The new year will bring decelerating development and leasing.
Development and leasing activity have slowed in most core and secondary U.S. real estate markets thanks to stock market volatility, rising interest rates, the waning effects of tax cuts, rising wages, a labor supply shortage, cooling job growth, softening housing markets, an inverted yield curve, and fatigue after a nearly record-setting period of economic expansion. For 2019, expect further deceleration as the year unfolds.
Key business indexes have declined in Europe, which is responsible for nearly a quarter of global gross domestic product, while China's economy continues to slow.
Seeking New Locations
The ongoing migration of people and businesses merits monitoring. Despite the good news of Amazon and Apple expansions with jobs promised in Northern Virginia; Nashville, Tenn.; and Austin, Texas, the positive effects on office and retail leasing will be highly localized, with just a handful of communities benefiting.
The recent announcement of McKesson Corp.'s move of its headquarters from San Francisco to Dallas, where it already has a campus, could be the tip of the iceberg. New tax laws take effect in April, and many residents of high-cost states such as New York, Connecticut, and California may consider relocating to lower-cost areas. Potential destinations include, in particular, non-personal income tax states like Texas, Tennessee, and Florida. In announcing its move, McKesson Corp. cited reasonably affordable housing, good school systems, and a business-friendly environment. Because the country is essentially at full employment with unemployment at its lowest in 17 years, companies may move for employee retention. It's easier to fill jobs when the area offers attractive community amenities.
In the property sectors, industrial, manufactured housing, and seniors housing still are going strong. Most of the primary industrial markets in the U.S. have sub-5 percent vacancy rates, and they are below 2 percent in Los Angeles-Long Beach; Chicago; Houston; Dallas-Fort Worth; Riverside-San Bernardino-Ontario, Calif.; Atlanta; New Jersey; and all the port cities. Low vacancy rates largely are driven by consumer spending and e-commerce, particularly the Amazon effect. The first mile-last mile battle that started in earnest two years ago is approaching its midway point, and it will continue to drive industrial markets until a recession slows it down. Retailers reported that e-commerce sales, which do not include food and gas, jumped 26.4 percent around the 2018 Thanksgiving holiday compared to the previous year, according to Adobe Analytics.
Multifamily faces challenges due to rising construction costs in both labor and materials. One developer recently said that construction costs are rising roughly 1 percent a month, or 12 percent a year.
Office markets mostly are flat, with exceptions in cities like Houston, New York, and San Francisco. Companies that are adding office jobs continue to shrink office space allocations on a per-person basis. Work benches, open cubes, and creative/collaborative space dominate interior designs and tenant improvements.
Retail development is practically nonexistent and, by some estimates, more than 20 percent overbuilt. Apparel stores are in retreat, while malls are struggling to stay open and find the right tenant mix. In recent years, more than 300 U.S. malls have closed, with more likely to follow. Retail rents largely are down, with the change mostly attributed to America's changing shopping habits.
Notable exceptions in retail that are outperforming other categories are neighborhood, food-anchored shopping centers, and off-price stores, such as T.J. Maxx, Ross Dress for Less, and home furnishing and improvement stores.
The self-storage real estate sector rebounded in 2013 and started breaking record valuations in 2015 and 2016. Select markets and cities now are showing signs of overbuilding. The national average of new supply as a percentage of existing supply was 8.7 percent in July 2018, according to MJ Partners Real Estate Services, yet it was 28 percent in Nashville and 23 percent in Portland, Ore., for example.
Sell Now, Rent Later
The landscape is not entirely bleak. As NAI Global reported last summer, thriving secondary and tertiary markets like Salt Lake City, Utah; Orlando, Fla.; Central Wisconsin; and even Ocala, Fla., are “getting calls from national companies for office space requirements that we have not seen in years.”
That said, most economists expect job growth to slow in 2019 and 2020. As development and leasing activity continues to slow, property owners should make any reasonable deal now and not hold out for top dollar, because it will likely be worse in six, 12, or 18 months. Conversely, tenants (except most industrial tenants), should wait to sign or renew a lease if possible; rates are likely to come down.