Trends to Watch Out For in Commercial Real Estate This Year
Political and economic uncertainty has pervaded the past year, with the U.S. economy showing signs of growth amid low inflation and a distressed retail segment in 2017, as accountants struggle to understand all the implications of the recently passed changes to the tax laws and Europe prepares for Brexit. Here’s a look at three commercial real estate trends to watch in 2018.
With Jerome Powell set to take over as new Federal Reserve chairman, there is some uncertainty surrounding the Fed, specifically whether it will stick to its plan to continue raising interest rates and what it might do about the stubbornly low inflation. The benchmark lending rate rose in December by a quarter percentage point, to a target range of 1.25% to 1.5%. At its December policy meeting, the Federal Reserve left unchanged its forecast for three 2018 rate hikes, following three increases in 2017.
Yet the 10-year Treasury rate has been fairly stable since its steep rise in the second half of 2016, indicating that the market may not be convinced the Fed will be raising rates significantly. The Federal Open Market Committee signaled late last year it expects job market growth to slow, by leaving out prior comments saying further strengthening was expected and instead saying monetary policy would help the labor market “remain strong.”
If the underlying pace of inflation accelerates, as it unexpectedly did in December, rate hikes seem more likely. But if inflation continues to be as sluggish as it has been for most of the year, it may become harder for the Fed to justify additional rate increases. Indeed, two policymakers voted against the most recent rate increase.
So what does this uncertainty means for the commercial real estate industry? If interest rates are not going to rise significantly in the coming year, the benefit would be that the cost of borrowing and the value of properties can be expected to remain stable, all other things being equal.
On the flip side, the absence of significant rate hikes could potentially pose the risk of a bubble as it removes lender incentive to tighten lending standards. And it could be an indication the economy is not particularly strong, which could in turn inhibit the commercial real estate industry.
Though the latest changes to U.S. tax laws have been touted as benefiting business because of a lower corporate tax rate, they could have a negative impact on big U.S. and foreign banks that do business – very much including commercial real estate lending – both in the U.S. and abroad.
In the short term, several large international companies have said they expect the new tax rules to cost them billions of dollars each in the final quarter of 2017 due to forced write-downs in the value of tax credits accumulated from previous losses under the tax overhaul signed into law in December. Citigroup and Bank of America are among the banks that have said tax changes will likely bring down their 2017 profits.
Another tax issue that could affect multinational companies– including European banks such as Barclays and Credit Suisse, both of which are active in U.S. commercial real estate financing – is the base erosion and anti-abuse tax, or BEAT, which imposes a tax on payments made between U.S. and foreign affiliates of the same corporation. Enacted to give U.S. companies an incentive to keep profits at home rather than shifting them to countries with lower tax rates, this regulation could end up having a negative impact on foreign banks and other businesses that have U.S. branches and regularly shift money between different units of the company. However, implementation details remain unclear, and some have speculated that the government may ultimately decide to rein in BEAT’s effect on the banking system.
Of course, U.S. taxes aren’t the only issue to affect foreign lending. 2018 will be a crucial year for Britain and Europe, as the U.K. and EU head toward talks on a post-Brexit trade deal in March. The European Commission has said that unless a deal is signed by October, the U.K. will become a “third country” on March 30, 2019, when it will no longer be part of the European Union.
In January, U.K. Chancellor of the Exchequer Philip Hammond and David Davis, the U.K.’s Brexit secretary, said on a trip to Germany that the European Union’s refusal to include financial services in a trade deal, presumably in a bid to stop banks and other financial institutions from relocating to Germany, risked disaster for Europe’s banking sector, the Guardian reported. Meanwhile, the EU is warning companies in various industries that if no trade deal is reached by the time Brexit goes into effect, the EU will shut down their ability to operate across Europe.
Lenders that are both exposed to Brexit fallout and help finance U.S. commercial real estate include U.K. banks HSBC and Barclays, London-based hedge fund Child Investment Fund and Germany’s Deutsche Bank, which is based in Frankfurt but has a major office in London that the lender describes as the base for its largest investment banking operations.
Deutsche Bank employs over 8,000 people in the U.K., and media have reported that about half those jobs could leave the country after Brexit. But CEO John Cryan said this month that Brexit will prompt Deutsche Bank to move hundreds of jobs, not thousands, with bankers, technology experts and traders largely remaining in London. Yet the bank was reportedly scouting Frankfurt late last year for post-Brexit office space that could hold as many as 1,600 workers
The more important issue for commercial real estate is the extent to which the tumult surrounding Brexit will constrain overseas lending by banks exposed to possible losses as Britain and continental Europe drift further away.
Retail and industrial sectors
2017 was a record year for retail, and not in a good way. Last year store closing announcements more than tripled, reaching about 7,000, said retail think tank Fung Global Retail and Technology. Bankruptcies have increased too, with over 600 reported in the retail sector in 2017. The hit list has included big guns like Sears, Kmart, J.C. Penney and Macy’s (store closures) and Toys R Us, Payless, The Limited and Hhgregg (bankruptcy).
And there’s more to come, warned Cushman & Wakefield. The commercial real estate firm said the number of U.S. store closings is expected to jump at least 33% in 2018, to more than 12,000, and forecast that another 25 major retailers could file for bankruptcy. Gap, Banana Republic, J. Crew and Teavana have already announced plans to close stores in 2018.
Walmart has already kicked off the year by shutting down 63 Sam’s Clubs stores – including those at 2425 E. Florence Blvd. in Casa Grande, Arizona; 3360 El Camino Ave. in Sacramento, California; and 5135 S. Dale Mabry Hwy. in Tampa, Florida – even as it attempted to control the news cycle by announcing employee bonuses and an increase in its hourly minimum wage.
It’s no coincidence that some of the Sam’s Clubs stores belonging to one of Amazon’s biggest rivals will be converted to e-commerce distribution centers. This brings us to a key point about retail trends and their effect on commercial real estate: As e-commerce keeps growing, the retail sector’s need for commercial real estate isn’t disappearing, but rather is shifting as industrial real estate – namely, warehouses and distribution centers – play an ever-bigger role in the retail industry.
Indeed, commercial real estate industry observers like PricewaterhouseCoopers and the Urban Land Institute, which publish an annual report on commercial real estate trends, have singled out the industrial segment as the top-ranked property type for 2018 as well as the previous four years, while Colliers recently found the industrial sector far outperforms all other segments.
We expect to see issues like rate hikes, the impact of tax changes and Brexit on foreign lending, and the ups and downs of the retail segment playing a role in the commercial real estate industry – and the economy at large – in 2018. Here’s to a productive and plentiful new year.
Article Resource: Forbes