Executives with industry heavyweights such as Blackstone Group, Prudential Real Estate Investors and Federal Realty Investment Trust told attendees of the University of Miami’s Real Estate Impact Conference that 2016 won’t be as strong for real estate values as the previous two years, but we’re not headed into a recession.
Nearly 600 people learned about what’s ahead in the real estate market at the conference held by UM’s business and architecture schools on Feb. 11. Some of the news could be difficult to stomach for investors who are counting on rapid value appreciation. Fortunately, they see the real estate market as more stable than the volatile stock market, and Miami remains one of the most attractive cities for global investors.
Here are five insights from the UM conference:
Don’t expect explosive growth in 2016
Low capitalization rates have driven up real estate prices in recent years, but that probably won’t last as Treasury yields rise, said Alfonso Munk, chief investment officer of Americas, Prudential Real Estate Investors “It’s about time where we’ve seen a year where our values will go down,” Munk said “There’s a probability that 12 months from now that prices will go down and it’s normal. If it goes down 10 percent, then it’s not bad compared to the equities. We will be fine as long as we aren’t over leveraged. Those crazy cap rates will get back to normal because they are unsustainable."
Many of the foreign investors that contributed to the run up in real estate values have been pulling back, Munk said. That’s actually a good thing because many of them just wanted to park their capital in the U.S. regardless of the returns, he said.
“With cap rates so low you won’t see them grow lower,” said Jon Gray, global head of real estate for the Blackstone Group (NYSE: BXG), which manages close to $175 billion in real estate assets worldwide. “You could see a year of modest growth in value but the idea that you’re going to see a steep decline, with these market fundamentals, that’s just not the case.”
Expect 2016 to be a pretty good year, but slower than 2014 and 2015, said Don C. Wood, president and CEO of Federal Realty Investment Trust (NYSE: FRT), the retail REIT that bought CocoWalk and the Shops at Sunset Place in 2015. He said the company invested in those retail centers for the long term potential to revitalize them so they better serve their neighborhoods. In both deals, FRT brought in local partners Grass River Property and Comras Co.
“The overall bet we made in Miami is that over the next decade or two that this city is truly growing up and can expand its employment base,” Wood said. “We basically made a $200 million decision in a $12 billion company and committed at least another $200 million to see those projects to fruition, and it may be a little more than that. It’s based on the ability of this market to expand.”
Yet, when Wood sees groups buying properties at a 4 cap, he thinks that’s crazy.
“If you are looking for long term growth, I don’t think you can count on cap rates bailing you out,” Wood said.
“Gray said there’s a shortage of supply on the residential market, both for single-family homes and apartments, and that should keep rents and values growing. That’s especially true in land-locked cities like Miami, he said.
“However, Gray cautioned that activity in the high-end condo market could slow because they are discretionary purchases, so the global economic slowdown could deter purchasers. He’s also concerned that there’s too much hotel construction in Miami.
“Howard Lorber, president of the Vector Group and chairman of Douglas Elliman, said there’s clearly been a slowdown in luxury condo purchases in Miami, but he feels it was for properties that were overpriced.
““When people are building just for the very high end there’s going to be a slowdown,” Lorber said. “Especially when many people are out of the market like Asians and Latin Americans and Russians.”
“Lorber doesn’t anticipate a real estate crash like last time because condo developers are building mostly with buyer deposits, with little reliance on debt.
““When we think what could cause you to get really nervous about real estate we think about cranes - how much new supply there is - and the amount of capital. Is the debt market driving prices to unsustainable levels?” Gray said. “We don’t’ think either of those conditions exist. We are in a period of much more moderate growth than we were so you should set your expectations lower, but you don’t want to panic here.”
Don’t overreact to stock market turmoil
Gray said the problems in the global markets will hurt real estate, but investors should have a long term view. He said the equity market declines are another ripple from the previous recession. China couldn’t maintain its aggressive real estate boom and ran up a lot of debt, so it needed to slow down. That resulted in a loss of production in Latin American countries that provided construction materials to China, he said.
