Category: Real estate news

Fundamental Factors that Drive Commercial Real Estate Markets

Posted on February 14, 2020March 9, 2020 | Leave a comment

While most of you reading this come from the commercial real estate industry, it can be useful to brush up on the fundamentals. With this in mind, here are some of the fundamental factors that drive the commercial real estate market.

The Local, State, and Federal Economy

Without a doubt, the state of the economy is a primary mover of the real estate market. Understanding exactly how the economy impacts commercial real estate is more complex. First, we must measure the health of the economy using metrics including gross domestic product, gross national product, productivity, spending, unemployment, and much more. Ask ten economists which metrics matter most, how to properly measure them, and what trends will impact commercial real estate most, and you are likely to get ten different answers.

It is not vital for commercial real estate professionals to understand the intricacies of the economy. It is more important for CRE professionals to keep an eye out for dramatic economic shifts like the next recession.

Interest Rates – CRE Loan Rates

Another key factor in CRE health are the past, current, and future interest rates. Similar to an individual seeking a mortgage for a home, investors looking into commercial real estate properties seeking a loan must consider interest rates for their loans. When interest rates rise, demand for properties is generally lowered. Conversely, lower interest rates frequently spur new investments/restructuring for commercial real estate loans. The factors that determine interest rates are many, but essentially boil down to lenders covering their costs and risks of loaning money.

Unlike mortgages for residential properties, commercial real estate loan rates can vary from 3.5 to 20 percent. This wide range of rates stem from the different property types, investment types, loan types, and details of the individual/group seeking the loan. Because there is such a gap between different CRE loans, it is prudent to understand one’s unique situation before assuming a range of rates.

Regional Population Demographics and Behaviors

The national landscape of commercial real estate might not extend to your region. A simple example would be state population increases and decreases within certain demographics. If your state is experiencing a large influx of young professionals, the commercial real estate market is likely to experience a boost. Yet the CRE environment is not a 1-1 relationship with population alone. In our Western PA region, we are simultaneously seeing a growing demand for convenient housing for young professionals in urban areas and a growing need for senior citizen housing and resources such as medical facilities.

Demographics that influence commercial real estate also stem from shifts in demographic behavior. Where Baby Boomers were reliable home owners for many decades, they have recently begun a shift towards renting their homes for financial and convenience reasons. For this and many other reasons, “there are more of group x moving to our area” is not a slam dunk when it comes to CRE forecasting.

Governmental Policies on Commercial Real Estate

Buying, renting, and selling properties all involve government regulation. These regulations have always existed, but have increased in the years following the Great Recession of 2007-2009. Because the recession was tied into the lending crisis, federal and state regulations on real estate loans and transactions become stricter and more invasive. The commercial real estate industry is built to adapt to these changes. It has been argued that one of the major reasons why CRE bounced back faster than other real estate industries in the wake of the Great Recession is that adaptability to changing government regulation.

CRE professionals might want to stay abreast to the changing regulations through the Code of Federal Regulations (CFR). “CFR stands for Code of Federal Regulations. The CFR is the codification of the general and permanent rules and regulations published in the Federal Register by the executive departments and agencies of the federal government of the United States. This codification of what is sometimes called “administrative law” has been published annually since 1938. The CFR is divided into 50 “titles” that are meant to cover broad areas such as Commerce and Foreign Trade, Federal Elections, Employees’ Benefits, Internal Revenue, and Education, just to name a few.”

Going Forward

The current outlook of the commercial real estate market in Western PA and across America remains cautiously optimistic. The US economy has been relatively strong over the past few years, with a few cracks starting to form in recent months. Loan rates remain appealing for commercial real estate investors, and the overall trend for real estate has continued to rise. However, many of the industry drivers we listed here today are beginning to flatten or even regress. This, and many other complex factors, have led economists to predict a looming recession in America. Recessions are an unavoidable part of a free economy, and we are overdue based on historical precedence.

The silver lining in these predictions is that the Great Recession of some 12 years ago has left the commercial real estate industry more hardened against economic downturn. Remember that economic strength is only one of the driving forces of CRE markets. Understanding the bigger picture allows us to accurately predict what we can expect going forward.

Increased Senior Housing Needs’ Impact on Commercial Real Estate

Posted on February 4, 2020March 9, 2020 | Leave a comment

It is no great secret that our country is aging. In fact, recent estimates provided by the US Census Bureau project that “older people (are) projected to outnumber children for the first time in US history” within the next 10 years. Not only will this put an economic strain on our nation, but it will also challenge our existing resources and infrastructure. An example of this strain is the existing problem of demand for senior housing outpacing our current supply. This dynamic is likely to impact the landscape of commercial real estate for years to come, but how?

Today, we will review the current reality of seniors’ housing needs, what those needs are likely to look like in the near future, and how these shifting realities will impact the CRE industry today and moving forward.

