On September 19, 2019, PwC and the Urban Land Institute (ULI) released their “Emerging Trends in Real Estate 2020 Report.” According to PwC leaders, the annual report looks forward to the year ahead, unlike most reports that look back at the last quarter or year. The report was compiled from surveys and interviews of over 2,250 real estate executives, investors, developers and market experts. Trends that shaped the 2020 outlook included low taxes, economic diversity and a high quality of life among the driving forces behind the strong showing of eight southern cities in this year’s top eleven markets for real estate investors and developers.

“Even though we are late in the expansion cycle, volatility in global financial markets, coupled with global geopolitical instability continues to drive investors towards U.S. real Estate.  The asset class remains desirable as investors seek predictable cash flows from tangible investments,” according to Mitch Roschelle, PwC Partner and Business Development Leader.

As this economic cycle entered the history books as the longest in U.S. history, the level of confidence in the real estate industry has been palpable.  “Real estate will continue to perform,” one experienced investment manager said.  “We don’t see oversupply or overleverage.” Developers continue to see opportunities, and one Sun-Belt broker commented, “Builders going gangbusters even though this cycle is old makes me feel good.”

Reinforcing the optimism about real estate’s ability to withstand a recession is satisfaction that the property sector’s discipline in this recovery means that, “this time it won’t be our fault” if the economy falters.  Any warning signs are arising from causes that real estate has little control over.  As an economist from an institutional investor put it, “How much energy should you use worrying about stuff you have no ability to change?”

Recessions strike the economy at its points of excess.  Many believe that the shape of the present expansion – moderate in pace as well as extended in length – has protected it from overheating.  This is said to be reflected in the low rate of inflation, due in some measure to the failure of wages to rise over most of the period of declining joblessness. The coincidence of low inflation with low unemployment is said to be a justification for easing monetary policy even as the long economic expansion persists.

Many real estate professionals take comfort in their experience (“We’ve been through cycles before”), expect that the next recession will not be as severe as the global financial crisis (very probably true), and that the next recovery will be at least as strong as the current expansion (highly unlikely) if the 2020s decade projections are even approximately correct.  CBO projections call for real GDP growth to drop to 2.1 percent in 2020 and remain below 2 percent throughout the coming decade.  Average monthly gain in employment is projected to be just 46,600 after growing over 200,000 jobs per month on average during the current expansion.

It hardly seems possible that it has been 25 years since Emerging Trends began to discuss the live/work/play environment under the rubric of the ”24-hour city.”  But that is a fact.  Cities and their suburbs have evolved tremendously since the mid-1990s, and the “proof of concept” of live/work/play has long since been established in the sociological sense of lifestyle preferences and has also been validated in terms of superior real estate investment returns.

Success has a way of spreading, and 24-hour downtowns have provided replicable models that many of the suburban communities are seeking to emulate.  From dense northeastern cities like Philadelphia, to Sun Belt giants like Atlanta, to boutique markets like Charleston, focus groups have uncovered the desire of suburbs to create their own versions of live/work/play.  There is a term of art being heard to capture this concept: HIPSTURBIA.

Many of these “cool “ suburbs are associated with metro areas having vibrant downtowns.  A Jacksonville, Florida respondent noted, “You can’t be a suburb of nowhere.”  One example of the term “hipsturbia” was from a focus group in Atlanta, explaining that “suburbs are taking a chance on mixed-use, walkable, millennials-attracting development.” Concentrating the talent pool of young workers is seen as a key to luring <or keeping> large employers in an era when downtowns are competing ever more effectively for businesses.  Around Atlanta, communities such as Decatur and Alpharetta are bidding for a spot on “cool suburbs” maps.

