The USA: Regional Real Estate guide provides expert legal commentary on the key issues for businesses involved in the real estate sector. The guide covers the important developments in the most significant jurisdictions.
Last Updated May 14, 2019
Notwithstanding tumultuous domestic and international political conditions, the US economy has continued its steady growth over the past 12 months. The Dow Jones Industrial Average has continued to set new record highs, the US unemployment rate is still achieving historic lows, and consumer confidence remains strong. Foreign investments into retail have sharply risen. In a reversal of 2017, office sector deals have increased despite a drop in foreign investment in the sector.
In an effort to reverse these current downward trends, owners of retail and office properties have started to rethink the ways in which they attract consumers. Many retail and office spaces are beginning to provide access to a wide variety of amenities and 'full-service' hospitality-like facilities, and are revamping the services that they already have to offer. The Opportunity Zone legislation finally has workable regulations in place and is offering very attractive incentives to investors and developers alike in exchange for stimulating growth in qualifying regions across the country. Meanwhile, industrial and logistics properties continue to be some of the hottest assets in the US real estate market. The US also managed to ward off an economic downturn and performed beyond many expectations. This has translated into a highly active and dynamic real estate market over the past year.
The retail sector continues to evolve as e-commerce takes its toll on traditional brick-and-mortar businesses. National Real Estate Investor (NREI) reports that “[t]he U.S. retail sector posted the worst drop in sales in nine years. After a downwardly revised 0.1% increase in November, sales unexpectedly fell 1.2% in December 2018.” Consumer sentiment, on the other hand, improved at the end of 2018, outperforming the ten-year average, but it dropped again in January, also due in large part to the government shutdown and stock market volatility. Private Equity Real Estate (PERE) reported, however, that “[w]hile overall retail sales are expected to grow another 4% in 2019, e-commerce is expected to grow 15%-16%, and result in a tremendous amount of absorption.” Many major US retailers are currently in the middle of significant expansions to supply chains via additional regional distribution centers because of their new focus on the e-commerce space. This absorption is also reflected in the real estate sector as distribution and logistics will continue to see increases in demand where the retail real estate sector falls short. A positive note is that some forward-thinking retailers are still expanding thanks to the rise in consumer demand, a combination of competitor closings and the adoption of innovations such as omnichannel marketplaces, which may keep the storefront relevant without falling behind logistics behemoths that can provide what consumers need at their doorsteps. In real estate, this means that there is the possibility of a retail sector flattening or even an upward tick of modest growth.
The strong economy has been a catalyst for strong office job growth. Cushman & Wakefield reported at the end of last year that “U.S. Office sales accelerated in the fourth quarter of 2018. Sales rose 19% quarter-on-quarter and 13% year-on-year.” Thus, the US office market should continue to experience positive growth in 2019. STEM-related companies have been and will most likely persist in reporting the largest employment gains. These employers and flexible space providers will remain key drivers of demand for office space. Connecting employees to their building, available services and extended community through technology will be a focus for landlords and employers alike in 2019. In a race for talent, office space continues to be a key tool for tenants to attract and retain employees, similar to reports in 2018. Accordingly, tenants are seeking new, innovative office spaces to conduct their business. Landlords acknowledge the need for such spaces and are beginning to offer amenities which “include finishes that rival those seen in hotel lobbies, large public spaces to relax and plug in, multiple food options, high-end fitness facilities, event space, roof decks, and outdoor spaces.” It is likely that older buildings will struggle in this regard, given the difficulty and cost to retrofit existing spaces to incorporate these features. Owners of new buildings, however, are designing their spaces around such amenities, making them focal points of their new properties. This demand for new, high-quality office space is reflected by CRBE in its report that “[c]onstruction completions totaled 49.0 million square feet in 2018, the second-highest annual total since 2009.” With demand showing steady signs of growth and with cyclical lows of office vacancy in 2018, 2019 and 2020 could witness increased demand for development in addition to office building transactions. The forecast is therefore for moderate sector growth even if there is an overall softening of economic growth.
