Real Estate Digest - October 2016 Issue

Real Estate Digest

October • 2016

Volume 42 • Number 10

Six Commercial Real Estate Trends to Watch for the Remainder of 2016

T

he U.S. property market landscape has not seen many changes since 2015. In addition, the U.S. Federal Reserve has already stated last December that it expects to increase the federal funds rate by 0.25 points, which should further stabilize the economy.

While the U.S. unemployment rate continues to decline, demographic shifts have also continued. Millennials are finding jobs and forming their own households, while baby boomers continue to retire in order to downsize and move to urban walkable communities and senior housing. Technology has also continued to change the way people shop, work and interact with their surroundings.

In light of these developments, several

trends on the horizon will affect commercial real estate. Here are six to watch for the remainder of 2016.

1 Global Economic and Political Uncertainties The upcoming presidential election in the United States and the Brexit vote in the United Kingdom will undoubtedly create some uncertainties that likely won’t be fully understood or resolved in the near term.

2 Steady Interest Rate Environment In the beginning of 2016, it seemed almost inevitable that interest rates would continue to rise. However, with global economic growth lower than expected, the Fed is likely to wait to weigh the effects before making any additional changes to interest rates.

3. Foreign Investment in the U.S. Economic and political uncertainties across the globe are continuing to drive capital incontinued on next page

October • 2016 vestment in the United States. As a result, international capital flows into U.S. real estate assets are expected to increase. The year 2015 proved to be a record year of capital inflows. The changes to the 1980 Foreign Investment in Real Property Tax Act (FIRPTA) in 2016 also permitted foreign investors to be treated in a manner similar to their U.S. counterparts, which is expected to further drive foreign investment growth in U.S. real estate.

4. Slowing New Supply in Real Estate Sectors Available supplies of most types of property will remain limited.

However, certain sectors, such as single-tenant industry and repurposing for suburban malls, will likely see a growth in supply. Lending sources remain skeptical about funding new construction. Further, the current lending environment is expected to tighten with the introduction of bank reserve requirements from Basel III and commercial mortgage-backed securities (CMBS) risk retention requirements from Dodd-Frank by the end of 2016.

5. Continuous Changes in Retail Retail will continue to struggle as the trend toward e-commerce continues to grow. Analysts expect that the most successful retailers will incorporate both virtual online and physical in-store shopping experiences (“clicks and bricks”). However, traditional retailers, such as Sears, JCPenney and Macy’s are continuing to lose ground with only a short window of time to regain competitiveness among lower-end discounters.

6 Volatile Energy Markets Energy market volatility will likely continue to affect global economic security while causing downturns in regional U.S. economies that are highly impacted by oil prices. However, lower oil prices may have some benefits by reducing some construction, manufacturing and logistics costs.

Property markets will be affected differently by declining energy prices:

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Y Office demand is not likely to be directly impacted by lower energy costs. However, lower operational expenses increase corporate hiring profits, which could fuel hiring and business expansion.

Y Retail can benefit from lower energy costs because households tend to spend windfalls, which could translate to better-than-expected holiday sales.

Y The industrial sector can benefit from lower energy costs with lower distribution costs and lower input costs for petroleum-based products. Demand for warehouse and distribution space will increase due to higher consumer spending.

Y The hospitality sector may see benefits from lower energy costs as leisure and business travelers find traveling more affordable.

New Food Trends Are Changing Retail Real Estate For the first time in nearly 20 years, restaurant sales are higher than supermarket sales. With the trend towards e-commerce keeping customers away from shopping centers, food is helping retail landlords turnaround struggling shopping malls.

“It changes the landscape of retail real estate fundamentally, because what we have is a really fundamental shift in the different categories that are performing well and those that are struggling,” said Melina Cordero, CBRE’s head of retail research in the Americas. “With restaurants that are coming in with strong, high growth, they’re sort of the saving grace for landlords of these retail spaces to come in and drive traffic and sales.”

According to a new CBRE report, retail landlords are focusing on four categories: food trucks, ‘grocerants,’ food halls and restaurants featuring celebrity chefs. Landlords are also seeing these new concepts for food retail as business opportunities by offering seed money to selected food start-ups to set up locations in their shopping centers. The landlords are then taking an equity stake, which is also changing the traditional concontinued on next page

October • 2016

cept of the landlord-tenant relationship between shopping malls and food retailers.

In shopping centers that feature big supermarkets, the model is also changing. Food retailers like Whole Foods now have eating areas, known as grocerants.

Chinese Investment in U.S. Hotel Real Estate on the Rise Investments in U.S. hotel real estate by mainland Chinese investors have continued to rise. The trend dates back to 2010, when the U.S. was just beginning to emerge from the recession. Major properties that have been purchased by Chinese investors include the Waldorf Astoria New York, ($1.95 billion), Marriott Los Angeles Airport ($155 million), and Lux Los Angeles City Center ($104 million).

