Real Estate 2020 covers 46 jurisdictions. This edition features information on the impact of disruptive technologies, important areas of law, sale and purchase, real estate finance, regulatory authorities, commercial leases, investment vehicles and taxation.
Last Updated: April 14, 2020
Real estate sits at the intersection of supply, demand, liquidity and capital markets, and reflects the dynamics and trends of the broader global economy. As the third largest investment type (following fixed income and publicly traded equities), commercial real estate (CRE) has firmly established itself as a major global asset class. As we enter the third decade of the 21st century, it’s a good time to pause and reflect on the significant shifts in the real estate industry over the past 20 years and look at the challenges and opportunities facing the industry in the coming years.
More than ten years following the Global Financial Crisis, the 2019 global CRE market continued a strong run. In 2019, while US CRE transactional volume was flat, JLL’s City Momentum Index 2020 found global commercial transaction volume reached an all-time high of USD800 billion, representing a 4% year-over-year increase and making 2019 the most liquid year on record. Several asset classes grew at record paces, particularly logistics and multi-family. Despite the US Federal Reserve Bank changing direction last year on interest rate policy and alleviating one of the major concerns for the industry’s growth outlook, there are still disrupters that are causing uncertainty for the industry. Global political instability (including the US Presidential election and the implementation of Brexit) and a fear that the current business cycle must come to an end at some point are just two examples of uncertainty in the market.
In fact, the coronavirus disease (COVID-19) pandemic may be the greatest global disruption in the past 100 years. As the first quarter of 2020 comes to a close with global financial markets down significantly, there is no consensus on how long the financial recovery may take, but the combination of the market dislocation with the pandemic has led many to believe this could lead to the worst global recession since World War II. As the United States fights to control the spread of COVID-19, one can only speculate on the impact on CRE in the coming months and years. But governments and financial institutions around the world are collaborating and taking unprecedented steps to support markets, businesses and consumers to defeat the disease's spread and to lead us back to a strong and stable recovery.
CRE lending remained strong in 2019, with total loan volume up 6.3% over the prior year, according to Real Capital Analytics. In addition, Commercial Mortgage Alert reported that worldwide commercial mortgage-backed securities exceeded USD103 billion in 2019, a 24.7% increase over 2018, and respondents to the Mortgage Bankers Association's 2020 Commercial Real Estate Finance Outlook Survey (prior to the COVID-19 pandemic explosion) expected that 2020 loan originations would increase modestly from last year.
Capitalisation rates remained at record low levels in many international markets in 2019, with predictions that similar levels will continue in 2020. For example, before the protests in Hong Kong and the COVID-19 outbreak, cap rates were as low as 2% for Hong Kong offices and retail and 1.5% for luxury residential in Singapore, and UBS predicted that, “As interest and bond yields continue to fall, cap rates in major global cities could start to approach the levels of these Asian cities.” However, some industry experts have questioned how long the low rates can be maintained. In the 2019 DLA Piper Annual State of the Market Survey, 13% of respondents who noted they are bearish about the CRE market said their lack of confidence was due to unsustainable low cap rates.
In addition to cap rates, other factors that have caused concern for some investors include the US Presidential election, uncertain international trade policy and global instability from hotspots such as North Korea and Iran. Moreover, the volatility of global financial markets in the face of the COVID-19 pandemic has brought an end to the 11-year rally and made CRE value predictions even more difficult. History suggests that liquidity in markets is affected by both uncertainty and the prospect of substantial market changes. On the other hand, geopolitical unrest and other uncertainties often lead to an increased demand for investment in countries that have sophisticated and relatively transparent markets, such as the US. Such demand could also be fueled by recent interest rate cuts and additional financial stimulus to address the impact of COVID-19, resulting in a lowering of the cost of debt capital and a focus on more stable investment vehicles and hard assets.
