Thoughts on the Market 2014

As we are entering the New Year, we are looking at a much more stabilized commercial real estate market. Transaction volume has picked up noticeably, as the US is widely considered the most sought after real estate market in the world. Our team is experiencing this international demand ourselves, having dealt with multiple aggressive foreign investors last year alone on transactions. Overall, widespread distress is behind us and the investor’s threshold for risk has increased. In many cases, cap rates for core assets have dropped below their lowest points during the peak of the market in 2007. Secondary markets are also rebounding and receiving more investor interest as investors chase stronger returns.

As we look ahead, emerging from the recession we are rightfully reminded by savvy investors to keep a close eye on the actions of the FED, consumer confidence, volatility in emerging markets and the state of the general economy, etc. Below are some key factors to keep in mind going forward:

Keep a very close eye on two significant trends, demographics and technology, intersecting at the same time with each trend magnifying the impact of the other even more:

  1. ​Demographics: One could argue that there are seismic demographic changes occurring. The largest generation in US history, the baby boomers, is nearing or reaching retirement age. As a result the change in their shopping patterns is likely to accelerate. This generation is significantly more affluent than past generations in same age bracket. The millennials, one of the largest generations in history is now entering the workforce but has significantly less wealth and completely different shopping patterns than the same age group in generations past. These demographic changes impacting real estate will create both great opportunities and challenges ahead.
  2. Technology: We will see more changes over the next five years in how we conduct business and live our lives than we have seen over the past ten to fifteen years. The biggest threat to existing retailers is not going to be their exiting brick and mortar competition, but from new internet or new brick and mortar retailers using disruptive technologies. As investors, we need to become technologically savvy, observe new trends, and look beyond the latest trends emerging from existing retailers. Doing so will ensure we can take advantage of these rapid changes rather than be a victim of them.

Much of the growth in property valuations has been capital markets driven. We are now at a point where fundamentals need to improve to support the run-up in valuations.

Retail real estate is becoming more and more dependent on CMBS financing. Close to half of all larger retail transactions were financed by CMBS; the highest ratio of any product type. Hence, retail benefits from Wall Street and yet is also most vulnerable to fluctuations in the world’s capital markets.

The number of medical and educational users/tenants in shopping centers is likely to significantly grow.

Last year there were over a trillion dollars of global commercial real estate transactions. One third of that occurred in China and much of it is from the sale of speculative land which is driving significant wealth growth in China. The Chinese government is trying to rein in speculation. Hence economic success or failure there could have an impact on real estate here in the US.

There will be significant growth in loan maturities each year, peaking in 2017. Barring any macro-economic shock, we are unlikely to see any distress as a result but this rapid increase in loan maturities is likely to lead to a noticeable increase in the number of assets coming to market for sale.

As we look ahead at this ever-changing environment, we tend to anxiously focus on what we perceive as our disadvantages and major weaknesses. I came across a book called David and Goliath by Malcolm Gladwell that challenges that thought process. In this book, Gladwell articulates that what we sometimes view as our disadvantages have the opportunity to be our major strengths. You can click on this link for Gladwell’s TED talk on David and Goliath:

http://www.ted.com/talks/malcolm_gladwell_the_unheard_story_of_david_and_goliath.html

Wishing you a great year ahead and hoping that you identify great opportunities and strengths in areas in business and family that you may have thought of as weaknesses in the past.

Best Regards,

Reza