Chinese investors have also started to invest in hotel portfolios, with recent sales including Strategic Hotels & Resorts, Inc. to China’s Anbang Insurance for roughly $6.5 billion in March 2016. In February 2016, Chinese investment firm Cindat Capital Management purchased a 70 percent interest in seven Manhattan hotels, with a purchase price of $571.4 million.

According to the Asia Society, “Chinese investors are attracted to U.S. markets given [the higher] return potential, array of investment opportunities, economic and property market stability, strong foundation of property rights, and the sheer size and maturity of the market.”

With China’s recent reforms to the approval and registration processes for outward foreign investments, investment activity has continued to increase. In addition, Chinese investors are looking at U.S. real estate as a safe way to diversify their portfolios outside of their own economy.

Volume 42 • Number 10

New Tech Every Home Will Likely Have by 2020 New technology is entering residential real estate to provide convenience for consumers. Here are some of the technologies that are expected to be standard in all homes by 2020.

Light-Transmissive Flooring: LED light-emitting flooring is designed to engage with people’s natural tendency to seek light. It can be used to provide an enhanced atmosphere for the home by providing safety, information and aesthetic benefits.

Smart Home Theater: With smart devices already found throughout the home, smart home theaters can provide greater value by reducing the number of gadgets that people need by working with other devices, such as TVs and gaming consoles.

Gesture Control: PointSwitch technology will allow users to control appliances and other objects around the home without having to actually press a button.

Smart Windows: Smart windows can change glass from translucent to opaque at the touch of a button. The convenience of smart windows will eliminate the need for curtains and window shades.

Fingerprint Unlocking: Fingerprints may soon be used as the default way to unlock homes and cars, providing an extra layer of security.

Communication with Appliances: Sending messages to your house and conversing with appliances by voice will make monitoring your home easier.

Sea Level Rise Could Trigger More Than $1 Trillion in U.S. Real Estate Losses A recent Zillow study revealed that water poses a major threat to real estate in all coastal U.S. states. The study determined that nearly 300 U.S. cities would lose at least half of their homes and 36 U.S. cities continued on next page

October • 2016 would be lost completely by 2100 if sea levels continue to rise.

Some estimates predict that sea levels will rise by as much as six feet by the year 2100 if climate change continues unchecked. Nearly 1.9 million homes (or roughly 2 percent of homes across the U.S.) are at risk of being underwater by 2100.

However, just a few states will shoulder the majority of the losses to properties. Florida (12.56%), Hawaii (9.07%), New Jersey (7.35%), Louisiana (5.88%) and South Carolina (4.42%) topped the list of states that are predicted to have the largest fraction of total housing stock underwater.

“In fact, based on our calculations, it may turn out that actual water poses almost as much of a problem for the housing market in the future as negative equity has in the past,” said Krishna Rao, Director of Economic Product & Research at Zillow.

While the value of the average U.S. home is $187,000, the median value of a home that is at risk of being underwater is $296,296. The value of homes lost in all states that are at risk totals more than $1 trillion.

How the Presidential Election Might Affect US Real Estate With the U.S. presidential election coming up in just two months, the economy is currently experiencing its slowest recovery in the past 50 years. While the economy has recovered modestly, housing markets have not yet bounced back to become the drivers of economic growth that they had been following other downturns.

“It’s not that people don’t want to own homes. The simple truth is that at a zero interest rate, it’s impossible to build the down payment necessary to buy a home. Savers were robbed by the Fed,” NAI Global Chief Economist Peter Linneman said.

Linneman is also predicting that the presidential election likely will have very few short-term effects on commercial real estate and that the retail and multifamily sectors will be even less affected. However, the

Volume 42 • Number 10

outcome of the election could have long-term effects on the real estate industry if Donald Trump is elected president, because there will be an overexposure of tax regulations’ impact on real estate due to the candidate’s involvement in the business.

However, Linneman predicts that there will be changes in the U.S. real estate market regardless of which candidate wins the election. As new regulations go into effect, small businesses will also be hit the hardest because they lack the financial resources to hire tax specialists who can help them adjust to any tax changes.

Nearly 6 Million Home-owners Are Still Under-water on Their Mortgages More than five years after the housing recovery started, 5.9 million borrowers still owe more on their mortgages than their homes are worth. On the positive side, the negative equity rate in the U.S. has continued to decline and now consists of only 12 percent of homeowners with mortgages, according to research from Zillow. In the past year, the negative rate has declined more than 2 percent from over 14 percent in 2014 and more than 30 percent since the height of the housing crisis. However, these figures are still well above normal and are equally distributed across both urban and suburban neighborhoods.

Housing markets located in the West, including San Francisco, Portland, Denver and Dallas, have the fewest number of borrowers in a negative equity position. This is due to the fact that these housing markets are competitive and have strong employment. In addition, they have seen the largest price gains.

