed, the office market is more dynamic today than ever before. Reasons for this include strong but slowing office-using job growth, the renaissance of the “new city” (new live-work-play neighborhoods in old-school cities), massive capital expenditure in older office inventory in major CBDs and agile office design. While a lot of the growth is expected in up-and-coming “tech cities,” old-school cities and many suburban markets that have what I call the “five pillars of awesome” (talent, infrastructure, foreign capital, live-work-play and low regulatory burden) should shine as well.
As the CRE industry becomes more dynamic and operational risk increases, alternative investments are gaining popularity. As a result, we expect 2020 to be another big year for data centers, alternative forms of industrial like self-storage and alternative forms of multifamily like senior living.
Commercial real estate has changed a lot since the 1970s, but many of the mega geopolitical and economic risks still ring true today. We hope you enjoy CBRE’s 2020 U.S. Outlook and that you underwrite commercial real estate with a 2020 “a-lot-has-changed” mentality, particularly since we’ve been traveling this same bumpy road for at least 50 years.
By Spencer Levy, Chairman of Americas Research & Senior Economic Advisor, CBRE.