Senior Citizen Demographics by the Numbers in 2020 and Beyond

To understand senior housing, we must first understand the senior citizen demographic in the US. Here are some fast facts on senior citizens in America:

Over 50 million Americans are aged 65 or older. It should be noted that this estimate is on the conservative side based on available Census data.

The population of senior citizens isn’t just projected to rise, it is expected to explode. Where 2018 statistics put the number of Americans aged 65 plus at 52 millions, that number will be approximately 95 million by the year 2060.
Older Americans are also getting more diverse over time. Today, approximately 77 percent of Americans 65 plus are white. That number is expected to fall to 55 percent by 2060. Despite this increase in diversity, older generations will continue to lag behind younger generations in terms of ethnic diversity.

Additional facts about senior citizens that remain relevant to our conversation about housing and CRE include: aging generations having higher levels of education, longer life expectancies, and significantly lower poverty rates.

Low Affordable Housing Supply May Price Seniors Out of Their Communities

While senior citizens are in better shape than ever before in American in terms of wealth and education, they are still vulnerable to rising real estate costs. For extremely low-income renter households, only 35 rental homes are available for every 100 families in need. This is an example of a problem for senior citizens: they are particularly susceptible to being priced out of their own neighborhoods. Coupled with a national housing shortage and a rapidly aging population, rising real estate costs are a very real problem for seniors.

In Pittsburgh, we can see this in neighborhoods like Lawrenceville. From the years 2010 to 2017, the median home sales price jumped from $95k to $237k. That is nearly a 150% increase in less than a decade. Many working class families who have been living in Lawrenceville for decades have been forced to look elsewhere for affordable housing options. Again, senior citizens find themselves being hit the hardest.

How America’s Aging Population will Impact Commercial Real Estate

The Baby Boomer generation is in prime retirement age in the US. With that paradigm shift, the commercial real estate market is looking to adjust. Baby Boomers have been driving the residential real estate market for 20 plus years. Now they are about to drive the rental and commercial real estate markets in a new way.

Baby Boomer retirement likely to increase demand for multifamily housing

Retiring adults have been showing more inclination towards “downsizing” as they approach retirement age. This means that the Baby Boomer generation is going to be predominantly looking for affordable housing and/or rental opportunities for the first time in many years. This change in desired housing will likely come with a higher demand for multi-family housing, including:

Apartment complexes aimed toward senior citizen needs
Gated townhome communities
Any residential plans which take care of lawn care, home maintenance, etc.
Convenient living with senior-friendly amenities such as ramps, elevators, etc.

Another key factor to remember is that many senior citizens desire to stay local as they downsize. This means that these amenities are going to be desired in their current suburban/urban neighborhoods for affordable rates. This creates a potentially lucrative opportunity for commercial real estate developers and/or investors to get ahead of a rapidly aging US population.

Going Forward

All signs point to senior citizens moving away from their single family homes into smaller single family homes, multi-family homes, or other senior-friendly accomodations. This is nothing new. What is new is that the population of Americans aged 65 plus is expected to nearly double over the next 40 years. As life expectancy continues to climb, older generations will be looking for affordable and convenient housing options in record numbers. From the perspective of the commercial real estate professional, the question becomes how our industry will adapt to this change.

Western Pennsylvania has already had an upturn in new construction for senior citizen centers, medical facilities, and other infrastructure to accommodate an aging population. Yet housing shortages and other factors will continue to create a situation where senior citizen demand for affordable and convenient housing will likely outpace the supply.

Real Estate Investment Trusts (REITs) Continue to be a Great Choice for Small Investors

Posted on February 3, 2020March 9, 2020 | Leave a comment

Perhaps the biggest problem being a modern real estate investor, or any type of modern investor for that matter, is an overabundance of choices. Stocks, bonds, mutual funds, options, annuities, direct real estate purchases, REITs, retirement accounts — the list seems to have no end. This leads to a situation where investors might miss out on potentially great opportunities in a sea of options. One such option is a real estate investment trust, frequently shortened to REIT.

Today, we will explore REITs, how they differ from direct real estate investment, and review why REITs remain a perfect choice for individuals in 2020 and beyond.

What are Real Estate Investment Trusts (REITs)?

According to reit.com: “REITs, or real estate investment trusts, are companies that own or finance income-producing real estate across a range of property sectors. These real estate companies have to meet a number of requirements to qualify as REITs. Most REITs trade on major stock exchanges, and they offer a number of benefits to investors.”

Let’s break that down. REITs are a unique way of investing in commercial, industrial, and/or residential real estate that is available to investors of all wealth levels. REITs are generally hands off, meaning that investors may have a vote, but will not directly control the buying and purchasing of real estate assets held within their REIT.

