2015 Commercial Real Estate Outlook

Where do you see the opportunities for growth in your sector

As we move into 2015, strong market fundamentals and the availability of a diverse array of funding sources will likely fuel industry growth. Rents and vacancies are expected to continue to improve across property types and availability of financing through traditional and nontraditional channels is likely to continue to drive domestic investor interest in US commercial real estate (CRE). In addition, US CRE is increasingly gaining international investor interest as limited home-country options and the gradual relaxation of outbound investment restrictions are driving investors to scout for cross-border options. Together, these should further strengthen transactions and pricing across primary, secondary, and tertiary markets. Talking beyond the US CRE markets, most REITs pulled back from international expansion in the global financial crisis. We’re beginning to see some return to, or at least express interest in, selected global opportunities.

From an investment perspective, REITs are likely to continue to offer positive returns against benchmark indices and investors will benefit from additional diversification opportunities from the growing number of REIT conversions in nontraditional property sectors. The private equity real estate funds appear to be having more success raising new capital and have increased opportunity to exit legacy investments due to higher property prices and an active transaction market.

Further, there is an increase in awareness and implementation of sustainability initiatives aimed at energy, water, and waste efficiency as indicated by a growth in green building certifications. The combined demands of occupiers, investors, and regulators are such that tangible benefits can be derived from embedding sustainability into the full investment process. Going forward, adoption, measurement, and reporting of sustainability initiatives will be a business imperative, given the broader benefits on rental growth, yield premiums, total occupancy costs, asset values, and marketability.

Lastly, companies will likely increase their investments in new technologies such as cloud, analytics, mobile, and social media. As technology adoption advances, CRE owners can consider using a combination of cloud, social media, big data analytics, and mobility to drive more informed decision-making and improved operating efficiency.

What should businesses be mindful of as they plan for growth?

Construction loan availability from banks might fall short of actual demand, even as lenders continue to ease standards for construction loans. However, alternative sources of development capital have emerged from private equity firms, international investors and other capital providers to fill the gap left by banks. Crowd-funding has also gained traction in supplying capital to smaller real estate development opportunities. That said, companies that raise capital through nontraditional channels may need to exercise caution as these sources come with their own quirks. For instance, green bonds require issuers to increase disclosure and transparency about sustainability goals and targeted use of funds to meet the stated objectives.

Further, companies looking to access cross-border capital should understand the investment pattern and objectives of foreign investors to build long-term and mutually beneficial partnerships. Many of these investors lack knowledge of US CRE markets, entitlement processes, and relevant regulations and tax laws, and seek out domestic partners to access local marketplace and regulatory knowledge. Similarly, with respect to outbound investing, US CRE players can leverage long-term partnerships with foreign investors to better navigate international markets.

Lastly, as CRE companies adopt more advanced technology, they will need to develop a customized plan for overall technology adoption as well as invest in appropriate security and privacy practices as a “one-size-fits-all” approach is unlikely to work.

What is the next big thing?

We believe that tenants’ sustainability focus and technology use will have a greater influence on space demand and supply, not only in 2015 but longer term. Consequently, we expect to see increased redevelopment of existing properties to better position those properties to compete with new development. CRE players should increasingly collaborate with potential and existing tenants at the design stage to understand their technology needs and sustainability objective to incorporate them as an integral part of design and/or redesign.

As companies aim to improve sustainability measurement and reporting, they should focus on quality over quantity (i.e., disclosing the right metrics rather than a large volume of metrics, of which many may be redundant). We expect positive engagement with integrated reporting principles to be the next vanguard for sustainable business practices for the CRE sector.

Real estate owners will increasingly invest in building automation, and the U.S. building automation systems market is expected to grow by 7 – 9 percent annually during the 2014 – 2017 period to $2.2 billion by 2017.^[1] As building automation advances, CRE players will likely derive greater benefits, beyond operational efficiency and cost savings, by increasing investments in intelligent buildings that integrate building management, communication technology, and business systems.

However, this increased technology adoption also exposes companies to new and complex risks. As CRE systems become more interconnected with systems of tenants and vendors, enhanced cybersecurity will become necessary to protect not only CRE company information and systems, but also to prevent unintended access to or information loss from tenant and vendor systems. It is important for CRE companies to appropriately secure data as any breach will have ramifications such as tenant loss, reputational damage, regulatory investigations, and privacy law violation penalties.

[1] “U.S. Building Automation Market Primed for Growth,” Electrical Construction and Maintenance, January 17, 2014

What markets do you see emerging in the sector?

The demand-supply dynamics are changing across property types and CRE owners need to assess the usability of existing space and new supply. Let us look at the trends for some property types. For industrial property owners, as omni-channel retailers with e-commerce activity focus on speed of delivery to improve competitiveness, location of the warehouse and distribution centers is likely to play a more critical role than before. Unlike the past, retailers position physical stores differently and consider them to be a part of the seamless omni-channel customer engagement model, rather than the “only channel.” Commonly referred to as concept stores, they blend physical inventory, online access, and experiential retailing to customize and enhance the customer experience. Hotel owners should consider adopting technology to offer innovative designs such as door lock technology (smartphone or finger print-enabled access), among others.^[2] This is important as competition from nontraditional and new players such as Airbnb^[3] could potentially disrupt the industry in the long term.

From a property markets standpoint, secondary and tertiary markets will show increased activity as numerous investors are moving up the risk curve in search of higher yields, given cap rate compression in primary markets. Hence, players will potentially benefit from capitalizing on the improved liquidity in the secondary and tertiary markets as competition will likely continue to intensify in prime markets.

[2] “Hotel Year Book 2014: Foresight and Innovation in the Global Hotel Industry”, Hospitality Financial and Technology Professionals, February 25, 2014

[3] David Shulman, “Technology vs. Commercial Real Estate: Retail, Office and Hotel Markets Face Major Disruptions,” UCLA Anderson Forecast and UCLA Ziman Center for Real Estate, June 16, 2014