Chicago and Las Vegas have the highest number of borrowers with a negative equity, with Cleveland and Kansas City making up the second group of markets with the highest negative equity rates in the country.

“Low levels of inventory across many markets will continue to put upward pressure on house prices for the foreseeable future,” said Sean Becketti, chief economist at Freddie Mac. continued on next page

October • 2016

IRS Tax Deduction Helps Unmarried Couples With Supersize Mortgages The IRS changed its stance on mortgage interest deductions last month by allowing couples who jointly own one or more residences but are not married to deduct mortgage interest separately. In the past, the maximum amount of mortgage interest that individuals who are co-paying on a high-balance mortgage could jointly write off was $1.1 million thanks to a rule passed in the late 1980s.

Under Section 163 of the Internal Revenue Code, taxpayers were permitted to write off interest paid on up to $1 million of “acquisition indebtedness” and on up to $100,000 of “home equity indebtedness,” up to a combined limit of $1.1 million.

For couples who are unmarried but are paying a mortgage together, that meant a maximum deduction of $500,000 in acquisition indebtedness and $50,000 in home equity indebtedness for each taxpayer. This rule was even applied in the same manner to married couples filing separately.

However, in 2012 an unmarried California couple who jointly owned expensive homes with big mortgages decided to challenge the IRS decision in U.S. Tax Court. Although the Tax Court disagreed, last month the U.S. Court of Appeals for the 9th Circuit reversed the Tax Court’s ruling, stating that the limit should be applied on a per-taxpayer basis.

Housing Markets Battered During the Recession Now See Biggest Growth For more than a year now, home prices in the areas that were hit the hardest by the housing crisis have been experiencing the sharpest increases. Miami, Las Vegas, and parts of Arizona

Volume 42 • Number 10

and California were all places that topped the list of housing markets most affected by the real estate downturn that began in 2006.

According to data from the research firm CoreLogic, sales of homes priced at $1 million or higher nearly doubled in 2015. Miami’s property markets are currently seeing their biggest home price increases since 2006. In Phoenix, Arizona, home sellers saw an average 29 percent gain, according to RealtyTrac.

“In the last boom, you had severe overbuilding, which caused an influx of speculators to flock to many of these cities, and that caused a somewhat artificial market,” says David Blitzer, managing director and chairman of the index committee at S&P Dow Jones Indices. S&P Dow Jones Indices is responsible for compiling the monthly S&P CoreLogic Case-Shiller Home Price Indices. “Tighter restrictions on mortgages mean lenders are less inclined to enable these types of buyers, and that’s helped build a more balanced market.”

However, the reasons why home prices are increasing also differ from the last real estate boom. In each of these hot housing markets, the economy is rapidly expanding, along with population growth and a chronic low supply of homes for sale, according to Jonathan Smoke, chief economist at Realtor.com.

Agents’ Corner

Should Agents and Others Invest in Real Estate with a Partner?

Investing with a partner may seem like a good option when it comes to mitigating risk and delegating responsibility. However, you should proceed with caution. Like any other business undertaking, real estate investing partnerships come with potential pitfalls. Here are a few things to consider if continued on next page

October • 2016 you are trying to decide if you should invest in real estate with a partner.

Financial and Operational Considerations: Funding investments is typically the biggest hurdle to getting started in the real estate investment business. Forming a partnership can help you gain the necessary capital that you need while mitigating risk.

In addition, you may not have all of the experience needed on your own to make your investment a successful one. Forming a partnership with an experienced professional can help you to gain the operational expertise to succeed in areas where you are lacking, such as permitting or construction.

Types of Partnerships: The structure of a partnership is extremely important. You must define your roles and your responsibility so the partnership works for both parties. For some investors, a fifty-fifty partnership where each party invests the same amount of money and time while reaping the same benefits may work best.

In other cases, a partner may have the experience but lack the capital to pursue the investment, which is what the other equity partner brings to the partnership. The partner who puts up the funds for the partnership is known as the limited partner, while the general partner is responsible for the day-to-day operations of the business.

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In this scenario, the partnership payout structure can range from fifty-fifty to a scenario in which the limited partner is paid via a preferred rate of return and increasing profit split as the profits from the real estate venture increase.

Partnership Agreement: One very important aspect of the business that partners often overlook is the actual partnership agreement. The partnership agreement is a legally binding document that should clearly outline the rules, responsibilities and rights of each partner. You should have the partnership agreement reviewed by a lawyer so you can ensure that the terms are fair and legally enforceable.

A partnership agreement is especially important if your investment partner is a friend or family member. Many people make the mistake of entering into a partnership with a friend or family member, thinking that nothing can go wrong. However, investments don’t always perform as expected and you need to be prepared for any negative outcomes.

Securing Your Investment: By understanding all of the risks that come with a partnership, you can prepare yourself for any disagreements that may arise. In addition, make sure to thoroughly research any markets and properties that you plan to invest in. By planning your partnership carefully, you can dramatically improve your chances of success.

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