Skip to main content

Deloitte 2019 Outlook Points to Increased Allocation to Real Estate

October 29, 2018




Deloitte 2019 Outlook Points to Increased Allocation to Real Estate

The outlook surveyed 500 global commercial real estate investors on the factors that will drive their investment decisions in the year ahead. Jim Berry, U.S. Real Estate Leader at Deloitte & Touche LLP, noted that more than 97 percent of those surveyed indicated they would increase their capital allocation to real estate in the next 18 months, despite concerns about interest rates, trade tariffs, tax reform, and Brexit uncertainty. At the same time, investors plan to diversify their portfolio, “to capture the evolution of the real estate market due to the changing nature of work and tenant preferences,” Berry said. Meanwhile, the Deloitte report refers to certain real estate companies as “change agents,” due to their ability to alter the view about how physical space is used today. “Every company at this point has an opportunity to advance the ball, to adopt some of these change agent-type mentalities…it’s no longer an option to sit still and follow the old models,” he said. Berry also noted that pension fund survey respondents are planning to increase their capital commitment to real estate by 9 percent over the next 18 months—and a “significant portion” of this could be directed toward REITs. “It’s not just the largest REITs, but probably some of the midsize and smaller REITs, that have an opportunity to capitalize on these institutional investors as they plan to expand beyond just core markets in search of additional yield,” Berry said. (Nareit)



Strong Absorption and Record Lease Rates a Common Theme in Q3

CBRE recently released its Q3 reports analyzing the recent performance of metro Denver’s office, industrial and retail commercial real estate sectors. Across all sectors, strong absorption and record or near-record lease rates was a common theme while construction activity slowed from earlier in the year. In total the three sectors recorded nearly 3 million square feet of positive net absorption in Q3 and 8.7 million square feet of commercial space was under development at the end of September. “Denver has maintained its position as a place where top talent and top firms want to be. This is driving strong economics and positively impacts all corners of the commercial real estate market,” said Matt Vance, economist and director of research & analysis, CBRE.

Q3 Office Highlights

Driven by occupancy in newly constructed buildings, Q3 recorded 873,501 square feet of positive net absorption, bringing the year-to-date total to just under 2.0 million square feet., already surpassing year-end totals for 2015, 2016 and 2017. The average asking lease rate increased to $27.88 per square feet—a 5.7 percent increase year-over-year and the fifth consecutive quarter in metro Denver with a record-breaking lease rate. Almost 2.8 million square feet of office space is under construction, which is actually a slowdown equating to the lowest construction footprint underway since Q4 2015.



Q3 Industrial Highlights

Q3 marked the 34th straight quarter of positive net absorption for metro Denver, bringing year-to-date industrial net absorption to 2.5 million sq. ft., driven primarily by companies occupying newly constructed buildings. Over 4.7 million sq. ft. of industrial space was under construction in Denver at the. end of September, which is also a bit of a slowdown, but it’s temporary as several sizable projects are anticipated to break ground in Q4. The overall average asking lease rate rose to $8.22 per sq. ft. triple net, the highest rate ever recorded in metro Denver. Year-to-date overall sales volume totaled $1.3 billion, up 68 percent from last year, driven primarily by large industrial portfolio sales.

Q3 Retail Highlights

Over 561,000 sq. ft. of new retail space delivered to the market—the greatest quarterly total this business cycle—and more than 1.2 million sq. ft. of additional retail space is under construction. Nearly 385,000 sq. ft. of positive net absorption occurred in Q3, driven primarily by the opening of Denver Premium Outlets. The average direct asking lease rate reached $18.90 per sq. ft. triple net—the second highest rate on record. Trends – what are we seeing retailers, owners and developers do to adapt to the changing industry:

o Owners are overhauling existing shopping centers with more entertainment and medical service options

o Developers are prioritizing mixed-use, in-fill projects

o Retailers are introducing smaller-format, urban concepts

o Restaurants are revamping their kitchens to handle more delivery orders (MileHigh CRE)



Strange Things Afoot: Rents, Vacancies Decline

Apartment rents and vacancies usually move opposite of each other, but they both fell in the third quarter, according to the latest Denver Metro Apartment Vacancy and Rent survey out on Tuesday. The average apartment rent in metro Denver dropped from $1,484.02 in the second quarter to $1,464.90 in the third, a decline of 1.3 percent or $19 a month. Over the past year, average rents are up 3.4 percent. Typically, average rents rise in the third quarter as high school and college graduates and summer newlyweds look for a place to live. But for the third year in a row, they have fallen. You’d have to go back to when Ronald Reagan was president and the average apartment rent in Denver was $396 a month to find a streak that long, said Teo Nicolais, a Harvard Extension School instructor who specializes in real estate. Also, unusual — rents softened even as the supply of available apartments tightened. The vacancy rate dropped from 6 percent in the second quarter to 5.5 percent in the third. Normally, a falling vacancy rate means upward pressure on rents as the market tightens. Ron Throupe, associate professor of real estate and construction management at the University of Denver’s Daniels College of Business, argues that new housing units are now being added at a faster pace than new households are forming. Projections call for 30,000 apartments over the next 30 months, which when added to new home construction translates into about 2,600 more units a year than what household formations can support, Throupe said. He expects the apartment vacancy rate to rise above 7 percent. “That rate is not a travesty. It is still considered a solid market, and the unit slack could be absorbed in the following years,” he said in a release. But Nicolais notes that developers are on track to deliver fewer units this year than last, when 13,348 apartments came onto the market. Through the first three quarters, they have delivered 8,448 units in metro Denver. Despite warnings the past few years of an apartment glut, developers kept building and young adults kept moving here and renting those units, Nicolais said. The trend he sees now is toward a “normal, balanced” market. “Supply is finally catching up with demand. It has been a long time in coming,” he said. The highest average rents are in downtown Denver at $1,958 a month, followed by Boulder’s university area at $1,791 a month, according to the survey, which is published by the Apartment Association of Metro Denver. The lowest rents in the area are Wheat Ridge at $1,100 a month, Aurora Central northwest, near I-225 and Alameda, at $1,236, and Denver’s far southeast corner at $1,302 a month. (Denver Post)



