6 Major Misconceptions On The State Of Today's Commercial Real Estate Market
The commercial real estate industry is evolving, but not everyone is keeping up.
What was the norm only a decade ago has been upended by two key factors: The use of technology has made processes, investment strategies and properties more efficient and the health of the U.S. economy is experiencing its second-longest period of economic expansion in history.
These factors combined have worked together to change the built environment, transforming those trends that were previously the norm. To bring commercial real estate owners, investors and tenants up to date, Bisnow debunks six common misconceptions that professionals in the industry still operate under, according to studies conducted by Newmark Knight Frank researchers across the country in “Myth vs. Reality: Evaluating Popular Misconceptions in Commercial Real Estate.”
Myth No. 1: E-commerce is stomping out brick-and-mortar retail.
The rise of e-commerce has forever changed the way consumers shop, but physical retailers are in no way extinct or dying. In-store retail sales accounted for 91% of the $5.1 trillion U.S. retail market last year, NKF reports, and retail sales are expected to advance 4.4% in 2018, according to the National Retail Federation.
As stated by 28 global commercial real estate leaders, the retail industry is in the throes of a seismic shift fueled by online shopping and consumer demand for experience. To accommodate these preferences and give shoppers a reason to power down their computers, landlords are turning to entertainment, food-and-beverage and pop-up tenants to give consumers the diversity they are longing for.
“It’s really about a transformation of the retail market. We’ve seen success for luxury goods and discount stores — it’s that middle part of the market that has an increasingly harder time standing out,” Newmark Knight Frank Senior Managing Director of National Research Sandy Paul said. “So what those middle-market retail centers are doing is trying to find ways to offer customers something they simply cannot get online.”
As for the massive wave of store closures the country has been experiencing these past few years, many of the closings can be attributed to the country’s excess of retail real estate. The U.S. has more retail real estate, 23.6 SF per capita, than any other country in the world, according to NKF. Though certain segments, like department stores, are facing more hardships reinventing themselves, discount and convenience merchandisers are thriving and opening new stores in droves.
Myth No. 2: When it comes to office design, efficiency and cost control are most important.
Though cost savings was top of mind for employers following the Great Recession, it is no longer the primary focus of office design today. Thanks to a full labor market and a decades-low unemployment rate of 3.8%, available talent is scarce and employers are competing to attract young professionals to their businesses.
“Certainly many tenants are reducing their footprint when signing a new lease, but the focus isn’t necessarily all about that,” Newmark Knight Frank Associate Director Bethany Schneider said. “[The] focus now is about improving the employee experience.”
Office amenities and workplace productivity are now key design elements companies take into consideration to attract and retain talent. This can include both flexibile and activity-based workplace design, which consists of a variety of closed and open workspaces to fit everyone’s preference. Some employers have even considered monitoring employee happiness by hiring chief happiness officers to keep track of employee engagement, empowerment and fulfillment.
It doesn’t stop there. Smart buildings that can anticipate employees’ needs — when it is too warm or too bright — and improve the experience using artificial intelligence and machine learning all factor highly into office design today. Some employers are even paying a $33M annual premium to be in the country’s top tech cities and burgeoning markets to appeal to young professionals.
Myth No. 3: Foreign investors have turned away from U.S. commercial real estate.
Political headwinds and high property valuations have created the misconception that foreign buyers are pulling away from U.S. commercial real estate, but the opposite is true.
Though foreign investors accounted for 19% of total deal volume in 2017, down from 2016’s peak of 22%, according to NKF, U.S. transaction volume has been sluggish across the board — for both U.S. and foreign investors. The slowdown has been in response to hundreds of billions of dollars in dry powder competing for the same deals, and a frustrating bid-ask spread hindering investors' ability to secure the yield they desire. Commercial real estate pricing advanced 1% in May, according to Green Street Advisors, but remained flat year to year.
“[Foreign buyers] are still investing at a substantial rate, but they are beginning to explore new submarkets and secondary metro areas in a search for yield,” Paul said. “For example, investors that had been putting a lot of capital in assets in downtown San Francisco are now looking at submarkets in the Valley. The same goes for Washington, D.C.”
According to Real Capital Analytics, cross-border acquisitions in U.S. commercial real estate was up as of Q1, with Canada, China and Singapore deploying $20.3B, $8.9B and $7.7B in the past 12 months, respectively.
Myth No. 4: More often than not, close-in industrial assets are vacant and outdated.
Industrial real estate is red-hot, and demand for these assets is not expected to slow anytime soon. Demand for industrial product is soon expected to catch up with supply due to frothy pricing and construction labor shortages.
“The myth is that the older product very close-in to major cities is not performing well because it’s dated and obsolete,” Schneider said. “The reality is there is a large demand for close-in product because of last-mile costs. To be able to be within 10 miles of a city center is very advantageous for industrial tenants, even if product is a little dated.”
According to NKF, transportation costs make up about 50% of the average distributor's overhead, while real estate costs account for only 4% of their overhead. Close-in warehouse and distribution centers are in particularly high demand thanks to the rise of e-commerce retailers. A need to be near densely populated urban metros to fulfill last-mile deliveries is driving demand.
Last month, gains in industrial real estate values led the overall 1% increase in year-to-year U.S. commercial property pricing. According to Green Street Advisors, industrial prices are up 15% from a year ago, which speaks to investors' appetite for the red-hot sector.
Big-box industrial properties, which are typically more than 200K SF with 28-foot ceilings, have become increasingly valuable. CBRE reports the value of the assets now surpasses that of office buildings.
“You may recall two years ago if you ordered something on Amazon you were happy if you got it in two days. Then that became one day, then one hour, then 30 minutes. In order to fill orders like that they have to have larger warehouses closer to city centers where the largest populations are,” Paul said.
Myth No. 5: Suburban office locations are unattractive and employers and employees don’t want to be there.
For years following the financial crisis, urban centers became the desired, hip, go-to office destination for major companies. Though this trend persists today, employers in search of top talent are not turning up their noses at suburban offices.
Lower costs, desired walkability, access to public transit and a live-work-play dynamic comparable to what can be found in central business districts have made some suburban markets appealing to young professionals and employers alike.
In the last five years, suburban office markets have tightened at a faster rate than downtown metros, NKF reports. CBD office absorption in the 56 major markets tracked by NKF stood at 31.5M SF between Q1 2013 and Q1 2018, while suburban office tenants absorbed 186.6M SF during the same period.
“I think the key for suburban locations to be desirable is having access to highways or to transit and having those amenities,” Schneider said. “The way we look at it is suburban locations that can replicate urban convenience, those are the suburban office product that is performing well."
Myth No. 6: The future of multifamily demand is centered around millennials alone.
Though millennials are still the largest living generation in American history and the generation is expected to drive multifamily demand through 2024, baby boomers are increasingly accounting for a large chunk of multifamily absorption.
The “silver tsunami” describes the wave of aging baby boomers who are entering their retirement years. According to the U.S. Census Bureau, the 78 million people age 65 and older are expected to outnumber youth under the age of 18 by 2035. The elder generation is increasingly offloading single-family homes in the suburbs in search of smaller, more manageable apartments in urban metros. According to the Census Bureau, renters age 65 and up accounted for the largest gains in renter households in the past decade.
Paul said developers should shift their focus from solely millennials' preferences and begin building multigenerational housing designed to appeal to older renters as well.
“[Baby boomers] often want larger units and rooms that can accommodate larger furniture or a spare bedroom where their grandkids can visit,” Paul said. “When designing, don't just think of millennials, think about the entire market.”