Here's What We Got Wrong When We Tried To Predict 2019 In CRE
Commercial real estate is a business that relies, to an extent, on predicting the future. Every purchase of a building is a statement of confidence by the buyer of the building's future performance, if not the local economy surrounding it.
As chroniclers of the industry, some Bisnow reporters may get the notion that they know a little something about real estate, enough to see where it is headed. This is a reminder that we should probably stick to our day jobs: the predictions Bisnow made for 2019 that either didn't turn out quite how we thought, or didn't come true at all.
Honorable Mention 1: Opportunity Zones Craze To Persist
Signed into law at the end of 2017, opportunity zones grew as a topic of interest over the course of last year, kicking into high gear after the IRS and Treasury Department released the first round of guidance and regulations governing the zones in October. This year was supposed to bring the finalization of those structures and a potential deluge of investment.
Well, about that ... That finalized version still hasn't materialized as 2019 draws to a close. Though interest, discussion and debate remained robust through the summer, a fraction of the investment volume some expected has materialized.
Some don't want to commit chunks of money until the rules are set in stone, and some have not been convinced that the benefits are worth learning an entire new section of the federal tax code or hiring the advisers to do so. Allegations of corruption have also reintroduced political conflict into what was a solidly bipartisan policy, dulling its luster.
The deadline to receive the maximum tax discount on capital gains invested in qualified opportunity zones is Dec. 31, so there may be a brief rush of closed deals in the next couple of weeks, but nothing like what we expected last year.
Honorable Mention 2: Grocery Chains To Move Further Online, Expand Their Online Offerings With The Help Of Tech
Faced with the looming specter of Amazon, grocers seeking to avoid the fate of so many brick-and-mortar stores in other sectors had begun investing heavily in technology and data to modernize before the e-commerce giant had a chance to make them seem obsolete.
Bisnow thought that grocery stores were trying to carve out early territory in the online grocery delivery space, as Amazon had already begun to use its acquisition of Whole Foods as a platform to get its own delivery service off the ground.
But Amazon's 2019 experience with Whole Foods was a harbinger for the entire industry it had newly entered.
The plans for a major Whole Foods expansion that Amazon announced early in the year never publicly moved into the next phase. By the end of the year, Amazon's public focus seemed to be on launching its own grocery store brand and growing its cashier-less Amazon Go model into something more like a grocery store.
Rather than bringing more of themselves onto the internet, grocery stores have brought more of the internet and information technology to their brick-and-mortar locations.
“I would say a lot of retailers have been investing heavily in digital tech and omnichannel retail in the grocery space, but it hasn’t led to a lot of e-commerce, online-only adoption as much as order online, pickup in-store or curbside," said Melina Cordero, CBRE's managing director of retail capital markets in the Americas.
Honorable Mention 3: U.S. Hotel Occupancy To Break Records In 2019
Hotel occupancy in the U.S. indeed had its highest average occupancy ever — 66.2% — in the 12-month period ending in May, according to industry research firm STR, but the year that the industry experienced wasn't as positive.
“The U.S. hotel industry built more rooms than ever, so as the year progressed, occupancy declined from that record level," STR Senior Vice President of Lodging Insights Jan Freitag told Bisnow. "We’ve continued to set demand records and we’re selling more rooms than ever, but in June, August, September, October, we’ve seen monthly occupancy decline."
Ever our own toughest critic, we couldn't give ourselves credit for a correct prediction when we expected it to be the signpost for a banner year. Instead, May turned out to be the peak of a multiyear trend, with the rest of the year spent in a decline that could stretch at least a couple of years into the future, Freitag said.
The U.S. hotel pipeline has held relatively steady at around 205,000 rooms under construction for the past few years, which STR projects to continue for another couple of years, at a rate of 2% supply growth for 2020 and 2021. Corresponding with the softening economy, demand growth will hit 1.8% in 2020 and 1.5% in 2021, STR predicts.
Perhaps more concerning to the industry? Room rates and RevPAR have flattened in the past year, Freitag said. Some contributing factors could be the ongoing price pressure from hotel alternatives like Airbnb and/or online comparison shopping, or even from owners and operators acting conservatively. They want to preserve those occupancy numbers amid all the new deliveries, but no answer is completely satisfying for industry observers.
"It's interesting, because we’ve sold more rooms than ever, so how come there’s no pricing power?" Freitag said. "That’s the $100M question in the hotel industry today. It’s underwhelming and perplexing.”
Whiff Number One: Federal Reserve To Gradually Boost Interest Rates Due To The Strength Of The Economy
When you run a massive institution tasked with maintaining the stability of the U.S. economy, life comes at you fast — in the form of President Donald Trump. The tariffs he has levied with little warning as part of his trade war with China have caused wave after wave of uncertainty in the global market, sending long-term Treasury bond yields downward into recession territory.
The U.S. Federal Reserve and Chairman Jerome Powell have responded by reversing course on the interest rate hikes of 2018 and cutting rates multiple times in order to prolong the cycle's growth. The moves risk diminishing returns, but across the globe, several major economies have gone into negative territory to prevent investors from hoarding their wealth in savings.
Even if the trade war ended overnight (unlikely), there are overarching factors at play that could prevent interest rates from rising meaningfully for years to come, Arden Group Chairman and CEO Craig Spencer said at Bisnow's Philly 2020 Forecast on Dec. 5.
The two largest generations in terms of population size, baby boomers and millennials, are the two generations saving the highest percentages of their income. Combined with birth rates too low to incentivize large-scale manufacturing increases and average life spans lengthening (thus requiring more saving), Spencer sees little reason to expect a turn toward aggressive spending for a decade, maybe more.
“Because people are saving more, you have oversupply of capital and lower interest rates," Spencer said. "These are things that you can’t change overnight ... I think we have a much longer way to go down.”
Whiff Number Two: Retail Bankruptcies To Slow, Retailer Earnings To Stabilize
Yeah, about that: The number of announced store closures this year surpassed 2018's total in May. Retailers like Payless ShoeSource and Dressbarn ceased operations, taking nearly 3,000 stores off the market between them, and they were far from alone.
Though some of the biggest holders of retail real estate believe that 2019 will turn out to be rock bottom, several chains still hang in the balance during this condensed holiday shopping season.
Retail continues to adjust to e-commerce, but even as the economy remained relatively steady, some companies simply can't overcome the massive debt loads placed on them by private equity investors who took ownership in leveraged buyouts.
Tariffs of Chinese imports have raised costs for retailers across the board while keeping pace with modern shopping trends has required major capital improvements for many chains. Incremental gains in earnings won't be enough for companies to keep pace if they can't spend enough to compete. While 2020 might not break 2019's record for closures, expect at least a couple of brands to keep making 2018 Bisnow look silly.