Real Estate Trends for 2019

Note: this learning series on Modern Commercial Real Estate Investing first appeared on the EquityMultiple blog. Please check in there for updates and additions to this series.

Our young industry — variously referred to as “real estate crowdfunding”, “online direct real estate investing”, or “platform-based CRE investing” — began around the apex of commercial real estate’s recovery from the Financial Collapse, with 2015 the high water mark for transactions. 2018 was the 9th consecutive year of growth for the U.S. commercial real estate market. As we will discuss, growth is expected to moderate this year, and at this point in the cycle we can expect opportunities for yield to be less uniform across markets, property types, and investing strategies. Despite a tapering on volume and valuation, commercial real estate (CRE) markets remain healthy.

This article takes a look at the real estate trends that matter, and what they may mean for you.

What trends — demographic, macroeconomic, and technological — will define real estate investing in 2019 and beyond? What do current and emerging trends portend for platforms offering private commercial real estate investments, and individual investors seeking exposure to alternative investments?

Current Macroeconomic Factors & Real Estate Trends

As a recent survey revealed[1], two thirds of economists expect some form of economic downturn by 2020. While this consensus is not encouraging for CRE markets at a high level, neither is it cause for panic. The same survey yielded little consensus regarding the severity or length of the recession, and many experts have been quick to note that real estate fundamentals are on much more solid ground than they were in 2007, leading up to the financial collapse.

Along with geopolitical turmoil and international trade, rising interest rates have been consistently identified as a potential cause of an economic correction, and a headwind against continued growth in real estate values. While this remains a real concern, the Federal Reserve has recently telegraphed a slowing of interest rate hikes in 2019 and beyond. This comes as welcome news for real estate investors.

The consensus forecast for overall economic growth is between 2.2 and 2.4% for 2019, down somewhat from the 2.7–3% we have been accustomed to for the past several quarters. Average GDP growth is forecasted at 1.8% for the years 2018–2028 (with the caveat that 10-year forward-looking economic forecasts often are about as accurate as the musings of an amateur astrologist). That said, there is still room for the economy to grow and potentially exceed these cautious projections. Though real wage growth and workplace productivity figures have been lackluster throughout the recovery, macro data suggests that we are finally seeing improvement[2] — a path to further growth for an economy already at full employment.

The bottom line: the consensus among economists is that growth will moderate, and that some form of correction is likely within the next several years. However, this should come as no surprise and should not cause despair among real estate investors — macroeconomic market fundamentals remain strong, there are still pockets of yield potential in certain markets and property types, as we will discuss.

Demographic Trends & Real Estate Markets

Real estate trends remain inextricably linked with the millennial generation: those aged 25–37 who in many cases are entering the prime of their careers and making lasting decisions regarding where to live and work. The preferences and migratory patterns of this generation are a major factor in the relative appeal of real estate markets and dynamics within them.

In the years to come, Generation Z — the younger generation just now entering the workforce — will come to dramatically reshape real estate trends. For now, though, the millennial demographic continues to wield tremendous influence over real estate demand drivers. A few key trends:

The New Tech Hubs, and the “Rise of the Rest”

Gateway cities like San Francisco, Los Angeles and New York continue to attract tech talent and tech employers and, while some see Class A multifamily and office becoming frothy in these ‘superstar’ cities, capital continues to flow in from home and abroad.

These three cities in particular, though, are increasingly plagued by housing unaffordability (even for relatively high-paid workers) and brutal average commute times. While gateway cities are still magnates for talent, many millennials are opting for Mountain West and Southern cities in search of affordability and livability. Perhaps as a consequence, more tech job growth is forecasted in the secondary markets of Austin, Dallas, Seattle and Provo (Salt Lake City) than in any gateway city or Silicon Valley through 2023.

At the same time, the local economies of numerous mid-American cities have diversified, presenting more opportunity for educated young professionals who seek urban vibrance and cultural opportunity. Witness the evolution of Houston from a one-trick-pony energy town to a global hub for biomedical technology and research with a rapidly growing service sector.

Millennial Living Preferences

While homeownership rates are finally on the upswing after more than a decade of decline, they are still quite low by historical standards (as of July 2018, the national homeownership rate was at 64.4%, down from a pre-recession high of 69% in 2005 , with many millennials opting to continue renting later in life.

Part of this is a matter of preference: millennials have exhibited lower rates of family formation than prior generations, and a preference for urban convenience over the large lots and quiet of the suburbs. (Though this trend too appears to be tapering off somewhat). Part of this is a matter of necessity: single-family home prices are at all-time highs in gateway cities, and homeownership remains out of reach for even well-compensated millennials in many markets.

Indeed, the continued rise in single-home values and a failure to build enough serviceable multifamily units in many markets has created a nationwide shortage of affordable housing. A recent study by researchers at The National Association of Home Builders estimates a need for 4.6 million additional rental housing units by 2030, or 325,000 per year.

Amenity Creep

Technological advancements in security and IoT (internet of things) and the demand for rich experiences (like concierge services, pet daycare, spas, or even more niche deluxe features) has led to sky-high expectations among Class A multifamily tenants. In dense, affluent markets, it is not hyperbole to call this an amenities arms race among developers and operators.

