Commercial real estate investors are facing an array of unusual conditions—including technology that’s changing the design and use of buildings, record-low interest rates, and even the growing trend of legalized marijuana, all of which present new opportunities and challenges.
The opportunities are multi-layered and include the chance to reshape commercial and retail facilities with Internet of Things capability. Ralph Lauren’s New York City flagship store, for example, previously debuted a “smart mirror” that let shoppers vary the changing room’s lighting, reads the RFID tags on clothing carried in and displays the items side-by-side with details like other color and size choices, and lets customers request items or seek assistance from associates with a tap on the mirror. Another example is JLL’s geofencing tool, PinPoint, which evaluates the nuances of shoppers’ behavior by analyzing mobile data, according to the global audit, consulting, tax, and advisory services firm Deloitte.
“It assesses the quality and quantity of time consumers spend shopping and uses data and analytics to generate insights,” notes a Deloitte report. “The company plans to share the information with both retail and investor clients to help them make more informed leasing and location decisions.”
Even as CRE investors consider these technological changes, they’re dealing with record-low interest rates that have a kind of double-whammy effect: discouraging investments in bank accounts and bonds, while making real estate more attractive.This was reflected in a survey released earlier this year by AFIRE, an association for global investors focused on institutional real estate in the United States. “Investors generally remain confident in a strong U.S. economy, solid real estate market fundamentals, and continued capital inflow to US real estate,” according to the AFIRE announcement.
The spreading movement to permit marijuana, for medicinal and recreational use, is also having a positive effect on the CRE industry. A 2017 CBRE report—three years following Colorado’s decision to legalize recreational pot use—found that lease rates for industrial warehouse space were two to three times higher than average for comparable properties.
More recently, the CEO of a sizeable REIT said that recreational cannabis legalization in New Jersey—a goal of Governor Phil Murphy—would have a significant positive impact on that state’s real estate market.
Proceed with Caution
These and other developments are giving CRE investors plenty to cheer about. But a word of caution is also appropriate. As investors chase after higher rates, some CRE investors are jumping into new spaces where they’ve got little or no experience. As demand continues to rise, an artificial price bubble could form, and with some economists predicting a slowdown—if not an outright recession —in the next two years or so, we could witness another drop that may rival the 2008 recession.
Clouding matters even further, there are arguments on both sides for continued expansion or a sharp contraction. Base fundamentals indicate that the U.S. CRE market “remains on a strong footing,” according to a Deloitte report. “Rental growth increased, and vacancy levels steadily decreased across property types; total transaction volume increased 2% year-over-year to $119 billion in the second quarter of 2019, and average commercial property cap rates remained stable and trended at 6.6% in the second quarter of 2019.” Additionally, despite tightened CRE lending standards on the part of banks, “demand for most categories of CRE loans changed little on balance,” according to the Federal Reserve’s October 2019 Senior Loan Officer Opinion Survey on Bank Lending Practices.
And a 2019 State of the Market Survey, released by the global law firm DLA Piper indicates, “exactly half of respondents have a bullish outlook on the next 12 months” representing “the first increase in bullishness since 2015 and a spike from the 42 percent who reported being bullish in the prior survey which was conducted during the US government shutdown.”
There are bearish concerns, as well. Top worries include the U.S. and global economy, “which appear to be nearing a tipping point” and the amount of space that coworking continues to lease, since “it is a house of cards.” Additionally, exogenous shocks, “geopolitical conflict or war and continued flooding of coastal cities due to global warming,” also drive their concerns.
What should CRE investors do? There’s no single answer—and unfortunately no guarantees—but some prudent steps can help an investor’s position. The first is to constantly scan economic, political and demographic landscapes, spotting developments that can impact the CRE market while maintaining an awareness of geographic and other trends.
Industry trends can also be significant. If retailers, for example, are beginning to embrace “smart” devices in their facilities, CRE investors may wish to consider if their portfolios are IoT-friendly, or will require significant investment to get that way.
Another potential change involves the structure of commercial leases. According to a Deloitte study, the industry currently relies on duration-based leases, commonly classified as short-term or long-term. But more than six in 10 of the respondents surveyed by Deloitte noted that tenants prefer flexible leases, as opposed to traditional ones. In New York City, for example, the amount of space under flexible lease rose 44 percent year-over-year in 2018. CRE investors may wish to ensure they’re on top of developments like this.
Commercial real estate, like other investments, involves some degree of risk. But prudent investors—who don’t get swept away by the latest fad and instead engage in reasonable research—stand a better chance of riding the next wave without toppling off at either the crest or the trough.
Aysha Cox serves as vice president of Case Real Estate Capital LLC.