Originally posted by Reonomy – Jan 07, 2020
As we close out one decade and start the 2020’s, we take stock of the past year and look at the year ahead.
Looking back at 2019 in aggregate, the commercial real estate (CRE) and property markets across the US in the first three quarters generally kept pace with the prior year. While honing in on the specific markets will show that markets had different head- and tail-winds, the overall picture was positive. With inexpensive financing and the economy humming along, the case for CRE and property remains strong. Major property types will face headwinds – some new (e.g., cool down of industrial) and some old (e.g., continued deleveraging across retail) – but all in all, 2020 will likely benefit the CRE and property markets.
CRE and property investment activity is dependent on both local economic and macroeconomic dynamics. While we at Reonomy have the data covering all US cities, metropolitan statistical areas (MSAs), and states – we won’t dive in that deep in this article. But, we will touch briefly on some macroeconomic data as it relates to CRE and property markets.
The last year of the past decade saw the longest economic recovery on record continue, and this aggregate backdrop helped push the CRE and property markets along. While some signals are beginning to flash red in the US, and geopolitical tensions increase, the picture is not all gloom and doom. Even though late in the cycle, there appears to be room to run for the economy and
What did we see in 2019?
Not too dissimilar to the holidays spent with extended family, 2019 was a time to be celebrated, but tensions and many strong mixed opinions that could spark rich and heated debate remained just under the surface. As of writing, positive gross domestic product (GDP) growth, unemployment below the long-term natural rate, and steady corporate after-tax profits helped to push the broad stock market up nearly 30% for the year. However, during 2019, we also began to hear more concern and caution voiced.
Despite the macro economic concerns raised in 2019, the first three quarters saw total dollar volume transacted in the property market keep pace with 2018, approximately $845 billion across over 516,000 transactions.
Zooming in on the major types of properties tracked by Reonomy, the following total dollar transaction volumes and counts are compared to 2018 (first 3 quarters of each year):
What do we expect to see in 2020?
The US pushes ahead into the late stage of the economic cycle and continues its longest economic expansion (ever). Signs of slowing growth and pockets of economic weakness are starting to show, prompting the Federal Reserve to step in and resume monetary loosening, which will sustain the stock market rise, easy credit for those that can get it, and keeps businesses’ cost of capital low – allaying severe recession fears in the near term.
Given the economic backdrop inherited from 2019, the outlook for 2020 is net positive. While market and economic cycles are alive and well (and we will be reminded of a recession before we forget), the current deteriorating conditions are more akin to wear-and-tear and less imminent danger. The US’s condition relative to other major developed economies will benefit it and make it look more attractive. Additionally, the high level of pessimism in the markets is comforting, as it might be interpreted as a sign of preparedness among investors – something that may help to mitigate the downturn.
Some of the property trends that we expect to see in 2020 include:
Cheap credit and (relatively) attractive opportunities support investment levels:
The low rate environment will continue to encourage transactions and keep financing costs and debt service low – for those who can get it. Despite delinquency rates and transitions to special servicing being at record lows, market reversion worries will be on lenders’ minds throughout 2020. Banks and insurers will tighten underwriting standards, more so for smaller firms and consumers than for large institutions and corporates, resulting in a more pronounced size bias for access to credit.
This will result in an active investment market for CRE and property, with notable portfolio deals by institutional investors. While total transaction dollar volume will not be too far off from the 2017 full year transaction volume ($1.0 trillion), it will be below the recent full year peak in 2018 ($1.2 trillion) because of the economic and political uncertainty. Institutional money will still flow into property markets because the risk-reward profile will be attractive, especially compared to any assets with market risk and greater volatility.
Demographic preferences drive regional outperformance:
The divisive dynamic of the rising cost of living and stagnant wage growth, along with preferences for more space and flexible working conditions, will help fuel the net migration towards the south and west to rising secondary MSAs. Primary MSAs will continue to be just right for those who can afford it.
Property type-specific outlook
Industrial had a very hot 2019 – we expect that to calm down in 2020.
The structural shift within retail increasing the importance of logistics and distribution, plus the continued broad economic expansion continued to be the two driving forces. 2020 will not see a repeat of 2019’s hot industrial market, as new arrivals are absorbed and economic worries cause potential buyers with less bullish conviction to put a pause on purchase decisions.
We will continue to hear buzz around repositioning derelict and dark retail space, and some innovative examples will likely get a few minutes of fame, but the big wave of repurposing retail as industrial will not happen this year. While industrial properties as a whole do cool off a bit in 2020, expect to see more attention and interest in the more niche sub property types (e.g., cold storage, data centers).
Market uncertainty props up multifamily
Multifamily will continue to be a star property type in 2020, drawing attention from investors who are looking for a defensive asset and supported by the expanded caps granted to the government sponsored enterprises (Fannie Mae and Freddie Mac). While capitalization rates are likely compress to new lows in 2020, the property type will continue to perform through 2020. Expect to see excesses in the multifamily market beginning to surface in later 2020 and heading into 2021.
Right-sizing retail remains local
While the retail sector continues its structural deleveraging and individual retailers scale back and right-size their physical real estate footprint, 2020 will be another year of mall closings; however the pain won’t be felt indiscriminately, top notch mall operators and high quality assets will continue to outperform. Shopping centers performance will depend greatly on the local markets, and will follow the southern and western migration.
Office stays local
The co-working revolution did not quite pan out as its promoters hoped it would in 2019, but will continue to have attention in 2020 as it finds its right pace within the officerena. Office space will continue to be a local story and will reflect worker preferences for short commutes. Look to the steadfast primary MSAs and the positive net-migration MSAs to continue to outperform.
Budgeting hurts hospitality & lodging in 2020
Investment in hospitality and lodging properties in 2020 will be bifurcated, as worries of an economic recession will permeate the labor force and travel will decline. As business leaders pinch down on expenses and commentators stoke the fears of a recession, domestic travelers will select more affordable lodging. As the US dollar continues to strengthen against foreign currencies, foreign visitors will be dissuaded from lengthy stays at luxury lodging.