This is part 7 in a multi-part series about the latest Emerging Trends in Real Estate® report, an annual forecast on the outlook of real estate finance and capital markets, investment and development trends, property sectors, metropolitan area, and other issues affecting the industry in North America. Check out the earlier installments here.
Property Type Outlook: Part 2
One of the most fascinating features of the human race is the ability to adapt, and there are few places that have displayed this quality quite like in America. From a predominantly agricultural nation to the industrial revolution and beyond, the form and function of of our land have shifted with increased populations and technological advancements. The transformation of lofts to housing, or offices to hotels demonstrates how the needs of the people shape the real estate developments and markets. Existing properties continue to “adapt their physical design to new functional needs,” accommodating the latest and greatest of our ever-changing nation.
In this part of our series on the Emerging Trends in Real Estate® report, we’ll examine how the different real estate sectors have adapted to the times, and what we should look for in the coming years. In Part 2, we’ll take a look at the office and hotel sectors, with other parts focused on industrial, apartments, retail and housing.
There is quite a gap emerging between CBD and suburban offices, displaying the broadness of the U.S. office market. Many of the survey participants spoke of “pocket markets,” or secondary office markets that are either redevelopments or conversions. Struggling suburban office parks, which include a plethora of parking, are finding it both efficient and desirable to convert to a mixed-use concept. Much of the recent investment in office space has been in the downtowns of large cities. And while those office markets are continuing to thrive, new research shows a “vibrancy” in live/work/play locations in 18-hour cities.
Yet CBD has outperformed suburban offices in total returns in one-, three-, five-, ten-, and 20-year time frames. One survey interviewee specializing in office investment sales said, “Tenants want to be in urban locations, so investors want to be there too. There is a good degree of due diligence being done on deals, so we are not getting out over our skis.” Another made the connection between the desire to be downtown and attracting top-notch employees. “Companies are all competing for talent. How are you going to attract the talent right out of college? The CBD is benefiting from the trend of companies moving from the suburbs into the center city.”
As these trends continue, it’s not too far-fetched to think that this “back-to-the-city” movement isn’t going anywhere. But beware of overgeneralizations. Several other interviewees cautioned that the suburbs are not dead, especially considering that the gap in rents and prices between gateway markets downtown and the nearby suburbs can’t expand forever. At some point, the price advantage creates demand. Markets all over the country are already showing massive suburban office sales improvements, with cost of living driving many young employees to secondary markets like Pittsburgh, Minneapolis and Austin.
Many office investors are being thoughtful with their approaches, remaining conservatively in the urban sector while searching for opportunities in “second-ring urban neighborhoods.” These are the places with historic retail cores on Main Street, with mixed-use potential, minus the high density of the true urban areas. “Close-in suburbs” are also generating interest. These areas offer transit nearby, are very walkable, and provide the feel of a city.
And then there are the trends with the actual office space to consider. The buildout of these suburban spaces have seen quite a few innovative plans, with the “open space” concept at the core. The space for individuals is decreasing while a focus on common space is expanding. There are a lot of plans utilizing light and glass, and then there’s the “Zen space,” where millennial employees can go to “mellow out.” The downsizing of personal space isn’t meant to save space, but rather to improve collaboration and interaction. It’s all about form following function. Back to attracting talent.
But some industry experts are still skeptical. One institutional investor said, “At some point, the novelty will wear off. We are going to see the pendulum swing back a little on this dense open-office configuration. I’m hearing more and more evidence that some of the new dense-space configurations are simply less productive than those that do have more privacy.” Like all trends, the truth in sustainability is time.
The improvement of the U.S. dollar is making international travel to the United States more expensive. And options like Airbnb are further diverting demand from full-service hotels. Despite these factors though, the hotel occupancy and revenue per available room (RevPAR) data have improved year over year. The overall development/investment outlook is improving, however the percentage of survey respondents favoring a “sell” posture has risen since the previous survey for limited-service hotels. Larger and more prestigious full-service hotels are still favored by offshore investors and publicly owned operating companies.
Volatility in the hotel sector is always the norm because the “lease term” is night to night, and fluctuations in both room rate and occupancy are expected. This simple fact can be good when the markets are tight, like they have been. But the risk is dramatic when an increase in supply and decrease in demand meet head on. In addition to Airbnb and Home Away-type services, boutique hotels are competing to take market share from established chains as well.
“Everyone is trying to stay ahead with design forward,” said one hotel investor, who also mentioned strong demand dynamics in 18-hour markets like Nashville and Austin.