It may be a surprise to some that millennials and the suburbs may well be a key to investors’ increasing confidence in 18-hour cities.  By definition, “18-hour city” most often refers to a secondary real estate market that offers services, amenities and job opportunities comparable to those in the big six gateway markets but without operating on a 24-hour basis.  Emerging Trends has previously identified the success of 18-hour cities in developing urban amenities that have led to economic growth.  The market still appreciates the urban opportunities in these markets, but interest in suburban submarkets is being mentioned as a benefit as well.  In the Emerging Trends survey, respondents continued to express their confidence in the performance of these nongateway markets.  Eight of the top ten markets and 16 in the top 20 markets in this year’s rankings fall into these categories.

This year’s Emerging Trends identifies a growing commitment to the tenets of environmental, social, and governance <ESG> principles among corporations generally, and in the real estate field in particular.  Millennials drive ESG, according to a recent study, with 55 percent of them indicating that they factor ESG policies and performance into their investment decisions – a far greater percentage than for Generation X (25 percent) and Baby Boomers (11 percent).  This suggests that the power of ESG to influence capital deployment will be rising over time, qualifying it as an emerging trend.

As greater attention is devoted to ESG, in real estate as elsewhere, sustainability evaluation is becoming a checklist item for institutional investors.  A recent study found that 4,700 office buildings in the 30 largest U.S. markets have earned “green” certification, which is 41 percent of the total in these markets. ESG has become a “market standard” for investment benchmarking.  Moreover, it is top of mind for leading architects and designers and, this will be shaping new deal development for the foreseeable future.  Climate change, ethics issues both in business and political spheres, concerns for health and wellbeing, and many other issues fall under the aegis of ESG concerns.  Given real estate’s enormous environmental and social footprint, attention to trends in this area will assuredly grow in the decade ahead.

The Emerging Trends survey reviews 80 U. S. markets as to their overall real estate prospects.  A confluence of factors have elevated markets in the Southeast region, led by Raleigh/Durham, Nashville, Charlotte, Orlando, and Atlanta.  All except Atlanta were in the top 10 a year ago, when Atlanta ranked number 11.  Demography, both recent and anticipated metro-area growth is the driver by and large.  Respondents to the survey – both within the region and beyond – anticipate strong population inflows over time as the state and local taxes <SALT> provisions of the 2017 Tax Cuts and Jobs Act prompt outmigration from more costly states.  Florida is ranked at the top for tax advantages, according to a 2019 Tax Foundation Analysis, with Tennessee a strong number eight and North Carolina number 16.

Raleigh/Durham, ranked number two overall, has been seeing impressive investment in its suburban office and multifamily sectors.  This market’s concentration of educational institutions – Duke University, The University of North Carolina, North Carolina State University, and several smaller colleges – coupled with the Research Triangle Park, has branded the area as a technology mecca, and it now has more than 89,000 tech jobs, which, at 10.9 percent of the employment base, ranks third behind Silicon Valley and San Francisco in tech industry share, according to a recent “Tech Cities” report.

Nashville, considered a leading 18-hour city, moved up to number three overall in real estate prospects from fifth place a year ago.  The local mood is ebullient, with expectations strong for continued investment and development.  News on the corporate location front – Alliance Bernstein’s headquarters, an Amazon operations center, and the expansion of dental products firm Smile Direct Club – has bolstered confidence and generated real estate activity associated with more than 8,000 new jobs linked to these firms.

Charlotte also has moved up in the survey rankings, placing fourth overall <up from last year’s ninth place>.  It is no surprise that one real estate investment trust <REIT> executive interviewed listed Charlotte as one of five cities to be in “if you were starting a company with a clean slate.”  Charlotte is attracting technology and manufacturing firms, as it continues to diversify its economy beyond the banking sector that dominated over the past 20 years.  Charlotte has focused on infrastructure, with its airport expansion and light-rail growth emblematic of its commitment in this crucial field.

Atlanta was knocking on the door of the top 10 last year, and comfortably gained admittance in this year’s survey, placing eighth in overall prospects and 10th in local expectations of investor demand in 2020.  Like many cities, Atlanta promotes its “unique culture” and successful reinvention.  A once-neglected urban core is seeing a resurgence of intown living and suburbs are becoming known as “hipsturbia” as they aim to create walkable mixed-use developments.