A few takeaways:

• The growing importance of amenities and tech integration ups the ante for multifamily investors in competitive markets. Investors should consider the technological and operational knowhow of the Sponsor, developer, and operator.
• Specifically, developers, Sponsors, and operators in competitive markets must be able to leverage economies of scale in construction and operation to deliver the kind of living experience that Class A tenants demand.
• With heightened competition, and potential for amenities to eat into NOI, secondary markets and Class B or Class C workforce housing may increasingly become viable alternatives.

Real Estate Trends by Property Type

With macroeconomic, demographic, and demand trends as a backdrop, let’s take a look at some sector-specific real estate trends for 2019:

Multifamily

As noted above in the section on Demographics, multifamily is currently characterized by overbuilding and intense competition in certain Class A markets. Net-migration to secondary markets with burgeoning tech sectors will be a trend to monitor in the next several quarters, especially as yield becomes increasingly difficult to find in gateway multifamily markets.

Affordability (or lack thereof) and shifting preferences will also shape multifamily demand and investment potential in 2019 and beyond. Some specific implications:

• Alternative dwellings may exhibit increased demand, in particular:
• Co-living may continue to grow in prominence as an affordable, flexible, community-focused means of living in dense urban cores where middle-class residents are otherwise being priced out. Our project with Starcity — a leading operator in the co-living space — serves as evidence of how this innovation can help mitigate housing unaffordability in an acutely expensive rental market like San Francisco.
• Manufactured home communities may emerge as viable, affordable alternatives for working families seeking home ownership, particularly as the stigma of a ‘mobile home’ fades. Because of low overhead and (generally) low cost of land, this is a space drawing more and more interest from institutional capital.
• Opportunity Zones & Opportunity Funds may stimulate development and create investment opportunity where workforce housing is most needed.
• The “urbanization of the suburbs” is likely to continue. While millennials are showing more willingness to relocate to more affordable suburbs, urban amenities and connectivity are still in high demand. There is opportunity for yield where multifamily densification can occur in transit-rich suburban communities.

Some market-specific observations:

• As affordability plagues some West Coast markets, and remote work becomes more feasible for many knowledge workers, opportunity may arise in relatively-low-cost smaller markets with excellent access to outdoor opportunity: Tacoma, Reno, Sacramento, Bellingham, WA. and Bend, OR. to name a few.
• Brooklyn moved up to #2 in the latest ULI survey of multifamily investors, buoyed by growing interest in urban industrial — including ‘last-touch’ ecommerce facilities (more on this in a bit).
• Markets across the south-central US are appealing due to net positive in-migration, diversifying local economies, and a favorable mix of job creation and relative affordability that should appeal to millennials this year and beyond. Including Dallas, Houston and Oklahoma City.

The shortage of affordable, density housing in markets across the country — and the potential for Opportunity Zone investing to address this issue — will be one of the key real estate trends to monitor this year.

For more on trends in multifamily investing, please refer to this recent article.

Retail

Retail remains a frequent punching bag for pundits within and outside the real estate industry. With shopping malls and big-box brick and mortar retailers shuttering doors, harbingers of doom are highly visible

The demise of retail is frequently attributed to ecommerce. While ecommerce is becoming more omnipresent and widely-adopted, it still only accounts for 10% of overall shopping in the U.S., with a forecasted 14% share by 2021[3]. Excluding food and auto, ecommerce is estimated to account for roughly 20% of domestic consumer sales. Ecommerce operations will continue to expand, to the benefit of industrial real estate investors. In the meantime, however, there is still 80% of a $20 trillion + industry to consider. Meanwhile, after a temporary dip, consumer confidence is once again on the rise[4].

A few further notes:

• While ecommerce continues to eat into ‘big box’ shopping, immersive, tech-enabled shopping experiences are on the rise. This should manifest as growing demand for high-foot-traffic, smaller urban spaces that are easily accessed by more affluent consumers.
• As noted previously, the growing appeal of cross-functional, community-oriented built environments (including the ‘urbanization of the suburbs’) will create more demand for spaces that combine retail with multifamily, mixed-use (e.g. coffee shops) and office (i.e. coworking).

In other words, retail investing is hardly dead. But, with ecommerce gradually and intractably eating into market share in most retail verticals, retail investors must look to more dense, affluent submarkets, and to retail tenants that are adopting technology and experiential shopping.

Industrial

As noted above, the gradual ascent of ecommerce will be a boon for industrial real estate investors for years to come, generating predictable and sustained upward pressure on demand in the sector.

Ecommerce is also reshaping the landscape of demand for industrial space: consumers are expecting faster and faster delivery times, creating more demand than ever for “last mile fulfillment” centers. In practice, this means industrial space in more urban locations, close to large concentrations of consumers.