Real estate investment trusts are generally used as investment opportunities to grow the investor’s wealth. Most REITs focus on a particular subset of properties such as commercial apartment building, medical properties, data centers, hotels, and so forth. In this way, investors can choose the area of real estate they believe will make the best investment.

REITs vs. Traditional Commercial Real Estate Investment

So how exactly do real estate investment trusts compare to direct real estate investment? There are several ways we can compare and contrast the two:

REITs are the mutual funds/ETFs of the real estate world

As we described above, REITs give investors access to a multitude of properties through a trust. This means that REITs are more stable than direct real estate investment as one-off losses or gains will be balanced out by a larger portfolio. This also means that the potential for extreme gains with an REIT is generally lower than direct real estate investment.

Direct commercial real estate investment gives investors all the power

If you own a piece of real estate, you are in full control of that asset. You are free to buy, rent, renovate, or whatever else you might choose assuming you don’t have a contractual or legal obligation preventing such an action. REIT investors do not share this level of control or power. Instead, they buy into REITs which are managed by industry experts. A loss of control might be a non-starter for some investors, but the ability to diversify real estate holdings with REIT gives investors a much safer bet in the long term.

Direct real estate investment generally comes with a larger buy-in

REITs are extremely affordable. Much like stocks, bonds, or mutual funds, investors need only to be able to afford shares rather than making massive investments to purchase a real estate property. In this way, individuals and organizations of all levels of wealth can invest in the real estate market. This is a primary reason why REITs are perfect for individuals and small investors (more on this below).

REITs have guaranteed dividends

Another huge advantage of REITs is that a minimum of 90% of all payouts must come by way of dividends. This is a legal obligation based on federal REIT law. It is important to note that according to investor.gov: “The shareholders of a REIT are responsible for paying taxes on the dividends and any capital gains they receive in connection with their investment in the REIT. Dividends paid by REITs generally are treated as ordinary income and are not entitled to the reduced tax rates on other types of corporate dividends.”

REITs Remain a Solid Investment Opportunity

REITs are not meant to replace a solid investment portfolio by way of a retirement account and/or traditional investment account. Instead, they should be thought of as a perfect supplement to those investment opportunities which allows individuals of all levels of available capital to invest in the real estate market. A few reasons why REITs will remain a great investment opportunity include:

Guaranteed dividends
Real estate investment without the need for industry expertise
REITs are completely hands off/passive (unlike direct real estate investment)
REITs are liquid just like stocks or other traditional investments. Again, this differs dramatically from typical real estate investments
A traditionally strong performance compared to other investments

Going Forward

REITs were first introduced in the early 1960’s, and they don’t show any signs of going away any time soon. In fact, the total monies invested in REITs around the world has exploded from $300 billion in 2003 to a massive $1.7 trillion in 2017. Real estate investment is not just for the wealthy or the connected thanks to REITs. Anyone looking to build equity or expand their investment portfolio should consider a real estate investment trust.

A Chill in the Pittsburgh Office Market

Posted on January 29, 2020 | Leave a comment

Sometime in October every year, there’s an afternoon when you feel the wind blowing colder. It’s not quantifiable but it’s a chill that you know means fall is serious about setting in.

This past week or so, there was a similar chill in the air about the Pittsburgh office market. This time of year is when all of the real estate service firms issue year-end reports and it looks like 2019 was a year when the metrics slipped into more troubling territory. The 2019 reports are hardly bad news. Net absorption was positive, ranging from around 100,000 square feet to almost 300,000 square feet, depending on which report you read. (That’s a matter of when the researcher times the construction and completion, which varies.) Positive absorption in the face of record office construction is a strong signal. Rents grew again. But there were a couple of yellow signals.

Occupancy declined again, this time getting to mid-double digits. There have been some big spaces coming onto the market over the past few years, especiialy in One Oxford and 525 William Penn Place, and some significant sublease spaces. The effect of that has been to create higher vacancy, especially in the Central Business District (CBD).

Grant Street Associates/Cushman & Wakefield has the direct vacancy rate for Class A CBD at 13.9%. Newmark Knight Frank has it at 18.3%. (NKF excludes owner-occupied buildings from the calculation since they aren’t on the market.) JLL puts direct vacancy at 14.6% in the CBD.

The data, along with the national reports like CoStar’s, has made some of the brokers, lenders, and developers nervous. There are still great economic stories coming from Pittsburgh but with flat job growth, you may see a chill in the speculative office market, especially after the next couple of major projects get underway.

Speaking of the next major spec office, Burns & Scalo is bidding packages for the second phase of District 15, now called Vision on Fifteenth, a 275,000 square foot building. Carl Walker Construction is taking bids on a 376-car garage for the project.

In other project news, Al. Neyer will start construction on the 100,000 square foot Astra facility for Krystal Biotech in Findlay Township. The developers of 926 Smallman Street, an 81,000 square foot, 7-story mixed use building, are going through City Planning. Dick Building Co. is the contractor.

