Commercial Real Estate Outlook 2019: Macro Challenges Merge with Industry Changes

In many regions of the world, the commercial real estate (CRE) industry has been booming over the past few years. In the first half of 2018, global CRE transaction volume increased 13 percent year over year to $341 billion. Economic uncertainties, however, may cloud CRE prospects in 2019. Some indicators point to a general slowing of economic growth.

After years of steady gains, gross domestic product (GDP) in the US, China, and throughout the EU are expected to expand at a lower rate. The World Bank forecasts global economic growth will retreat slightly from three percent to 2.9 percent in 2019. Meanwhile, interest rates in the US and other countries are creeping up, making it more costly for leveraged real estate investors to borrow money. Several industry observers predict a commercial real estate downturn, saying property values could dip, or at least peak, leading to not-as-large returns on property transactions. However, there isn’t much talk of an outright industry recession. Commercial real estate is still considered a stable bet compared to other investments. People might just not make as much money as quickly as they have over the last few years.

Meanwhile, there are operational trends shaking up CRE, transforming it into a much more flexible and transparent business than before. The bulk of this is due to technological innovations. The rise of e-commerce worldwide has led to the closure of thousands of brick-and-mortar stores but has strengthened those that have survived, transforming them into omnichannel outlets. It has also made industrial real estate, which operates warehouses that house the products sold, stronger than ever. The rise of WeWork and other shared-office companies has influenced the property sector, (see Trends on page 10) making spaces more flexible for different uses with a concentration on shared areas. The increasing use of proptech apps and programs have also altered the landscape, allowing several of a building’s functions, from HVAC systems to joint-employee yoga classes, to be controlled via a smartphone.

So while 2019 isn’t a guaranteed pivotal year, keep an eye on several macroeconomic and business trends that may have a direct impact on commercial real estate.

Global Trade Tensions

The ongoing trade war between the US and China affected more than $300 billion in goods in 2018, and President Trump has threatened to expand the US tariff program this year. In trade wars, the opposing sides often experience declines in exports and GDP. Although this trade war will primarily affect China and the US, many other countries may experience a decrease in export volumes due to disruptions in supply chains or the impact of weaker global economic growth during the face-off between the two economic powerhouses. This has a direct impact on global industrial real estate, which represents the warehouses and distribution centers where the goods are stored before being sold to consumers or shipped to physical stores, which are the retail real estate sector’s assets. A dramatic increase in prices for consumers, or increased shipping times could hurt the companies that sell these goods, in turn potentially having a negative impact on the real estate they lease, especially if operations are downsized and locations are no longer needed as a result.

Rising Construction Costs

Tied to the trade war is the increasing cost of construction, which was already a problem before the dispute between China and the United States worsened. A recent report by JLL said that lumber, plywood, steel, and aluminum have all risen in cost, making the construction of all types of CRE properties more expensive, with the potential of stalling or derailing some projects.

Meanwhile, the construction industry also faces a severe ongoing labor shortage worldwide, which severely impacts getting commercial real estate developments completed on time and raises the cost of labor. Economic prosperity has led to fewer people seeking a career in construction, so those firms must pay higher-than-traditional wages to staff up. These costs are then passed on to commercial real estate developers, who pass them on to their tenants who pass them on to consumers. The industry enjoys rising rents as of now, but it’s not in CRE’s favor if they become unsustainable.

Shrinking Overall Workforces

Labor shortages aren’t just limited to the construction industry. Workforces in nearly 40 countries — including China, Japan, South Korea, Russia, and much of Eastern Europe — will shrink due to aging populations and fertility rates that are below replacement levels. Higher job vacancies in these countries could impede GDP growth, which may lead to lower rents and increased vacancies for all property types.

Experiential Property Settings

With the ability to both shop and work from home, it’s especially important for CRE developers and owners to create settings that drive people into stores, offices, and other venues for an experience that can’t be recreated at home. Experiential retail locations have live entertainment, classes, free samples, and other draws that get people into stores. It’s important to note that everything sold at an Apple Store can be bought online, but the company’s retail outlets have the highest sales per square foot of any chain in the world.

The creative-office movement has similar features. Employees have increased common space and employers provide workers access to wellness programs and team-building initiatives. Technology has made it possible to customize spaces geared toward individual employees’ physical-temperature and biometric environments, as well as coordinate child daycare and employee-transportation needs.

Attraction of Nontraditional Properties

As individual properties are becoming more customized toward the preferences of employees, investors are increasingly attracted to nontraditional types of CRE properties, according to a global Deloitte report. Investors are increasingly looking toward mixed-use assets that include several different property sectors, such as retail on the bottom floor mixed with offices and residential above. There is also more consideration for assets with flexible leases and spaces that can accommodate different types of uses on short notice, due to rapidly changing projects and business plans within companies. Meanwhile, older CRE properties are being re-configured and given major tech-infrastructure upgrades to meet today’s shifting business climate.

Looking Forward 

Although the CRE industry performed strongly in the aggregate last year, slowing economic growth — along with trade wars, political instability, and other risks — will likely create increased uncertainty in all commercial real estate sectors this year. While this might mean returns and valuations aren’t as high as investors have enjoyed over the last few years, developers have tempered growth since the Great Recession, and industry fallout as a result of overbuilding is not expected. Additionally, commercial real estate valuations, rents, and vacancy rates should remain at favorable levels, though certain markets might see a dip from the record-breaking numbers experienced over the last few years.

Finally, with major technological advances leading the way, commercial real estate is becoming more efficient with its use of properties and creating spaces that are transformable into changing work environments, increasing their value over time to tenants instead of becoming obsolete when a particular use has run its course. In short, risk has certainly increased, but not without its reciprocal rise in opportunity.

To read the full February issue of WTCA Meridian, click here.