Last year, US regulations and policy generally favoured CRE. First, the year saw increasing levels of investment activity in Opportunity Zones (OZ), which were created by the Tax Cuts and Jobs Act of 2017 (TCJA). This created special incentives to attract capital investment to low-income communities designated as OZs throughout the US. The TCJA did so by providing investors with two significant tax benefits:
The programme had a slow start in 2018, but with the issuance of several sets of US Treasury Department regulations during the past two years, there have been substantial investments into private equity real estate funds focused exclusively on OZ projects. According to the January 2020 Novogradac Opportunity Funds Listing, funds that invest in OZs raised a total of USD6.72 billion, an increase of 51% from the amount reported one month prior. This increase was likely due to the US Treasury regulations that made the end of 2019 the final days to receive the full benefits of the programme.
Another positive development in the US CRE market was the seven-year re-authorisation of the Terrorism Risk Insurance Act (TRIA). Without TRIA, which was scheduled to expire at the end of 2020, it is expected to be difficult – if not impossible – to secure financing from banks or pension funds on major CRE assets in first-tier cities. In regard to TRIA being extended until 2027, Debra Cafaro, CEO of Ventas, Inc. and Chair of the Real Estate Roundtable, said in a statement: “We cannot overstate the valuable safety and liquidity that the [TRIA] program brings to the US economy … and CRE markets.”
Progress in stabilising some of the uncertain trade agreements last year was another good development for real estate. The unpredictability in the global trade space has, in the past, created a drag on overall economic activity that directly impacted real estate. Congressional approval of the new US-Mexico-Canada Agreement in Q1 2020, coupled with the signing of the US-China Trade Deal on 15 January 2020, will hopefully stabilise the world’s financial markets and continue positive momentum for CRE.
On the other hand, the growing number of states and municipalities that have adopted some form of rent control legislation has raised serious concerns for CRE investors and owners. Rent control regulations applicable to multi-family properties were adopted in California, New York and Oregon. One justification for these new regulations was to create more affordable housing. While Real Capital Analytics found in its 2019 US Big Picture report that multi-family sales volume exceeded all other asset classes at USD183.5 billion last year, the expanding regulatory regime could chill future investment into multi-family assets and have the opposite effect on the important goal of increasing affordable housing. In addition, in reaction to the high cost of street retail rents in New York City that have forced many businesses to close, the proposed Commercial Rent Stabilization Act would allow a City Council-appointed board to set the rate of annual rental increases on retail, professional services and manufacturing storefront spaces. As this legislation was first proposed in late 2019, it is too early to predict the impact of this new regime, but it has already drawn scepticism from the real estate industry.
It is important to note that, in the face of the COVID-19 outbreak in the US, many states and municipalities have adopted laws restricting foreclosures and evictions. Moreover, the enactment of the CARES Act, the USD2 trillion stimulus package on 27 March 2020 has many implications for CRE.
Cross-Border Capital Flows
While 2019 was a strong year for CRE investments overall, capital flows from global markets into CRE were lower than usual at the end of the year as institutions became more selective when investing in real estate. For example, Chinese investment in US real estate dropped to its lowest level since 2012, due to the restrictions adopted by China's State Council in 2017 and the simmering trade tensions between the US and China. Given China’s previous large volume of investments, foreign investors in US CRE will now be on pace to sell more assets than they acquire for the first time in seven years, according to Real Capital Analytics’ research of deals of USD2.5 million and above. Despite this, experts have predicted that foreign investors would generally remain strong buyers in the year ahead, particularly from Canada and other Asian markets, such as Singapore, South Korea and Malaysia.
Evolution of CRE
Due to disruptions and rapid technological evolutions, the future of real estate has become a reality. Innovations, along with easy access to capital, have created an emergence of new real estate players and user expectations, while traditional CRE assets such as retail have faced challenges.
In last year’s Real Estate Guide, we raised several questions centred on the exponential growth of co-working spaces: Is co-working a permanent paradigm shift in the way people live and work? If so, what are the implications for future office development? How will traditional capital providers underwrite short-term lease commitments from many users?
