How Should Commercial Real Estate Investors Prepare For The Coming CRE Slowdown?

Jan 10, 2018

We’ve all heard the saying that all good things come to an end. And if you’ve been following the news, then you’ve probably heard rumbles that the commercial real estate market in the U.S. is on its way down.

With the current market cycle of expansion already up to eight years, it’s no wonder many experts are wondering when the other shoe will drop. According to some investors, there are already signs of a slowdown.

Certain niches, such as CBD multifamily and office rents, and high street retailers are already losing momentum. New office construction has increased by just 2.3%, which is the slowest rate since 2015. And although office demand was steady for most of 2017, the rising supply in CBD office markets has increased office vacancies by 10 basis points to 13.0 percent.

Morgan Stanley, for example, predicted that 2017 marks the end of the bull cycle and that higher interest rates and tightening lending standards will have a definite effect on the commercial real estate market.

On the other hand, some experts note other niches are still doing quite well. Suburban office and multifamily, as well as industrial, are still doing well, as are Class B and C multifamily properties. Of course, a great deal depends on location. Market cycles definitely act differently for different locations, with metro areas often peaking before suburban, and come cities doing well while others flounder.

What Type Of Asset Should You Focus On?

real estate has its ups and downs

Whether you believe that the commercial real estate market is doomed to crash now or in the next few years, the fact remains that real estate – like any market – has its ups and downs; eventually, the good times will come to and end and investors will be left with the decision about what to do.

The question becomes what type of asset has the best chance of doing well during a slowdown?

Of course the answer to that question depends on your long-term investment goals. Some investors are quite happy to wait out a cycle until the market swings upwards again. They expect to grab premium properties and rock bottom prices, hold for a few years, renovate, and then sell at a profit.

Others prefer to pare down portfolios, perhaps switching to less volatile property types.

Industrial Still Going Strong

industrial is a win-win for business and warehouse owners

Industrial, for example, has been doing very well over the last few years, partially due to the increase in e-commerce companies needing more warehouses to store products until delivery.

Amazon, for example, has increased the number of warehouses it manages in order to accommodate their 2 hour Amazon Prime Now service. Amazon already increased its warehouse space by 30% in 2016, and has already started building new warehouses in New York and Orlando.

Interestingly enough, a new startup company named Stord aims to compete with Amazon, allowing independent companies the opportunity to store products in available warehouses.

It’s a bit like Air BnB for companies needing warehouses, with one big bonus: Stord allows customers to see live data of their inventory across facilities, so they can organize their supply chain.

According to Sean Henry, who co-owns Stord along with Jacob Boudreau, “Since we give them insight into how much product they have, they typically save a lot of money on warehousing as a whole.” Indeed, the service might have a lot to offer investors who own empty or under-performing warehouses.

Normally these mom and pop owners have little to offer companies in search of additional space. Unlike the big companies which manage huge facilities of 9,000 square feet and more, complete with proprietary software that manages the whole supply chain, these owners are still relying on phones, faxes, and emails.

However, these same large companies are unable to respond quickly to changes in the supply chain, needing as much as eight months in order to set up lead chains. They are also expensive.

Stord, on the other hand, allows the smaller warehouses to compete with these massive companies, giving them access to customers they would otherwise be unable to serve. And because these owners are in every market, they are perfectly placed to meet companies’ demands.

It’s a win-win for both business owners and warehouse owners.

Baby Boomer And Millennial Populations May Help Multifamilies Weather The Storm

Statistics show that two populations, baby boomers and millennials, are set to explode the rental market. Millennials are now the largest demographic, and Baby Boomers, who make up 76 million of the current population. Both are looking to rent, for different reasons.

Millennials fleeing the cost of purchasing a house and weighed down by student debt, are flooding the rental market. They are flocking to urban areas in order to enjoy the city life, and nine out of ten are willing to pay an extra 20% for smart home tech.

Baby Boomer are also a lucrative niche for multifamily investors.

Many Baby Boomers are divesting themselves of their large suburban homes and heading to the city to enjoy the culture and be closer to work. They are actually competing with millennials for space, and since they are financially better off than millennials, are more than willing to pay for premium tenant amenities.

The biggest challenge faced by multifamilies right now is excess market supply, according to Kenneth Riggs Jr., CCIM, CRE, MAI, president of Situs RERC in Chicago, a real estate valuation advisory firm.

However, if investors focus on fulfilling the needs of a specific niche, for example tech-hungry millennials or Baby Boomers waiting to be pampered by 24 hour concierge service and other premium amenities, then they have an excellent chance of doing well even during a downturn.

Office Property Performance Gap Between CBD And Suburban

office performance gap between cbd and suburban market

While CBD office properties are doing well, many suburban properties have yet to recover from the previous real estate downturn.

Technology in particular has been responsible for a large sector of office growth in the last several years, and though office properties have had their share of challenges this year, overall vacancy rates are expected to decrease.

Retail Still Struggling

retail still struggling

Retail is still trying to find its place in a market heavily influenced by e-commerce. Although some brick and mortar businesses are doing well, success requires flexibility, integration with mobile technology, and the willingness to test (and test) improvements until the right balance is found.

Not all stores can handle the pressure, and there have been plenty of store closings and bankruptcies in 2017, a trend which will continue on into 2018.

Investors interested in maintaining a foothold in this challenging environment can gain a step up by re-positioning retail centers as “experiential retail centers,” rather than pure shopping meccas.

The idea is that while consumers can buy nearly everything online, they still prefer to go to an actual store to have “experiences.” These include everything from getting their nails done to rock climbing, to dinner theaters.

Retailers have begun catering to this desire by offering authentic experiences designed to engage shoppers through activities, classes, lectures, high tech software, and more.

Some examples include: home improvement stores with DIY classes, arts and crafts activities, stores with sophisticated software that allows customers to see clothing in different colors and styles, and sporting goods stores that boast climbing walls and golf or tennis simulators.

Other retail outlets are focusing on optimizing their supply chain; being able to deliver products to customers quickly and cheaply allows them to set themselves apart from similar retailers. They, along with other retailers, insist that there is plenty of opportunity for nimble retailers willing to try out new methods in order to achieve success.

In summary, regardless of the niche you as an investor specialize in, there are plenty of opportunities to weather an upcoming slowdown in the market, whether it occurs now or in another five years.

A willingness to try out new strategies and test those strategies relentlessly appears to be a definite plan for success.

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