Retail and Office Financing
Foreign investment in the retail sector has surprisingly increased over the past 12 months. According to JLL, “[f]ull-year investment in the U.S. retail sector reached $70.9 billion, a 28.9% increase over 2017.” Meanwhile, foreign investment in retail amounted to USD30.4 billion, of which USD27.6 billion consisted of entity-level investment, as reported by CBRE. This is a substantial increase on the USD3.6 billion in inbound investments in 2017, which consisted almost entirely of non-entity-level deals. Excluding entity-level investments, foreign investments at the ownership level actually decreased by 21%, as reported by CBRE. With a combination of retail property transactions on a downward trend, higher activity in the past year due to the Tax Cuts and Jobs Act and higher rents on retail properties, such a sharp rise in investment at entity level, can be explained; but as markets prepare for slower growth in 2019 and 2020 and a resulting slowdown of capital infusion on behalf of investors, retail investment levels will more than likely return to expected rates of decline.
In a complete reversal of the previous year, according to CRBE, foreign investment in the office sector dropped slightly from USD21.4 billion in 2017 to USD20.3 billion in 2018, which is lower than the total foreign investment in the retail sector. Of those totals, non-entity level investment increased over the past year from USD1.2 billion to USD4.3 billion, matching the trend in other sectors, though significantly lower than the retail spike. JLL reported that “[p]ortfolio activity declined by 15.5% from 2017, driven in part by concerns over exit pricing assumptions in secondary markets” in this sector. While demand for office buildings will likely remain strong, a liquidity crunch among foreign investors expecting a tougher global economy may very well be an issue for this sector to overcome.
The US industrial and logistics sector has continued to be one of the strongest performers during the past 12 months. It has been a favorite for domestic and foreign investors in real estate. Since demand has gotten so high, developers are starting projects frequently; investors and owners are on the hunt for properties that will maximize and diversify their profits, while landlords are looking to take advantage of construction’s inability to keep supply high enough to meet growing demand. Much of this has come at the expense of the retail sector, since e-commerce is increasingly displacing storefronts as a preferred way to shop. Logistics and distribution centers have therefore become a hot commodity as major retailers adopt online platforms and increasingly need to fulfil these operational demands.
Opportunity Zones have become a very popular subject among key players in the real estate industry since they were created by the Tax Cuts and Jobs Act this past year. Developers and investors are seeking advice and guidance on this new program to take advantage of the tax benefits. The federal government is offering a great deal of incentives for investors to pump capital into rural and low-income communities in every US state. With programs this new and ambitions there is, however, a knowledge curve extending through both compliance and program participation to the possible outcomes of these projects and investments. Certain luxury assets such as golf courses cannot be built in opportunity zones, and for good reason, if the intention is to revitalize communities that have been left behind and need stimulus in their local economies. What can be built, however, is far from limited to affordable housing and small business ventures. Therefore, when the government offers tax incentives with certain very specific conditions and goals in order to capitalize a community, the results for all stakeholders – owners and developers, governments, community members, and newcomers – are less predictable. As the name suggests, this does provide the opportunity to benefit all parties if things proceed according to plan.
The US economy continued to show strong numbers over the past year, bringing higher than expected activity into the retail and office sectors. Retail saw expected drops in transactions but experienced a massive influx of entity-level foreign investment. The office building sector, on the other hand, seriously outpaced expectations for construction and transactions, while witnessing a drop in foreign investment. Industrial and logistics properties have been some of the best performing assets over all in 2018. As far as what is to come, more stock market volatility, uncertainty regarding tariffs and global trade, and an end to the last decade of economic growth are more likely to stymie the flow of capital domestically and across borders than they were the previous year. Consumer sentiment and retail sales may help slow the decline of the retail industry; however, retailers will have to continue to evolve as far as customer experience and services are concerned in order to stave off the rise of e-commerce and a possible economic downturn. Demand for new office buildings may very well bring overall positive results to that sector for the coming 12 months, depending on whether tech and other newer industries continue to have strong hiring gains in spite of a lower performing global economy. Opportunity Zones will more than likely be this year’s real estate trend as industry players and their attorneys fully unlock the capabilities of these new federal incentives. Lastly, the industrial and logistics sector will feed off e-commerce’s absorption of the traditional retail industry and will remain a strong contender for project financing, investment, and government dollars.