Top Trends to Watch in the 5 Commercial Real Estate Sectors

Apr 20, 2017

Trend watching in commercial real estate is tricky business, but with some experience in observing the industry, patterns emerge. Let’s look at some current trends to watch in each of the major 5 property types: Office, Industrial, Retail, Multifamily and Hospitality.

Office — Home of the 9 to 5 Workplace

The Trend: Steady growth driven by lower vacancies and higher asking rents.

Driving Factors: Because the economy is growing at a reasonable pace — and the U.S. is seeing steady job growth— the next year in the office sector will probably be one of good growth, both for absorption and development.

Research conducted by Marcus & Millichap is projecting net absorption of 83 million square feet of space in 2017, which will bring national office vacancy down 20 bps to 14.3% — a low for the current cycle.

Lower vacancies should spur an increase in average asking rents in the 3.5% range. That, in turn, could spur additional development — though 2017 is likely the zenith in terms of crane activity for the current cycle.

As long as Millennials want to work in downtown locations over the suburbs, cities will have the advantage in attracting businesses.

Industrial — Where Goods are Made, Stored or Organized

The Trend: Consumer behavior is putting pressure on the Industrial sector. The demand for faster product deliveries means the need for smaller, more flexible spaces located closer to the consumer’s doorstep.

Driving Factors: Driven largely by the growing popularity of e-commerce, industrial properties have had a strong run of late. But the dynamic is changing because of disruption to the marketplace.

First, the good news: rents were consistently higher in most industrial markets in 2016, part of a multi-year surge. CBRE Inc. expects rents to increase by an additional 5% in 2017, setting another record high. Rent growth should continue over the short term, even as there is a steady increase in new construction.

But the popularity of e-commerce is shifting what industrial space looks like. This is mainly due to the phenomena known as “last mile logistics,” which is the challenge of getting goods as close and quickly to the consumer’s doorstep.

As recently as five years ago, the most sought after feature for a warehouse was low cost. That has quickly shifted as consumers demand faster and faster delivery. As a result, the need for large industrial spaces is decreasing as smaller and more flexible spaces within city boundaries are better suited. This trend will only increase as more companies expand into the same day delivery space as companies such as continue to push expectations.

Retail — Malls, Lifestyle Centers, Big Boxes, etc.

The Trend: Retail is going through some tough times. To compensate, the industry will see more retail owners merging into industrial owners.

 Driving Factors: On the flip side of the industry and logistics equation, brick and mortar retail is going through some tough times. Experts agree that there is too much retail space in the U.S.

Even longstanding, well-established brands such as Macy’s and Sears are in trouble. In January, Macy’s announced it would shutter 15% of its locations (68 stores) by the end of the year. Sears shed workers and 150 locations as if the economy was in recession, which it is not. Familiar mall staples will become a bit less commonplace in upcoming quarters, with Abercrombie & Fitch, American Apparel, Crocs, Guess, BCBG, GameStop all announcing plans to downsize.

The next 12 months will continue to be difficult ones for retail real estate as this major correction in the market proceeds. What kind of correction? Remember that there was explosive growth of retail properties in the booming 1990s, and an equally explosive growth in the (mostly) early 2000s. Now all that is being reversed.

But that doesn’t mean that all retail properties are going to lose money. In fact, well-located properties in major markets, especially those ‘experiential retail’ assets that are part of mixed-use developments in urban settings, should do very well in the near- and longer-term.

One more thing about retail: there’s a blurring of lines between retail and industrial that’s just beginning. For instance, retail properties now sometimes double as fulfillment centers.

Retail owners are trying different store formats and enhancements to the end-customer experience, some of which involve online ordering and store pickup. Walmart, for example, announced in April that it’s planning to offer lower prices on a million online-only items if you opt for store pickup.

Multifamily — Rental Apartments, Buildings with 5+ Units

The Trend: Millenials are giving the multifamily sector a big bump.

Driving Factors: The U.S. apartment market has had a phenomenal run in recent years, and it isn’t quite over yet — but the brakes are on, somewhat.

As a result of the recession, and Millennials’ taste for urban living, the multifamily sector became the darling property type among owners, developers and lenders in the 2010s. Among all the property types, vacancy rates are the lowest in apartments, and rent growth has been the highest for years. So what next?

More rent growth and more development, but not quite as robustly as in recent years. Demand is still strong, but some markets — Boston, Seattle, and Denver, just to name a few — have seen more high-end development than perhaps their markets can absorb in the near term. This has put a check on rent growth, at least among Class A properties. Class B and C are different stories.

According to data from Reis, Class B and C rent growth is now outpacing Class A rent growth, 3.4% to 3.5%. While it is just a slight difference, it marks a first for this cycle.

One more brake on apartment development in the near future: lenders are a little more reluctant to lend now, especially for development. They’re aware of the risk of overbuilding in some markets, so they’re holding back more than even six months ago.

That doesn’t mean financing is impossible for apartment development, just harder — the deal has to be just right.

Hospitality — Your Home Away from Home

The Trend: Hotels are staying strong, but be weary of the balance between rapid development and labor costs.

Driving Factors: Next to apartments, hotels have had the best run as a property type after the recession. In terms of room occupancies and revenue per available room (RevPAR), two important metrics in the hospitality industry, 2016 was the best year ever.

People are traveling again, both for business and pleasure, and not even industry disruptive ventures such as Airbnb can put much a dent in that. But there are challenges ahead for hotels and hotel operators. One is labor costs. As occupancy expands, so does the need for workers, and a shortage of skilled workers has meant upward pressure on wages.

Also, the rapid development of new hospitality product means that, among other things, there will be pressure on existing properties to up their game in terms of service and amenities, all of which cost money.

Even in a boom time — and the boom should continue — the hotel game will continue to be competitive.