Stuck in Neutral: CMBS Issuance Stalls Amid Stiff Competition

CMBS lenders are working harder to retain market share in a highly competitive sector where the overall pie for conduit lending doesn’t appear to be getting any bigger. CMBS issuance, which started out the first half of the year with a solid increase in activity, has slowed noticeably in the third quarter. According to Commercial Mortgage Alert, an industry newsletter, year-to-date issuance of $64.7 billion through mid-October is now trailing the pace set last year by 3 percent. And with what appears to be a thin pipeline of deals ahead for the fourth quarter, lending volume may fall short of the $87.8 billion in issuance reported last year. One of the main factors dragging on lending volume is a shrinking pipeline of maturities. The peak years for CMBS loan maturities are now in the rearview mirror. The volume of maturities dropped from highs of $136.0 and $124.6 billion in 2016 and 2017 to $18.6 billion this year, according to Trepp. Although the volume of maturities is set to increase somewhat in 2019 and 2020 with about $40 billion in annual maturities, the decline is having a big impact on the market, notes Joe McBride, director of research and applied data at Trepp. At the same time, CMBS lenders are battling more competitive pressure from other capital sources. CMBS has traditionally been the dominant capital source for higher leverage loans, which typically equates to LTVs of 70 to 75 percent these days. However, in recent years there has been more capital moving into that higher leverage space in search of higher yields. Traditional lenders are pushing leverage higher and equity investors are also allocating more money to private equity debt funds that provide bridge or mezzanine loans on top of senior debt, notes Keith Largay, managing director and head of the Midwest capital markets group for real estate services firm JLL in Chicago. In addition, bridge lenders are emphasizing the added flexibility of those loan products, he says. “So, the bridge loan market is absolutely taking market share from CMBS,” he adds. CMBS lenders are also adapting to a shift by senior CMBS investors that are applying their own pressure on lenders to create loan pools with a lower weighted average leverage—oftentimes at 60 percent or below. That means that the CMBS market has had to go out and source low leverage loans to balance out some of the higher leverage deals with a range on individual loans that might be from 55 to 75 percent. Low leverage loans for high-quality properties are highly competitive, and oftentimes mean that CMBS lenders are competing directly with life company lenders. “I think CMBS has really had to change its lending strategy to aggressively pursue high-quality, low-leverage assets and try to compete with the life company market,” says Joe DeRoy, senior vice president and CMBS program manager at KeyBank Real Estate Capital. CMBS lenders are finding an edge by offering more interest-only loans. What ratings agencies and research groups have pointed out in some of their statistics is that concentration of interest-only loans in CMBS has steadily increased over the last three years, says DeRoy. “I think that is partly due to the fact that lenders are being asked to originate pools that have a weighted LTV of sub-60 percent,” he says. For example, Moody’s Investor Services noted in a June report that interest-only loans represented more than three quarters of U.S. CMBS conduit pools in the first quarter and full-term interest-only loans accounted for almost half of all pools. Over the past decade there has also been a bigger shift for CMBS to finance large single-borrower transactions—mega-deals for large trophy assets or portfolios of half a billion dollars and up that can be too big for the regular lending market to execute. Those single-borrower deals now account for about half of all CMBS transactions, notes McBride. Some CMBS lenders are also working to grow market share by differentiating themselves with new products or services. For example, KeyBank is projecting that its CMBS issuance will be up about 15 percent this year. KeyBank has been focusing on real estate owners and operators that are using the bank’s balance sheet lending and then taking those loans into the permanent market through Fannie Mae, Freddie Mac, HUD and CMBS. “That direct relationship channel is part and parcel to our real estate strategy, and KeyBank having all of those products and services for our customers has really benefited us in the marketplace this year,” says DeRoy. KeyBank also launched a streamlined small-balance conduit program last year that is continuing to gain momentum. Local and regional operators have become increasingly fatigued by the CMBS process, including both executing loans on the front-end and servicing existing loans on the back-end, notes DeRoy. In its new streamlined conduit program, KeyBank hopes to eliminate “pain points” by controlling originating and processing and retaining all of the servicing rights after the loan closes to give borrowers a single point of contact. The company is also putting a cap on fees to provide lower fixed loan costs. Despite the competitive pressures, industry participants are optimistic for a still steady pipeline of issuance in 2019. “I think the CMBS market is healthy and liquid and the industry has reacted well to some of the pre-recession criticisms,” says DeRoy. The industry as a whole has done a good job of making CMBS lending a more transparent process, real estate fundamentals are very strong and the economy is still spurring new business investment, he says. “So, I think there are still brighter days ahead for CMBS and that 2019 should still be a healthy year,” he adds. (National Real Estate Investor/Beth Mattson-Teig)