As the New Year (2020) is already underway, I recently had discussions with several commercial real estate professionals about the ups and downs of the commercial real estate market in 2019. Overall, the commercial real estate market did well in 2019; however, it was certainly based on property type and location. There was a lot of continued interest in commercial real estate investments, especially for multifamily and industrial and most predict this will continue for another year or two. In addition, there have been several articles published by both National Real Estate Investor (nreionline.com) and the CCIM Institute that have outlined some major issues affecting the commercial real estate market both positive and negative and ironically, most do not even mention the word recession.
Regardless of whether a Recession is even on the forefront of most CRE professional’s minds, there is no doubt some macro changes are taking place based on the advancement of technology and the abundance of capital available to purchase real estate investments. Some of these major macro changes may not directly affect us in smaller markets like Mississippi, but will still have some impact. I have narrowed the list down to the top three (3) things that I believe have impacted our local market the most.
No. 1 — Interest Rates: Most investors and real estate professionals, like me, strongly believed the Feds would raise interest rates at least once in 2019. Many CRE investors were looking to potentially refinance before interest rate increases were announced; however, shockingly, interest rates were lowered three (3) times in 2019. Interest rates are already historically low and keeping rates low seemed to have spurred more interest in the commercial real estate sector. The expectation for Sellers has been that cap rates should be lower or at least stay the same in an already high valuation market; however, buyers on the other hand expect rates to eventually rise and have priced this into their cash flow model, which has only furthered the bid/ask gap. Based on the valuation differences between buyers & sellers, the deal volume for investment properties have started to slow. Who knows what 2020 will bring with interest rates as this is an election year and anything is possible.
No. 2 — Industrial & Retail Are Slowly Merging: It is hard to pick up any commercial real estate article and not read that industrial is the ideal investment vehicle for CRE investors. Additionally, retail properties are struggling overall and have fallen out of favor with real estate investors. However, what has been transforming over the past few years is that older shopping centers are finding new life by providing the needs of direct-to-consumer warehousing. As the demand for quicker deliver continues, the push to get home delivery done in less than 48-hours, and in some cases, same day deliver will be a logistics nightmare. However, due to some of the ideal locations of older shopping centers, there will be a shift to using these properties for storage/warehousing for home deliveries. It should further be noted that some “online only” retailers are now thinking of branching out to some brick & mortar stores and the older shopping center on a busy thoroughfare are serving both retail and industrial uses.
No. 3 — Alternative Properties Gain Market Share: Most non-institutional investors have had a hard time finding yield (cash flow) in the primary markets so most have opted to go into both secondary and tertiary markets. In addition, they are finding better deals in “alternative” properties than traditional properties such as office, retail, industrial & multifamily. What are “alternative” properties? These properties could consist of self-storage; student housing; data centers; single-family rentals; short-term rentals; senior housing and mobile home parks. This is not a complete list, but will give insight into other property types other than the traditional properties as previously mentioned. Typically speaking, there is less competition from institutional money in these sectors and offers investors more yield and/or upside. I expect this trend to continue through 2020.
There were a few other major changes impacting the CRE investment market that definitely deserve mentioning and they are rent control and PropTech. There are major rent control regulations for multifamily being enforced in New York City and many of the larger cities on the West Coast. This has spooked a lot of investors who may need appreciation in rents to justify acquisition cap rates. Although this doesn’t directly affect smaller markets, it does have an impact on where investor’s may look to place capital. Our markets in Mississippi are definitely “Pro Landlord” and most investors looking to invest in multifamily will find stable cash flow and laws that allow them to operate the property in a more capitalistic way. Just as I was writing this article, a colleague from Seattle mentioned there are possibly going to be new regulations on background checks. As these additional regulations continue to mount for multifamily, it will be interesting to see if investment capital will leave this space for fear of limiting future cash flow.
PropTech is short for “property technology”. There are massive amounts of capital and start-ups that are targeting the commercial real estate industry which historically is slow to adopt technology. The Internet of Things (IoT); databases and artificial intelligence (AI) have already altered the landscape of CRE. Every year there are new platforms which to operate, lease and sell commercial real estate and the traditional methods are becoming somewhat obsolete. Property management used to be very local; however, technology has allowed remote managers to manage many of the building components from their desk. The overall consensus is that artificial intelligence (AI) is going to drastically change the ownership and management side of the business. Buildings will become “automated” to the tenant’s preferences and in many cases be more of a concierge service.
Overall, changes in any industry are common; however, I do believe the commercial real estate sector is facing many more changes than most other industries. Not only are there technological changes happening, this industry constantly faces potential changes in the economy. As stated earlier, the commercial real estate industry has been a slow adopter to technology so the rapid changes are the industry’s way of catching up. I expect 2020 to continue to be very stable as interest rates are still at an all-time low and there is plenty of capital chasing deals. Expect to see investors be very disciplined which will slow investment sales, but in the event of a recession, most buyers will be able to handle a short downturn.
» Brian E. Estes is president and investment advisor with the Estes Group and can be reached at firstname.lastname@example.org.
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