No one truly knows what the future will hold, but it doesn't stop us from trying. Experts have stated their opinions of where the commercial real estate (CRE) market will go next year. Here are my five CRE predictions for 2020.
1. Interest rates will remain low, possibly dropping lower
The Federal Reserve took drastic measures in 2019 to keep our country out of a recession, including lowering the federal interest rate three times and pumping billions into the repo market to keep it from collapsing overnight. The repo market is where short term bonds are traded to help Wall Street leverage cash. Additionally, economists expect consumer spending to decrease and GDP growth to decline in the coming year.
The Federal Reserve's actions in 2019 are a clear indicator they will go to great lengths to keep our country out of a full-blown recession. It's likely interest rates will remain low, with the possibility of dropping even lower, making it a prime time to finance or refinance commercial properties.
2. Downward pressure on cap rates
The goal of lowering interest rates is to stimulate economic activity. The lower the cost of financing, the more likely people will borrow. This holds true for commercial financing. As the cost to finance CRE becomes cheaper, more people refinance or purchase new commercial real estate, driving prices up, while lowering the yield or return on investment.
Certain sectors of CRE that are oversupplied like self-storage, Class A multifamily, and senior housing are expected to see an increase in cap rates, which means an increase in yield and lower value.
While other sectors like Class B and C multifamily and office space will likely see downward pressure on cap rates which means an increase in price and lower return largely due from high demand and investor's continued search for yield.
3. Industrial will continue to be the leading CRE sector
As of third-quarter 2019, the industrial sector has outperformed all other CRE sectors by over double at a 13.64% annual total return. The CBRE Group predicts rents will increase 5% in industrial CRE in 2020 even though supply is expected to outpace demand. I believe it will continue to be the top-performing sector in commercial real estate. While the trade war with China could impact this sector, it's likely we will continue to see a strong performance in emerging and secondary sectors.
4. Increased lending means mortgage REITs will do well
According to the Mortgage Bankers Association, low-interest rates are driving record loan originations that are expected to hit all-time highs for multifamily lending in 2020. Debt real estate investment trusts (mREITs) will fare particularly well as lending increases. However, if the U.S. economy does experience a recession in the near future, it's likely mortgage REITs would be hit hard.
5. Alternative investment sectors will grow
The alternative investment sector of CRE like data centers, self-storage facilities, and medical facilities, has doubled since 2007, making up roughly 12% of all CRE. While I agree this sector will continue to grow, I also see adaptive reuse, a new alternative CRE investment, growing more popular next year.
Adaptive reuse is the process of repurposing a building that has outlived its original use. New projects are being developed across the country converting old schools, mills, factories, libraries and more into flex space or residential housing. I believe this could be the start of a new trend and hold opportunities for investors to take the leap into this new sector, especially when combined with special programs like Opportunity Zones or the Low Income Housing Tax Credit.
2020 CRE outlook
We are experiencing the longest period of expansion in the history of the United States, putting us in uncharted territory. The current trade war and the impending election will both play a big role in our economy.
Industry experts are expecting 2020 to be another prosperous year for commercial real estate with continued growth at a slightly slower pace. My personal outlook is far less optimistic and I would not be surprised if 2020 brought a recession. But the truth is we don't know what CRE or the economy as a whole will bring in the coming year. Only time will tell if these predictions will play out as anticipated or be completely off the mark.
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