Tampa/St. Petersburg <in 11th place> stepped down a notch from a year ago, although with a thin margin separating it from the top 10.  Tampa focus groups remain enthusiastic about the areas quality of life and talent pool.

Beyond the “Top 20 Markets for 2020” in the “Markets to Watch” survey, a new grouping of markets entitled “Treasures Ripe for Discovery?” was established this year where respondents to the survey had favorable comments, but which are not attracting investment flows consistent with their overall prospects.  Two such markets were Jacksonville, FL. And Greenville, S.C.

Jacksonville, in Northeastern Florida has had a population growth of 14.1 percent since 2010, bringing the metro area’s resident count up above 1.5 million.  Consequently, it is understandable that Jacksonville leaped from 48th place in overall prospects a year ago to 23rd in this year’s survey.  Yet its investment flows rank only 43rd since January 2016.  Focus groups in Jacksonville were bullish.  “This market offers the best of both worlds, with the suburbs allowing for quality of life with easy access to the “big city.”  Boosters see great potential in the central business district: “Downtown Jacksonville is a relatively clean canvas for development.”  And as to capital flows, local experts believe that “it is now Jacksonville’s time for investment and growth, with larger capital sources finally starting to look here.”

Greenville, South Carolina, finds itself rated number 44 in overall prospects, just about the same as a year ago.  This is somewhat surprising, given the very favorable national attention provided the city as it has revitalized its downtown with offices, condominiums, craft breweries, and restaurants.  Investors have not yet grabbed for the brass ring here, standing just 61st in total volume from early 2016 through June 2019.  This is low even considering the metro areas size.  Unquestionably, Greenville has seen growth this decade, with an MSA population increase of 10 percent, or 82,000 residents.  However, it is still well below the million-person population threshold that large real estate investors seem to consider “de minimus” for investment committee consideration.

As to the “office” sector, the war for talent is a key business driver.  Most developers and large enterprise users interviewed are using the workplace as a differentiator.  As coworking spaces have shown, common spaces, amenities, and community have become important components of a memorable workplace experience.

One large enterprise user explained that “community is part of our DNA,” so how can we create office workspace where people are encouraged to reengage with each other, a purpose-driven place where employees can collectively contribute an “be a part of something bigger” than working on their own?  Another described it as “geo-rationalization” – a drive to get people back to the office to increase physical presence to harness the power of people connections.

In the words of one corporate user, “We are competing with tech companies that are raising the bar in terms of amenities.  As our workforces age, the types of amenities that we provide are shifting.  It’s no longer about ping-pong tables, but different types of amenities to better suit an aging workforce that is at a different life stage.”

Last year’s survey had very little to say regarding medical office demand, however, this year a special section in the survey has been devoted to this sector.  Health care innovation is spurring medical office transformation while investment demand is bolstered by the demographic outlook.  Positive forces align to support medical office.  The aging population, an increased number of people with medical insurance, and cost-reduction strategies by insurance companies that favor outpatient care have converged to bolster medical office space demand.  In conjunction with a limited development pipeline, these factors point to continued momentum for purpose-built medical office space.

Over the last 10 years, medical office completions have averaged 13 million square feet per year, but in 2018 just 9.6 million square feet was completed.  This has sustained tight vacancy rates, with the U.S. average at 8.5 percent in the first quarter of 2019.  Compared with the 13.3 percent average vacancy rate of traditional office space, medical office continues to outperform.  The combination of positive demographic trends, increased outpatient services, and the rising number of medical school graduates – up 19 percent since 2009 – is expected to sustain growing medical office space demand in coming years.

According to CBRE Research’s 2019 Southeast U.S. Office Market Outlook report, every primary economic driver; tourism, technology, manufacturing and logistics; are all trending in a positive direction.  Strong demographic growth will help mitigate any downside.  Record rent growth and the relative affordability of the region suggests that more growth may be on the horizon.

