Despite global economic concerns, CRE executives see opportunity in 2016

After years of record setting performance in the commercial real estate (CRE) industry, many experts are reporting that 2016 will show the beginnings of a market slowdown. But what do CRE executives think? Their opinions are what really count as they evaluate and compare early predictions with current reality each day to ensure they are making proper strategic decisions for their portfolios.

Altus Group, in partnership with the National Association of Real Estate Investment Trusts (NAREIT) and the National Council of Real Estate Investment Fiduciaries (NCREIF), recently polled CRE executives for the 2016 Real Confidence survey to uncover their outlook on a range of topics affecting the industry. In charge of over $700 billion in combined real estate assets, these top executives offered important and interesting insights into what factors real estate investors are keeping in mind as they continue to invest this year.

A Broader Outlook

Economic instability doesn’t sit well when making large investment decisions, so to get a better understanding of executives’ perceptions of the current state of the economy, we asked them to quantify their confidence in both the U.S. and wider global economy on a scale from 0 (no confidence) to 100 (absolute confidence). While respondents rated the U.S. economy mildly healthy at 63.3 on the scale, their confidence wavered when it came to the global economy, rating it only a 45.4.

With a number of unpredictable global worries such as terrorism and energy prices, executives felt the U.S. was the best place to invest real estate capital as it offers broader opportunities and a more stable market. The respondents’ sentiments on the economy reflect other assessments of the U.S economy: inflation is tame; interest rate increases might have already been figured into forecasts; and the U.S. gross domestic product is poised to continue growing, if only just modestly.

Demand Side

The increased number of Millennials joining the workforce, along with an aging Baby Boomer generation, has resulted in a number of demographic shifts that will affect commercial real estate decisions this year. Millennials are proving to be unique from previous generations and their influence is being felt, particularly in the office space sector as they are creating distinct work environments that include communal spaces and allowing for telecommuting in order to attract young new workers.

When we asked CRE executives to rate their confidence regarding the growing importance of telecommuting, walkability, public transportation and mobile device communications on real estate investment decisions, they reported a stunning score of 75 out of 100, confirming the impact this demographic is having on the industry. Furthermore, executives were similarly confident that office redesigns would incorporate more “open air” layouts this year.

Even larger real estate changes are being driven by demographic trends in the multifamily sector. The increased demand in this area has resulted in Millennials renting in their preferred core markets for longer periods of time before buying homes. Additionally, walkability is becoming an increasingly important factor, not just with Millennials looking for convenience, but also for Baby Boomers who are now downsizing to smaller, more modern homes in accessible areas.

Supply Side

While the majority of executives surveyed aren’t expecting the same double-digit asset appreciation we saw in 2015, they rated their confidence in the state of the real estate industry a healthy 68.5 and showed substantial confidence that real estate development would increase this year, with a 58.9 rating. This assurance comes even though executives also felt strongly that construction costs for new projects would rise in 2016, rating their confidence in this area a 66.1 out of 100.

Respondents hypothesized that demand increases in the multifamily sector, where the occupancy levels are very high, and the industrial sector, where e-commerce and automation increasingly requires new space, will be enough to absorb the developments already underway and justify additional investments this year.

Performance

According to CRE executives, real estate will still be all about location. With a whopping 83.1 rating, respondents confidently stated that location has a much more sizeable impact on commercial real estate returns over design. Executives reported that design will also have an impact, but only scored a 57.1 confidence rating, indicating that great design at a less-than-perfect address will still have the potential to be a strong investment.

The biggest design changes in 2016 will be seen in the multifamily space. Apartment developers are moving away from the bland, boxy format in favour of eye-catching buildings that are close to public transportation and have walkability. Additionally, developers are increasingly taking chances on spaces outside of in-demand core markets in hopes that consumers will travel further to enjoy luxurious amenities at a lower rent.

Portfolio Challenge

In an attempt to uncover where CRE executives see opportunity in 2016, we challenged survey respondents to theoretically allocate $1 billion among a variety of real estate investment options, the goal being to produce the largest total return by the end of the calendar year. Their selections reflected an air of economic concern with the less volatile private equity option receiving 49.3 per cent of the $47 billion total capital. Four of the five core sectors within the private equity option – office, industrial, apartments, and retail – were fairly split, however the office sector came out slightly ahead with 25 percent, or $5.8 billion dedicated to that sector.

31.2 per cent of the additional capital was allocated to public equity real estate, or REITs, followed by a risk-averse choice in private debt at 13.3 percent. Public debt, commercial mortgage-backed securities (CMBS) or residential mortgage-backed securities (RMBS) options only amounted to 6.2 per cent of the $47 billion total allocation.

The investment trends uncovered by the portfolio challenge follow a pattern that reflects the economy.  While commercial real estate in general may experience some hiccups this year, by locking into more predictable and dependable ventures, investors can still see positive returns in 2016.

The insights from the 2016 Real Confidence survey show us that CRE executives appear to be more optimistic on the fundamentals of the economy than the broader markets would suggest. A market with strong essentials, an economy with slow and steady growth and a steady pipeline of development are giving investors hope for the year ahead. Even with a potential slowdown in the industry, commercial real estate will continue to justify its place in investment portfolios in 2016.

For more information on the 2016 Real Confidence survey, go to Realconfidence.com.

Charles J. DiRocco, CRE, CCIM, FRICS, is a Director of Research, Valuation and Advisory at Altus Group. www.altusgroup.com

Despite global economic concerns, CRE executives see opportunity in 2016
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