By Brian Ward, Trimont Real Estate Advisors
ATLANTA—It’s easy to feel uncertain about what this year will hold for the commercial real estate industry. After all, the industry is facing challenges from meta-trends like Airbnb (where do we begin?), e-commerce, even self-driving cars (and Uber’s legal showdown in California). Then there’s the broader, mature CRE market cycle, global liquidity and the continuing search for yield, and major uncertainties with the changing global political landscape. Will the CRE industry prosper or stall? Time will tell, but let these key trends for 2017 be the starting point.
1. Higher Capital Costs
We may see an increase in liquidity and leverage. If the incoming Trump administration is able to repeal or dilute regulations imposed by Dodd-Frank, Basel III and the like, the floodgates for capital will further expand beyond what we witnessed in 2016. While Wall Street and banks will benefit, the US central bank will be caught squarely in the middle and may have a tough task of balancing monetary policy, stable growth and a globally competitive US dollar.
These challenges will have broader ramifications beyond commercial real estate. We will see inflationary pressure, but it remains to be seen whether sustainable GDP and wage growth can be achieved to the level suggested by the incoming administration. If not, we are exposed to stagflation risk. Either way, we are likely to have higher capital costs for commercial real estate. In the near term, we doubt higher capital costs will translate into higher cap rates as the weight of liquidity and lack of investment alternatives will keep the pressure on. That could change in 2018.
2. Brexit Effect
Although we’ve had a continuing decline in the sterling post-Brexit vote, we have not yet seen a corresponding increase in UK investment activity. We believe this is due to continued uncertainty around the broader implications of Brexit—though it is too soon to draw definitive conclusions from this slowdown. It could be merely a pause in the market, with activity resuming in 2017 once further clarity on Brexit is communicated. The Brexit event is notable in terms of how quickly the uncertainties of politics and policy can erode investor confidence, or can at least be translated into a material pause in investment activity.
London will remain a global financial leader, although we wouldn’t be surprised if metros such as Frankfurt and Amsterdam see an increase in investment activity over the next few years, particularly as a result of their airports, favorable business climates and multi-lingual accommodations. Assuming Brexit happens, companies will diversify their UK positions into leading EU markets. There is concern that the average U.K. consumer could be hurt as a result of Brexit due to the rapidly increasing cost of consumer goods and declining sterling. A drop in UK consumer spending will most certainly hamper their GDP growth. We see the potential for parallels between the UK and the US when it comes to foreign investment, as well as potential adverse impacts for the average consumer.
Currently, foreign investment into US commercial real estate is at an all-time high. We don’t think that will change much during the first half of the year, but thereafter it becomes less clear. We are hearing words of caution from foreign capital on investment into the US. However, these cautionary comments are offset by the general belief that today, the US remains the best risk-adjusted market for commercial real estate investment in the world. That could change if, similar to the UK, uncertainties persist and risk-adjusted alternatives crop up.
3. Disrupt or Die
Technology advances are significantly changing the way we work and live, shifting how the industry imagines investment strategies. However, we are seeing a slow-reacting asset class. On retail, the loss from e-commerce has resulted in distribution gains. Malls will continue to become distribution spaces and the experiential consumer will encourage further blending of entertainment with apparel.
Transformation of the hospitality industry via Airbnb and VRBO will continue to face local regulations that may inhibit the threat they pose to commercial real estate. But the sharing economy is here to stay. With regard to transportation, driverless cars will present far-reaching social implications when you consider 17 million jobs are tied to individuals driving vehicles. The design of parking spaces is another area of investment that is shifting. There will be an increasing demand for these projects to be built as flat spaces, as it will be easier and more cost-effective to repurpose than the traditional ramp parking garage. We see these designs common in urban areas, but over the next few years, we may see more of these commercial projects pop up in suburban areas.
In the next decade, these technology advances will totally alter the thought process around real estate, how investment occurs, and how we buy and manage projects. If the industry doesn’t keep up, it’ll be decimated by the transformation.
Brian Ward is CEO of Trimont Real Estate Advisors. The views expressed here are the author’s own.