How the Housing Shortage Impacts Commercial Real Estate

Posted on January 24, 2020March 9, 2020 | Leave a comment

It doesn’t take a real estate expert to see that housing prices have been accelerating in recent years. Ten plus years after the Great Recession of 2007-09, residential real estate prices have more than recovered in most areas across the country. In its place, a housing shortage has created a situation where many Americans struggle to afford their rent, let alone to own a home. In fact, a significant portion of the current generation of young Americans have more or less resigned themselves to the fact that home ownership is unrealistic.

What is less obvious is how this residential real estate trend has and will continue to impact commercial real estate. It is unlikely that new home construction will be able to keep up with housing demands. Will these developments help or hurt the health of the CRE industry?

The Current State of Housing in the US

Let’s first establish a few key facts. There are approximately 138 million housing units in the United States. About 80 million of these units are occupied by their owners and 43 million are occupied by renters. By most estimations, the US actually has a very healthy ratio of available housing units to individuals or families in need of residence. So what is the problem exactly?

The answer lies in the fact that key markets such as California and Austin are being crushed by demand with a limited supply. The problem is that the current supply of housing units does not align with demand when it comes to price or location. This issue is particularly bad for more affordable homes, which cost between $100k-$250k, depending on the market. This creates heightened competition for more affordable homes, which drives up prices and makes these housing units less affordable to buyers and renters.

Ironically, as young adults flee from traditional markets like NYC and San Francisco and turn to hot markets like Pittsburgh and Kansas City, they are bringing big city housing shortage problems with them. For example, Pittsburgh experienced a 16 percent drop in relative housing availability in 2019 vs. 2018.

How Residential and Commercial Real Estate Interact

Based on these trends, one might assume that the commercial real estate rental market would be booming in response. This is not entirely the case. Despite housing prices rising to near-emergency levels, rental rates in 2020 are expected to remain relatively flat. The latest year-over-year numbers put rental rate growth at approximately 1.4 percent nationwide. Again, this is somewhat misleading as some regions have experienced explosive rental hikes while others have actually seen rental rates diminish.

Another key factor in this equation is the decision making process of young renters. Millennials and the generations who are growing up behind them have shown a tendency to choose convenience and amenities over square footage and perceived value. This is due to a number of reasons, including their desire to use public transportation and a preference for urban living.

These trends have been favorable for commercial real estate rental units which are focused on offering convenience first and foremost. Well equipped rental units in urban or even “urban suburb” locations continue to see high occupancy rates in 2020. As young adults continue to struggle to afford their own homes, rental properties should remain a safe bet.

Commercial Real Estate Projections in the Coming Years

By all current metrics, our nation’s housing shortage looks to only worsen in the coming years. This is especially true in mid-major markets experiencing a tech boom including Pittsburgh. As for commercial real estate investors in the area, that means that there will be an opportunity to deliver high quality housing at premium prices for young adults who are willing to pay for high level amenities.

For example, young renters are more likely to pay a premium for rental units in so-called “smart buildings”. These types of commercial real estate units are constructed or retrofitted to accommodate desirable features like ultra high speed internet and even 5G when that is released to the public. This is in step with the advantage that CRE has over traditional residential real estate: it can adapt more quickly on a larger scale to new technologies.

The housing market may be in a strange place, but that offers an opportunity to savvy commercial real estate investors. Understanding what young renters want will allow larger rental investments to continue to be profitable for years to come.

Going Forward

It may be a running gag that millennials can’t afford to buy homes, but that reality is no joke. The wealth of our country might be held disproportionately by older generations, but younger working generations are the key to future CRE success. Where traditional thinking has valued square footage and price first and foremost, young adults today are shifting their focus towards amenities and convenience. This, coupled with the ongoing housing crisis, creates a scenario where well positioned rental properties can dominate the market.

Lower Federal Funds Rate Impacts Real Estate

Posted on January 23, 2020March 9, 2020 | Leave a comment

Like it or not, federal regulations play a huge role in commercial real estate investment, construction, sales, and everything in between. Perhaps no singular federal policy has more of a direct impact than the federal reserve cutting or raising the federal funds rate. Separate but related to the federal discount rate, the federal funds rate dictates interest charged on a number of loans. The fed has recently decided to once again cut the federal funds rate in late 2019/early 2020. The impact on real estate will certainly be felt, but this is nothing new.

With this in mind, today we define the federal funds rate, discuss the details of the latest rate cuts and a brief history of past cuts and hikes, and finally identify how these changes will likely impact the commercial real estate sector.

Understanding the Federal Funds Rate

According to investopedia.com: “The federal funds rate refers to the interest rate that banks charge other banks for lending them money from their reserve balances on an overnight basis. By law, banks must maintain a reserve equal to a certain percentage of their deposits in an account at a Federal Reserve bank. Any money in their reserve that exceeds the required level is available for lending to other banks that might have a shortfall.”