For the past six years, industrial has been the top-ranked property sector in the “Emerging Trends” survey and it remains so for the year ahead.  Logistics real estate remains the consensus overweight among investors thanks to a compelling story of cyclical and structural factors that have united to deliver superior returns.

In late 2018, three forces combined to produce surging logistics real estate demand.  First, U.S. economic growth accelerated, driving a faster flow of goods.  Second, users of logistics real estate continued to expand distribution networks in order to satisfy rising service-level expectations.  Finally, volatile trade policies pulled import activity forward and boosted inventory levels.  As a result, 2018 net absorption reached its second-highest annual total of the last 10 years with 277 million square feet.  Following a frenzied pace of expansion in late 2018, demand returned to a normal, healthy pace of growth in early 2019.

Looking ahead, structural shifts in supply chains should continue to add tailwinds to demand.  Several large users of space have publicly declared billions’ worth of investment in their distribution networks as mission critical.  As this seismic shift continues to play out, users should incorporate new insights on operational risks and opportunities – including global supplier concentrations, labor availability and costs, and new technological advancements – into leasing decisions.

There also have been structural changes on the supply side, which are causing investors, owners, and users to reassess logistic real estate’s traditional reputation as being relatively easy to build.  Rising barriers to new supply broadly have kept aggregate supply behind or in line with demand.  These factors include the following: a lack of developable land, particularly plots that can accommodate today’s larger buildings; increased regulatory barriers to new supply; and a more institutionalized mix of developers and capital partners with an eye toward preserving net operating income (NOI). However, a long expansion, strong operating conditions, and an influx of capital combined to allow for an increase in construction activity in locations with lower barriers to development.

Today’s buyers see further potential for long-term gains, built on the structural trends that have driven recent outperformance.  Results from the Emerging Trends survey echo this sentiment: more than 80 percent of respondents would recommend Buy or Hold for both fulfillment and warehouse product.  The outlooks for both operating conditions and investment trends lean positive.  Sustained demand tailwinds should keep occupancy at an elevated level even as new supply comes online.  The spread between in-place and market rents is historically wide, which should drive NOI growth as leases roll and are marked to market.  Income growth should be the primary force behind future increases in values.  Finally, the institutionalization of logistics real estate as an asset class has reduced risk premiums in a long-term, structural manner, which should limit pressure on cap rates should interest rates rise.

The latest “Beige Book” report, issued by the Federal Reserve Board November 27, 2019, based on information collected on or before November 18, 2019, suggests that economic activity expanded modestly from October through mid-November, similar to the pace of growth seen in the prior reporting period

In Richmond’s Fifth District, the economy grew moderately since our previous Beige Book report. Commercial real estate brokers reported strong demand for industrial space and office leasing increased modestly in some markets.  Meanwhile, rental rates were reportedly stable to increasing modestly.  Commercial sales and construction increased modestly in some regions.

Aggregate business activity in Philadelphia’s Third District continued at a modest pace of growth for much of the current Beige Book period.  On balance, commercial real estate construction and leasing activity seemed to hold steady at relatively high levels.  Contacts reported continued strength in the industrial market, with ongoing demand for new construction.  Most contacts also noted a positive quarter for office space leasing, which may spur demand for new construction in the future.  Management firms noted positive net absorption, falling vacancy rates, and rising rents in many office and industrial segments.

In Atlanta’s Sixth District, which includes Nashville, TN, Tampa, and Jacksonville, FL, commercial real estate (CRE) leasing and sales activity generally remained positive and steady across most District markets and property sectors during the reporting period.
Overall, most CRE sectors experienced positive dynamics as rents continued to grow and vacancy trends remained stable or declined at a modest pace.  Industry contacts reported continued strength in the multifamily, industrial, hospitality and office sectors.  The pace of CRE project construction activity remained healthy.  Contacts reported that capital was readily available for most CRE projects via banks and non-bank entities and that lending competition appeared to be accelerating.

Updated 12/5/19