While the answers to those questions and others remain in progress, there is no question that the co-working world experienced its own paradigm shift after WeWork withdrew its IPO and faced all the consequences that followed. But while some landlords inevitably will be affected by the WeWork restructuring, it does not mean that co-working is going away. In truth, the CRE industry has been changed forever, with the need for flexible workspaces and the importance of introducing experiential and hospitality themes into the office building environment. It is possible, however, that the impact of "social distancing" in response to the COVID-19 pandemic may introduce new density concerns in office buildings that could adversely impact the co-working industry.
Confirming the staying power of co-working spaces (prior to the COVID-19 pandemic), 2019 saw large funding rounds for flexible work space companies such as Industrious and Knotel, while Convene increased its capital base via a partnership with Goldman Sachs, Morgan Stanley and Barclays that helped secure a new USD175 million credit facility. In an effort to meet demands for flexible work spaces, office landlords have introduced tenant experience apps (for example, Equiem, HqO and others) that enable every building occupant to access a platform of services and goods that are available – from fitness classes and conference facilities to local restaurants, ride sharing services and all amenities tenants require. One landlord reported that the app “dramatically improved the tenant experience and helped create new relationships and communities within our commercial properties." Tenant apps also may play an important role in the remote working environment that has become necessary during the COVID-19 pandemic.
Office spaces, particularly older buildings, will face many challenges in the new decade. New properties will continue to attract tenants to efficient, column-free floorplates and floor-to-ceiling windows, together with the best technology backbones that will be crucial to support the increasing broadband requirements of 5G, IoT and beyond. Co-working companies have been critical to the absorption of much of the space in second and third generation buildings. Only time will tell if that space truly has been absorbed and what happens next.
Much has also been written about the challenges in the retail real estate sector. The Wall Street Journal reported that investors in UBS Group’s flagship real estate fund have requested withdrawals of nearly USD7 billion based on concerns over its retail holdings (and that was before the COVID-19 pandemic). But while regional malls face some of the greatest challenges as a result of continued store closures and bankruptcies of major retailers, there is little question that retail will survive. While 2019 had a record-high number of store closures among national retailers, Business Insider found that 2020 may be trending in the same direction, with as many as 12,000 closures estimated to take place this year. Earlier this year, for example, Macy’s announced it will close 125 stores over the next three years. However, aggregate retail sales (excluding motor vehicles and gasoline) in 2019 increased 5.9% over the prior year, according to advance estimates from the US Census Bureau, and CBRE reported (before the COVID-19 pandemic) that more stores will be opening than closing in 2020.
Traditional brick and mortar retailers have adapted and innovated to remain attractive through omni-channel distribution strategies and to compete with the dominant e-commerce providers. In addition, the rising trend of “liquid spaces” has allowed companies to make use of empty space as they can be flexible for multipurpose and temporary use. For example, retail properties have offered rental options for pop-up shops, and big-box retailers have rented out parts of large stores.
Yet, e-commerce is still a major force, with 85% of respondents in the 2019 DLA Piper Annual State of the Market Survey saying that e-commerce will be the most impactful trend in the CRE market in 2020. As consumer demand for next-day and free shipping increases, there has been amplified attraction toward investments in distribution centres and warehouses. This shows the correlation between consumer habits and the CRE industry, as well as the synching of community and connectivity.
With connectivity at the forefront, 2019 was a breakthrough year for the CRE proptech industry. According to Steve Weikal of the MiT Center for Real Estate, from 2014 to 2019 the industry grew from just a handful of proptech companies to more than 7,000 globally. Capital invested in proptech companies in 2019 totaled USD24.9 billion, according to data from CREtech. Proptech companies are focused on every asset class as the pace of innovation and technology development continues unabated. There can be no doubt that proptech applications and programs will affect construction, property management, development, leasing, hospitality and virtually every aspect of CRE.
Like all industries, CRE is impacted by changes in technology, the economy, regulations, political uncertainty and other external factors. However, despite some uncertainties and apprehension about the length of the current market cycle and the uncharted impacts of the COVID-19 pandemic, CRE generally continues to perform well and is likely to remain an attractive asset class for most global investors. As a global asset class, there are almost always local issues and nuances that can materially affect an investment in CRE, and therefore investors are strongly advised to consult with local counsel and other expert advisers in each jurisdiction where an investment will be made.