The federal funds rate can be changed as many as eight (8) times per year as decided by the Federal Reserve. The actual rate can be influenced by buying and selling government bonds or other investment securities. The federal funds rate is determined separately from the federal discount rate, but these two figures generally have a symbiotic relationship.

As part of the regulations surrounding the federal funds rate, banks and other financial institutions are required to meet reserve requirements that must include non-interest bearing accounts. This secures short term loans and provides assurances for financial institutions and loan recipients alile.

Details on the Latest Fed Funds Rate Cuts

Normally three straight fed funds rate cuts is not a great sign for the economy overall. The last time this many consecutive rate cuts took place was in 2008 amidst the housing crisis and Great Recession. The latest cuts move the effective rate from 1.75% to 1.5%.

Generally, cutting the federal funds rate is intended to spur economic growth. These cuts come at a time when more observers are predicting that a recession is looming in the next year or two. Yet not everything is doom and gloom. Opportunist investors can take advantage of low fed funds rates to secure loans, make investments, and much more. Individuals who are looking to refinance mortgages or open home equity loans are perhaps the biggest winners from these fed rate cuts.

Lower fed funds rates only impact those who are looking to open new loans or refinance existing loans. For this reason, pre-existing loans and mortgages will be unaffected by the cuts. This essentially means that those who are locked into unfavorable loan situations might want to jump on this opportunity to refinance.

How Federal Rate Cuts Impact Commercial Real Estate

There are several ways in which federal rate cuts might impact commercial real estate, including:

Interest rates can impact local property values

Commercial real estate does not exist in a vacuum.The estimated values of surrounding properties go a long way towards CRE valuations. Federal funds rate changes can impact the calculations used to determine property values. Therefore, a change in interest rate can materially impact the value of commercial real estate properties without any other changes.

Interest rates, cap rates, and the spread

Commercial real estate investment can sometimes rely on what is known as “the spread”. The spread is determined by finding the difference between the cap rate and the finance rate. As federal funds rates influence finance rates, this can make CRE investments more or less attractive over time.

Federal funds rates cuts have a trickle down effect

It would be convenient to say that fed rates have a 1-1 impact on commercial and other forms of real estate. In reality, the relationship is far more complicated. Consider the fact that rate cuts are tied closely to poor economic performance. This in and of itself has reduced the positive impact of past rate cuts. Current and future rate cuts seem like they should have a straightforward, positive impact on commercial real estate investment. This simply is not always the case. Rate cuts might boost property values, but also may reduce demand, be tied to inflation problems, and many other potential impacts which are too complex to properly describe (or understand) in a single article.

Going Forward

It is yet to be determined whether the recent trend of consecutive rate cuts will continue as 2020 progresses. Rates are already very low, and can be reasonably expected to stagnate or bounce back in the future. This may also be reactive based on overall economic performance. Metrics point to mild recession in the next few years. How this will impact the federal funds rate will certainly continue to be a major factor in the commercial real estate investment space.

Why the Next Recession Won’t be as Hard on the Real Estate Market

Posted on January 22, 2020March 9, 2020 | Leave a comment

The Great Recession of 2008 has its name for a reason. It has been measured to be the largest economic disaster in American history since the Great Depression of the 1920’s-30’s. The recession was so large that a ripple effect caused a global recession just a year later. While no industry was unaffected, the real estate market took a particularly hard hit. In fact, a collapse in the housing market and other real estate markets in 2007 was one of the falling dominos that led to the inevitable recession just a year later.

Despite all of this (or perhaps because of it), there is reason to believe that our next recession will not take nearly as significant a toll on the commercial real estate market. This is partially due to the fact that the next recession will likely not be as damaging to the overall economy. It is also thanks to administrative efforts to protect the real estate market from present and future turmoil. With this in mind, here is why the next recession likely won’t be as hard on the real estate market.

Why the 2008 Great Recession Crushed the Real Estate Market

There can be no question that any recession would be expected to have a negative impact on the real estate market. The 2008 great recession was particularly damaging to house costs, commercial real estate, and rental vacancy numbers specifically because it was partially caused by a looming housing crisis. After all, when 8.7 million jobs are lost and house prices drop by approximately 28 percent across the country, the value of real estate is going to take a hard hit.

While the housing crisis gets all the press, commercial real estate was heavily impacted by the 2008 Great Recession. It is important to understand that many of the same issues which plagued residential real estate such as lax policies from the Federal Reserve including offering so called “exotic mortgages” did touch the commercial real estate market, but not to the same degree.

The primary cause of the commercial real estate crash in 2008 was an overall recession. Less money for businesses led to lessened spending. Lessened spending led to fewer employees. Fewer employees led to fewer jobs. Fewer jobs led to less need for commercial real estate and/or developing commercial real estate projects. And the list goes on. Still, CRE is heavily tied into federal policy which has been adjusted to be more conservative in the years since 2008. More on this below.

