The Top Ten Takeaways: 2015 Inside Real Estate Report

Principal Real Estate Investors, one of the largest institutional real estate managers in the U.S., releases an annual report on the state of the commercial real estate market. Considering that commercial real estate professionals are always strapped for time (and considering that time is money, especially in the CRE industry) we saw fit to bring you our top ten most important takeaways from this report.

1. The office sector appears to be at an inflection point since demand, occupancy and rent growth are poised to accelerate. Increases in operating income and relatively full pricing on core office properties in gateway markets has also provided the impetus for a new development cycle; as has the desire for many corporate occupiers to seek out newer flexible office-space layouts and working arrangements. From a capital markets perspective, gateway markets are the most likely to be exposed to a shift in monetary policy and will become more difficult to navigate.

2. Over the next year, the office market will remain on solid ground. An improving job market will continue to support growth in demand. Although operating income and cash flows will also grow, pricing will provide the primary headwind over the next year. In gateway markets spread stability or further compression will be required support stabilized pricing thereby presenting a downside risk to investors. Secondary markets with solid job growth and fundamentals should be explored along with suburban markets with spillover potential as increases in lease rates push the more cost-conscious occupiers outward from the urban core.

3. Industrial sector performance has been very strong in recent quarters as tenant demand and investment activity return to historic norms, signaling a healthy market. At the same time, perhaps more than any other property type, industrial is benefitting from secular change. Demand for warehouse space is being driven by increased global trade and cost advantages that are causing many manufacturers to re-shore production and the continued expansion of e-commerce, which continues to disrupt the traditional interplay between retail and industrial properties.

4. An important, but often overlooked part of the industrial market is the smaller warehouse (or light industrial) segment, or those under 100,000 square feet. Despite the focus on big-box warehouses, which are now the standard bearer for “class A” industrial space, these assets comprise the largest segment of the market, representing 50% of all rentable stock. Though small warehouses tend to suffer during recessions and thus have underperformed from a NOI growth perspective, they can offer solid revenue since their nominal rents tend to be higher and vacancies lower.

5. While the office and industrial sector are expected to see strong demand tailwinds, multi-family may face headwinds that stem from new supply and pricing in excess of replacement costs in many markets. Unprecedented demand in the multifamily market has driven vacancy rates to historically low levels. Rent growth has been strong, and capital has been readily available for financing and new development. In some markets, multifamily rents have reached levels that make ownership of a single-family home more attractive than renting.

6. The multifamily market is also likely to undergo meaningful transformation in the coming years with the last of the millennial generation entering the workforce and forming households. While this will continue to drive demand for multifamily properties, this group seems to favor urban location with live-work-play amenities.

7. In spite of healthy job gains and the re-achievement of prior peak employment levels in spring 2014, retail sales have been sluggish. The two primary reasons have been meager real wage growth and unwillingness on the part of the consumer sector to re-leverage despite very low interest rates and a return of the wealth effect

8. While both “thrifty” and luxury retailers have been doing pretty well as of late, mid-market brands such as Sears, Macys and JC Penney are underperforming and in some cases represent general credit risks. Along with generational shopping and socializing habits, e-commerce is a major reason for this.

9. Through Q3 of 2014, average hotel occupancies had increased by 190 bps (nearly double the rise experienced in the same period last year), while average hotel room rates had improved by 4.1%, compared to 1.8% during the same 2013 period. However, the recent strength of the dollar and a slowing global economy could result in a near-term slow down in tourism from foreign visitors.

10. The outlook for the U.S. lodging industry remains positive in 2015 with the economy forecast to stay strong.