At the same time, the weakening of foreign currency against the dollar hurt U.S. manufacturing and tourism, Gray said.That was compounded by an over supply of oil that reduced prices, he added.
“This is a slow down in China and it will slow U.S. and European growth but we don’t see this as a recession,” Gray said. “So this might create some interesting opportunities…We don’t see things as darkly as the markets do.”
Gray said the markets are reacting excessively compared to the underlying economic conditions. He sees many REIT stock that are trading well below the value of their real estate assets.
Build for millenials - if you can figure them out
The 87 million-strong millennial generation is the sleeping giant of the home market. They’re the largest population segment but their level of home ownership is much lower than their predecessors.
Millenials tend to live in small apartments in urban areas and wait longer to get married, said Garrick Brown, VP of market research for the western region at Cushman & Wakefield. High student debt has made it difficult for them to buy homes. However, when you survey millenials, you find that most of them aspire to buy homes and plan to have children one day, he said.
“The question is whether millennial preferences will remain permanent,” Brown said. “I’m not convinced millennials will go childless. I see nothing but pent up baby demand.”
Having children means millenials will eventually seek larger homes, likely in the suburbs, Brown said.
The shopping habits of millennials, especially their preference for buying online, has impacted retail real estate in a major way. Brown said traditional retailers will continue shrinking their footprints as customers purchase goods online. The luxury sector should remain strong and discount retailers will grow, but he expects retraction for mid-priced retailers. Online retailers like Amazon will open some retail stores, but not enough to make up for the closure of traditional retailers, Brown said.
“Regional centers and local shopping centers are doing well. Everything in middle is going dark,” Munk said. “There’s a ton of supply that’s not functional."
Wood said he tries to be as flexible as possible with FRT's retail space so it can welcome different types of tenants. There are many shopping centers out there that are obsolete, especially the giant big boxes, he said.
Katy Gnapp, head of commercial real estate banking for Bank of America Merrill Lynch, said it’s reducing brick and mortar locations as customers, especially millennials, switch to mobile banking. Only 35 percent of transactions are done at the teller and that number keeps declining, she said.
Seeing that millennials typically live in urban environments, Gnapp said BofA’s office lending strategy focuses on downtowns, which tend to do better in a recession.
Real estate must adapt to technology
Much like the taxi industry has been disrupted by Uber, certain aspects of real estate could get a run for their money from new technologies.
No where is this more apparent now than in hotels. Munk said Prudential owns many hotels in Paris and it’s seen occupancy rates fall there because of competition from Airbnb. There are about 90,000 Airbnb rooms in Paris, more than its hotel rooms, he said.
“Hotels will be completely transformed,” Munk said. “We won’t sell hotels until we realize what’s going to happen."
The driver-less car would have huge impact on real estate, probably on the same level as mobile phones, Brown said. If people could sleep, work or watch TV in their cars on the way to their jobs, they may not mind how long their commute takes, he said. That could make living in far-flung suburbs easier to take.
Online purchasing has also impacted how properties change hands. Jeff Frieden, CEO and founder, Ten-X (formerly Auction.com), said his online platform has sold deals as large as $96 million for a California office building. It once sold a Florida hotel to a man who bid on his iPad while on a cruise ship, he said.
“It allows for transparency for people to bid on a level playing field, whether you’re a large institutional investors or a wealthy family,” Frieden said.
Ten-X has been working with Google, one of its largest investors, to track data and predict home sales based on search activity, Frieden said. He hopes that providing more data will take the risk out of transactions.
Warehouses are where it’s at
Many experts said South Florida’s industrial market is a great investment.
Brown said he’s bullish on rent growth in the industrial sector. Amazon was larger absorber of industrial space in 2015, he said. E-commerce companies will continue seeking out warehouses, especially those that can deliver goods to population centers quickly, Brown said.
“Warehouse is a great business in Miami because of the amount of commerce and the inability to find space,” Gray said.
By Brian Bandell
Read more at bizjournals.com/southflorida.