TrendLines Yields 6 CRE Megatrends in 2014

By Keith Loria, Contributing Editor

Greg Leisch, Delta Associates

The TrendLines event produced by Transwestern and research affiliate Delta Associates in Washington, D.C., Feb. 6. offered six key themes for investors to consider in 2014.

The report, presented at its 17th annual meeting in the country’s capital, outlined the pivotal forces and issues that Delta Associates believes will affect the region’s economy and commercial real estate in 2014 and beyond.

“In my opinion, there are two game changing events that changed the commercial real estate landscape. The first is the passage of the two-year federal budget deal, which has reduced uncertainty in the metropolitan area,” Greg Leisch, CEO of Delta Associates, told Commercial Property Executive. “The second event of 2013 was the downgrading of the investment worthiness of the Washington metropolitan area, and I think that’s a positive sign. Moving from second to fourth is not exactly a pariah but it’s symbolic that it’s no longer first or second.”

Leisch said the importance of the budget is not so much for its policy implications—although he admitted they are significant, such as the $9.3 billion in GSA funding—but is more significant for the reduction in uncertainty that it brings to the Washington region.

“I believe for the foreseeable future, we face not just a more competitive market in certain asset types, but pressure on our industry to respond to a myriad of trends,” he said. “As we enter 2014, it takes a new playbook to do business in our industry in Washington; a whole new way of finding opportunities and taking advantage of them.”

First on his list of “MegaTrends” is the fact that there is less uncertainty in 2014 than there was a year ago in the commercial real estate market. A second trend is that the national economic recovery is gaining momentum.

The third MegaTrend reveals a challenge facing Washington’s commercial real estate market as there is a dichotomy in the real estate investment market between national capital flows and flows into Washington-area assets. According to Leisch, locally, capital flows into Washington have ebbed, a reflection of weaker property performance metrics in 2013, the political gamesmanship on Capitol Hill and higher returns available in secondary markets.

Another trend involves rising interest rates marking the end of cap rate compression, even though Leisch said that it’s not entirely due to that reason since outside of a blip in May, rates haven’t really risen that much.

“I think the end of cap rate compression is because prices are now in balance with intrinsic values and the spreads are at what they ought to be and real estate is properly priced based on a risk adjustment basis,” Leisch added. “Real estate now needs to perform if prices are going to rise, as opposed to prices rising because cap rates are declining.”

The final two trends to watch involve the “densification” trend, meaning the reduction in square feet leased per worker, combined with the changing nature of how tenants are using space; and the shift of Millennials making an impact on the commercial real estate market.

“These trends if you follow them and recognize them, they represent opportunity for investing and development,” Leisch concluded. “If any were ignored, they become concerning.”