Inevitability of the Next American Recession

It is only natural that the US will soon experience its next recession. There is no economy on earth which is immune to bull and bear markets — such is the way of any large economy. Unfortunately, many economic metrics are pointing towards the next recession coming sooner than later. Here are a few reasons why:

New York Federal Reserve recession probability model: The New York Federal Reserve is one of the most well respected authorities on predicting recessions. Their model has accurately predicted past recessions both in real time and retroactively. The accuracy and detail of this model shows that we are more likely to see a recession in 2020 than any year since 2009.

Inverted yield curve: You may have heard or read something about the inverted yield curve popping up for the first time since the great recession in 2019. Essentially, when short term yields are outperforming long term yields, that is a major red flag of a coming recession.

Unduly inflated economic numbers: The US is currently enjoying low unemployment rates. This is generally great news for CRE investors hoping that a recession is far away. Unfortunately, unemployment is not such a simple statistic. Underemployment numbers and part time employment numbers are on the rise. This is another staple of an upcoming recession.

The Next Recession Won’t be the Same as 2008 for Real Estate

Now that we have established that:

A recession will be upon us at some time in the relatively near future and
The last recession was devastating for the real estate market

Why exactly should we expect the next recession to be any different? The simplest answer is that the federal government and banking institutions have (mostly) learned their lessons. The ridiculous lending practices of the early to mid 2000’s have either been eradicated or constricted. The supplemental answer is that the 2008 was one of the most significant economic events in the past 50 years. It is extremely unlikely that the next recession will be as impactful overall. Whether we are talking about the housing market or commercial real estate, a repeat of 2008 is likely very far off.

Going Forward

The best laid plans of mice and men often go awry. Even with a looming recession, it is probably a good idea for commercial real estate veterans to go about their business as usual. The next recession will almost certainly not be the same cataclysmic event as the last one, and the real estate market is expected to remain much more stable this time around. Obviously, all recessions have an economic impact. History may not be repeating itself, but learning from our past mistakes is always wise.

The Rise of “Urban” Suburbs

Posted on January 14, 2020March 9, 2020 | Leave a comment

We tend to think of urban areas and suburban areas as completely different entities. One is filled with skyscrapers and buslines and the other is filled with houses with picket fences and well maintained landscaping. In reality, the line between these two residential and commercial real estate areas is continuing to blur in 2020. This trend is holding true in mid major cities like Pittsburgh and large cities like New York and Boston alike. So called urban suburbs are extremely appealing to young renters/home buyers as well as businesses. This is because they mix affordability with convenience and amenities.

This trend is what has driven the surge in investment and migration to neighborhoods like East Liberty, Lawrenceville, and, 20 years ago, the South Side. And it’s what is driving the speculative investment in next-level urban suburbs like Sharpsburg, Millvale, Carrick, and parts of the North Side.

With this in mind, today we will discuss the rise of urban suburbs by defining urban and suburban areas, pin down what it means to be an “urban” suburb, and why younger Americans are pushing real estate trends in this direction.

Defining Urban and Suburban in 2020

Per the Census Bureau, “urbanized areas” are regions in or surrounding a city that have more than 50,000 people living in them. If these neighborhoods are within the limits of a city, they are thought of as urban, and if they are outside city limits, they are colloquially referred to as suburban. Urban clusters, on the other hand, are urban areas with fewer than 50,000 people. In a more general sense, we tend to think or urban areas as being more metropolitan with less space, more people, and greater access to amenities like public transportation and entertainment.

Suburbia exists somewhere between urban and rural living. One of the definitions of the word suburb reads: “the residential area on the outskirts of a city or large town”. While this has traditionally been true and still remains true in many cases, the residential aspect of this definition is changing. Commercial real estate in the suburbs is extremely active and lucrative as many individuals look to live, work, and play close to urban environments without the hassle of fighting against rush hour traffic.

What are “Urban” Suburbs?

Despite a great deal of focus being placed on the idea of a Great Inversion, where affluent Americans are favoring cities over suburbs, the majority of Americans today continue to live in suburbs. Although it is true that some suburbs are facing challenges, many that are referred to as “urban suburbs” are thriving. In lieu of an official government definition of what constitutes a suburb, let alone the different types of suburbs, urban suburbs have come to be defined by their characteristics, namely urban neighborhoods outside of the city that provide a mixture of access to urban centers, universities, a stable housing market, reputable public schools and transportation.