A few further notes:

• Warehouse and distribution vacancy is at historic lows. In markets across the country, undersupply of industrial space offers investment opportunity[5].
• Opportunity Zones may create further impetus for industrial development and rehabbing in urban and suburban areas with robust connectivity to fulfillment and supply chain routes
• In urban Opportunity Zones that are not environmentally fit for new multifamily development, opportunities may arise for industrial development or rehabbing of existing assets, filling the need for “last mile fulfillment”, mentioned above.
• Further industrial investing opportunities may arise in states with legalized cannabis production, where there is new demand for grow and processing facilities.

Investment & development prospects across commercial asset types, per a ULI survey of institutional investors

Alternative Assets

As opportunities for yield dry up in certain markets, among certain property types, new investment potential is emerging in the so-called ‘alternative’ CRE asset classes. New property types may become viable investments by some combination of shifting perceptions (and hence demand), a change in the legal/regulatory environment, or technological advancements. We have already mentioned manufactured home communities, ‘co-living’ and ‘co-working’, and cannabis facilities. Here are a couple other alternative asset classes favored by current real estate trends:

Car Wash

The professional car wash industry achieved a 3.6% compound annual growth rate from 2013–2018, spurred by a steady increase in overall vehicle activity as well as a surge in ride-share drivers on the road (and seeking to maintain clean vehicles). Meanwhile, technological innovation has made the industry more profitable and efficient.

Because car wash facilities are located in highly-trafficked locations as a matter of necessity, solid downside protection is generally built-in: in the case of operational failure, the facility owner can rent to a different car wash tenant or repurpose as retail. For more on the topic, please review this recent article.

Data Centers

Put simply: with each passing day, there are more and more devices consuming more data. Hence, the demand for facilities to power this data throughput will continue to increase.

Because operators of data centers seek lower energy costs and, in many cases, data redundancy with respect to urban data storage, demand for data center facilities will likely remain concentrated in suburban and rural areas.

Final Notes: Commercial Real Estate Trends for 2019

• At this stage of the cycle, some markets are priced to perfection. In 2019, we may well see opportunities for yield shift away from coastal gateway cities.
• Opportunity Zones will create new opportunity across property types. This may well take place in resurgent secondary markets like Phoenix and Nashville, as well as in submarkets of primary markets (such as Downtown Brooklyn) already experiencing rapid growth.
• Repurposing of obsolescent retail assets is a huge opportunity, especially in Opportunity Zones.
• Availability of debt capital continues to increase — there is both plenty of appetite (as reflected by volume of deployable capital from CMBS and debt funds), and a softening of underwriting rigor over the past several years[6]. For individual investors consider a debt investment, this is all the more reason to examine overall leverage — LTV and DSCR — in the capital stack of the prospective investment.
• Institutional investors (pensions, endowments, etc.) are moving away from just ‘core’ and into core-plus, value-add, and opportunistic. With EquityMultiple, individual investors have the opportunity to do the same.
• We don’t know how or when artificial intelligence will impact labor markets, we only know that it will (in certain sectors, it already has). While AI may obviate certain job functions, it will create new ones in oversight, maintenance, and programming. We don’t pretend to know how AI will impact real estate investing in the near-term, but a strategy of geographic and sectoral diversification will serve investors best as technological disruption continues.

Generally speaking, there is reason to move cautiously in certain marquee markets at this point in the cycle. However, with market fundamentals still broadly strong, interest rates moderating, and a healthy economy, opportunities for yield still abound across a broadening set of asset classes and secondary and tertiary markets. These emerging opportunities will be driven by technological innovation, demographic trends, and the Opportunity Zone paradigm.

The length of the current cycle along with increased transparency has allowed a larger and more varied investor pool the time to evaluate these markets and find what works best for them. For a

From the latest Urban Land Institute report on commercial real estate trends:

“The diversity of investor goals and choices is healthy — far healthier than the herd behavior that has sometimes characterized markets. As an international investment fund executive told us, “The differentiation of opportunities has — to a degree — expanded; niche product types like senior housing and self storage are being viewed as ways to ‘round out’ real estate holdings, taking advantage of specialized uses that are not ‘averaged out’ in major trends.”

—

EquityMultiple connects accredited investors with pre-vetted, private-market commercial real estate investments across markets, property types, and investing strategies. Our portfolio approach is informed by industry trends, and our model affords individual investors the opportunity to build a diversified commercial real estate portfolio.

To learn more, please sign up or schedule a call with our Investor Relations Team.

[1] https://www.bloomberg.com/news/articles/2018-10-01/two-thirds-of-u-s-business-economists-see-recession-by-end-2020

[2] https://www.cnbc.com/2019/02/13/worker-wage-gains-are-keeping-up-with-inflation-and-then-some.html

[3] https://www.statista.com/statistics/379112/e-commerce-share-of-retail-sales-in-us/

[4] https://www.cnbc.com/2019/02/26/consumer-sentiment-hits-131point4-in-february-vs-124-expected.html

[5]https://multichannelmerchant.com/operations/historically-low-warehouse-vacancy-leading-upward-development/

[6]https://ulidigitalmarketing.blob.core.windows.net/marketingfliers/Emerging_Trends_in_Real_Estate_2019.pdf#ulip=et19cover (pg. 25)