Ben Breslau (@benbreslau) is no stranger to making economic predictions. As the head of Americas Research for global brokerage company JLL, prognostication fits his purpose. He’s comfortable telling wide audiences economic realities they may not want to hear. Yet, his Q4 economic update caught most of his audiences by surprise as it contained the ultimate commercial real estate curse word: recession.
We caught up with Ben for an insider’s view into the economic realities that institutional investors bank on.
All of the property sectors are showing a leasing momentum. Is this a case of what goes up will come down?
You’re right on both parts; we are seeing leasing momentum in all property sectors and in most markets around the world. The global office vacancy rate (across 98 markets) has dropped below the 13 percent threshold for the first time in the current cycle, fueling modest but fairly widespread rent growth. Mounting supply shortages have prompted another rise in construction activity and, globally, new deliveries are anticipated to be around 25 percent higher in 2015 compared to 2014, with prospects of even larger construction volumes in 2016 to provide tenants with some needed options.
Domestically, multifamily has been the quickest to recovery, and now has new deliveries starting to moderate rent growth prospects. Hotels, industrial and downtown office properties are all rising markets with strong demand while suburban office and lastly retail have finally moved into the recovery phase in the United States. We expect a strong 2015 and 2016 for these markets, but the economy and real estate sectors are cyclical, so risks will build for a correction as we head toward the end of this decade.
With Corporate America speeding up investments, are there more industries fueling demand for property?
We’re enjoying a more diversified economic expansion both by industry sector and geography, and U.S. GDP growth predictions suggest acceleration to the 3 percent range in 2015 and 2016. But while a range of industries are active in the space markets, each faces unique challenges as well.
The technology sector is the sweet spot for commercial real estate on the demand side, but tech employers are facing a war for talent and workplace flexibility issues that impact the decisions these companies make concerning real estate. Energy was the other hot sector; but it now appears wobbly after the sharp recent decline in oil prices that shifted the focus from expansion and production to profitability, and could impact niche energy markets. The flip side of slowing energy sector growth is a huge and broad boost to consumers from lower gas prices at the pump that should help retail and the economy overall.
How will the global markets affect property performance in the United States?
The global economy held up the BRICs (Brazil, Russia, India and China) countries as the star growth markets for many years. Today, it is just the ICs (India and China) that are poised for economic growth, and those look pretty “icky” now too, as China growth prospects decelerate and India works through reform challenges. There will be bumps in the road, but longer-term several of these emerging markets still present strong growth opportunities for companies and real estate.
Developed markets outside the U.S. may be more important to watch right now: Japan is in a recession, Europe is fighting deflationary pressures, and elections in Greece could rekindle the crisis there and threaten the stability for the Euro. Even with some near term global economic uncertainty, there remains a ton of capital chasing commercial real estate, and the U.S is the focus for much of it due to a comparably more stable growth outlook, its “safe haven” position, and the need for foreign capital sources to increase real estate exposure and diversify from their home markets.
What are the greatest risks to commercial real estate investment on the horizon?
There are a lot of factors at play including economic growth, deflation, geopolitics and the list goes on which could all lead to greater volatility. The headlines these days can make your head spin. Cutting through it all, in my opinion one of the one of the key issues is still the ability of monetary policy makers to navigate this environment without spooking the countries that still need support or stoking a bubble or inflation.
Divergent growth prospects and divergent monetary policy can create volatility in financial and currency markets. The Fed seems set on starting the process of normalizing interest rates in 2015, but the markets are not buying what the Fed is selling right now in terms of the rate outlook. Ten-year Treasury yields have again dipped to the 2 percent range. Either way, historically expansions last several more years once the process of interest rate increases begins, and the positive yield spread also suggests more room to run. We’re betting on that, but no doubt the ride will be bumpy as it has been as 2015 starts in financial markets, and getting out of the great monetary experiment will be more challenging than it was getting in.
Slower global economic growth, geopolitics, deflation, and monetary policy present key risks
Could the U.S. economy face the “r-word” in the short-term?
Just about all of the leading economic indicators in the U.S. are at recovery-to-date highs and despite talk of tightening next year policy is still incredibly accommodative, so that points to solid growth in the short term. We are already technically over 5 years into this expansion cycle though, and the good times don’t usually last forever. The last few economic expansions lasted an average of 7-8 years, so that length would put us somewhere in 2017 or 2018.
So in the medium term, some correction is likely on the horizon. Will it be a full economic recession? It could be. Something would have to trigger it such as more advanced monetary tightening, an asset bubble popping, or maybe a significant escalation of one of the many geopolitical conflicts percolating right now around the world. Also, by 2016 and 2017 there could be a bigger construction delivery pipeline hitting the market as the cycle ages. Overall we expect growth for at least another two to three years; but watch for 2017 or 2018.
What does this all mean for real estate investors?
We are in the sweet spot in the cycle for NOI growth, and real estate is a favored asset class globally, a good time for owners to make hay while the sun shines. The next few years should be great for harvesting returns and for strategic dispositions. But with pricing increasing ahead of fundamentals, and continued tremendous competition for core assets, many investors looking to place capital are challenged and have been pushed out the risk spectrum to find acceptable returns.
I’d be thinking about development in some segments, investing in higher risk assets where you feel good about being able to add the value in the next 2-3 years and exit, or else finding assets that can ride positive longer term secular trends and that you don’t mind holding through a cycle and owning 10 years from now.
For a more in-depth analysis on the global property markets and their impact on city performance, visit: JLL’s Cities Research Center