An example of an urban suburb is Mount Lebanon, an affluent neighborhood 7 miles south of Pittsburgh, with a median home value of $209,506, a reputable public school system that has won multiple National Blue Ribbon School awards, and a light rail system that provides easy public transportation to downtown Pittsburgh. Uptown Mount Lebanon has another key feature of urban suburbs: a booming business district with hair salons, cafes, shops, galleries, restaurants, and banks. Other national examples of larger suburbs with a more urban atmosphere include Grandview Heights, OH and Mountain View, CA.

Younger Americans Prioritize Convenience and Amenities

Urban suburbs are particularly attractive to younger American families who do not want to compromise on the convenience and amenities of urban living. They allow families to invest in their stable housing markets, reputable school districts, and enjoy access to business centers and easy transportation to metropolitan areas. Both renting and buying in these markets is attractive, as debt-ridden millennials who are parents may want easy transportation to their city jobs and favor renting in these areas for their school districts. For instance, almost 30% of residents in Mount Lebanon choose to rent, with the median rent coming to $861.

With the numerous websites and mobile apps geared towards renting and buying property, these desirable characteristics are easier to search for than ever. For instance, real-estate websites such as Zillow offer school ratings, commute times, walk scores, and transit scores under each property listing. With 81% of older millennials using mobile apps to find their homes, urban suburbs with high walk, transit, and school scores are coming out on top.

Going Forward

The rise of urban suburbs offer many takeaways. Suburban neighborhoods who are struggling to attract new home buyers can consider ways of increasing access to transportation to a nearby city. Trends show that urban suburbs offer many opportunities for both residential and commercial real-estate. Government agencies may benefit from defining suburbs and sub-types of suburban neighborhoods to better study trends. In the meantime, the rise of urban suburbs are a respite for those who are looking to rent or purchase property in a good school district but do not want to compromise on urban amenities and public transportation

Commercial Real Estate and US Economic Trends Going into 2020

Posted on January 13, 2020March 9, 2020 | Leave a comment

As with most investor markets and economic issues, commercial real estate is an ever-changing reality. What might look like a safe bet today could lead to huge losses tomorrow. Government regulations, environmental factors, and a looming recession are just a few of the ways that the commercial real estate landscape can change at any moment. Yet seasoned real estate veterans understand that these changes are just a surface disruption of CRE wisdom which generally holds true over time.

With all of this in mind, here is a brief report on the current realities of commercial real estate in the US as well as some insights into the near future.

2019 Commercial Real Estate by the Numbers

The commercial real estate market is currently valued in the ballpark of $1.1 trillion. To put that in perspective, if a trillion dollars represented $10,000, a billion dollars would be $10. Needless to say, there are massive amounts of revenue being generated in the CRE market in 2019. Here are a few other statistics to give a clearer picture of the current state of CRE:

The commercial real estate industry experienced an estimated growth of 2.2 percent in 2019. This is down from an average of ~4 percent annual growth in the CRE industry over the past five years.
Commercial real estate growth has outpaced overall real estate growth, rental rate growth, and leasing growth in 2019.
Seasonalized annual construction values from Q2 2019 are down by about five (5) percent compared to similar estimates from 2018. Newly constructed commercial structures saw the largest value losses over this time period.
Commercial property valuations are on a steady rise beginning with the recovery period in 2009-2010. During this time period, prices have risen the most in the Western United States with the Midwest lagging behind.
Rental rates have flattened to a relatively low 1.4 percent year over year growth from 2018 to 2019. This trend is expected to continue with many market indicators pointing towards a stagnant apartment market overall.

The State of the US Economy Looking to 2020 and Beyond

Before we stare into the proverbial crystal ball, we should first state the obvious: nothing is guaranteed. That being said, here are some likely events in the US economy over the next several years.

A recession is all but unavoidable in the next few years

As of the writing of this article, the latest news is that doom and gloom predictions about the next US recession may have been exaggerated. Despite this sudden onset of optimism, the plain truth is that recessions are a part of modern free markets. The most optimistic, realistic view of the situation is that our next recession may not take place in 2020 but in the years to come. Whether the next economic downturn occurs in 2020, 2021, or beyond, it will almost certainly have a material impact on commercial real estate just as it did during the Great Recession of 2008.

Climate change will continue to be a major player for the economy and for CRE

Recent scientific studies have predicted that extreme weather events in the United States will rise by approximately 50% by the end of the 21st century. This continues the already observable trend of extreme weather patterns like more frequent and stronger tornadoes, hurricanes, floods, and other natural disasters. This will impact both the overall economy and commercial real estate industries for obvious reasons. Building codes are likely to be updated, insurance costs will rise, and other incidental expenses will almost certainly take a hit. Economists warn that climate change will likely cost the US economy 100’s of billions of dollars by the year 2090.

Young adults will continue to struggle financially

Last but not least, the population of adults who should be representing the largest buyers in the US economy will continue to be hit by crippling debt, healthcare costs, and stagnant wages. Barring an unlikely dramatic shift in the political and/or economic landscape, the US Debt Crisis will be a huge factor in the economy for the foreseeable future. This has already played a role in lagging rental rates, home ownership, and spending habits. It is difficult to predict how this situation will play out, but younger generations have proven that they are willing to cut costs, something that is not a great sign for economic health.

Going Forward

The commercial real estate sector has been reliably strong for nearly 10 years now. After a two year dip in 2008-09, investors have enjoyed solid returns and steady growth. While it is reasonable to expect another downturn at some point in the next few years, it is also reasonable to believe that the US economy will bounce back and investments will continue to pay dividends. It will continue to be important for investors to keep up with the latest CRE trends such as co-working, energy construction projects, infrastructure construction, and much more. The commercial real estate world’s evolution is ongoing, and the only certainty moving forward is change.

Private Equity Real Estate Funds are Slowing

Posted on January 10, 2020March 9, 2020 | Leave a comment

For the commercial real estate investor, private equity funds have historically been safe bets which can be used to invest in a volatile real estate market over the long term. Private equity real estate funds are typically purchased by high net worth individuals, trusts, and/or pension funds to build portfolio value. In recent years, as commercial and residential real estate markets have inflated to the tipping point of true value, real estate funds have lost their luster to some investors.

Today, we will review how private equity real estate funds function and why they are lagging behind when it comes to both performance and participation.

Real Estate Equity Funds 101

Private equity real estate is a type of asset which pools private and public funds into the real estate market. Similar to how mutual fund ownership entails privately owning a number of stocks, bonds, money market funds, and other mutual funds, private equity real estate funds entail owning multiple properties through a type of pooled vehicle. While the concept of private equity real estate has been around for since the post WWII era, private equity real estate funds truly took off during the boom or bust economy of the mid 90’s.

Also like mutual funds, private equity funds are a long term investment. There may be penalties for early withdrawals, funds are tied up in the funds, and investors must understand that most private equity funds come with a lock-up period where assets are unredeemable. Due to the nature of real estate equity funds, there is typically a substantial minimum investment both up-front and potentially over time. As we mentioned in the introduction, private equity funds are typically reserved for wealthy individuals, pension plans, or other long-term wealth building strategies.

CRE Equity Funds by the Numbers

Commercial real estate plays a huge role in private equity real estate funds, but it is not the only player. Let’s take a look at private equity numbers to get an insight into industry trends:

2018 saw an overall fundraising downturn of approximately 10.6 percent compared to 2017. Total 2018 investments totalled approximately $118 billion. This is the lowest annual figure since 2013.
During that same 2013-2018 time period, commercial real estate has enjoyed a steady growth rate both in terms of average valuations and total commercial real estate investments.
The 10 largest private equity real estate funds make up over 35 percent of the total investment monies raises in 2018. This top heavy trend is likely to continue as the more well-established funds are better positioned to weather the upcoming bear market.
The amount of “dry powder” holdings has also gone up approximately 15 percent year over year. This could signal that investors are losing confidence while also accounting for a lack of fundraising overall.
Despite all of this, there are still large sums of money tied up in the private equity market. Recent figures put the total valuation of the industry at approximately $244 billion spread of 670 private equity real estate funds

Why Private Equity Real Estate Funds are Losing Steam

There are a number of reasons why private equity real estate funds are slowing down. According to the latest reports, here are some of the biggest sticking points facing private equity investors looking ahead to 2020:

A crowded marketplace. Mark Twain once said, “Buy land, they ain’t making any more of it”. In today’s market, this fact of life has been highlighted by population growth, corporate buy-ups, and maturing urban markets. When it comes to private equity firms, prime real estate is going quickly as well. This is yet another reason why firms like Blackstone are dominating the market with multi-billion dollar funds focusing on the highest-value properties.

Real estate market uncertainty and likely recession. If you’ve been reading/watching the news lately, you are likely aware of some of the more grim predictions regarding a nearing recession and real estate market downturn. This has led many investors to turn to debt investments and abandon mid to long range real estate investments until the market settles.

Other investment opportunities have taken attention away from PERE. Private equity real estate funds are in a strange middle ground of being well established over decades of solid returns but without the pedigree of mutual funds or the investor excitement of new programs like opportunity zones.

Slow payouts for private equity real estate. Many real estate funds have a problem: they have too much cash. This can result in a number of hiccups, including investor payouts being delayed. This is almost a situation where the success of PEREs has led to a bogged down payout process.

Going Forward

Most industry experts agree that private equity real estate funds will continue a modest slide moving into 2020. With economic uncertainty and an already waterlogged investment environment, PEREs will likely take a few years to bounce back. Of course, it is impossible to know how economic performance, consumer spending, CRE, and other outside factors will fall into place over the coming years. Despite all of these huge question marks, private equity real estate funds meet a need for many individuals and organizations looking to buy into potentially high yield, long term investments.