If you've followed real estate over the past year, you've likely experienced some good and some bad. We saw interest rates fall, housing prices (continue to) rise, and legacy big-box retailers continue to close stores and create vacancies in America's malls, even as other commercial real estate was booming. Housing continued to be rewarding for investors, even as many Americans increasingly struggle to find affordable housing.
But what will 2020 bring? More of the same, or will we see some of the trends begin to shift? We asked some of our contributors with expertise across real estate to weigh in with their expectations, and they gave us their predictions across commercial and residential real estate, interest rates, and even what governments and private sector companies could do this year to impact the affordability crisis.
Keep reading for a glimpse of what to expect in real estate in 2020.
Retail closures will continue to be a problem for landlords
Daniel B. Kline: Over 9,000 retail stores are expected to have closed by the end of 2019. That follows 5,524 that shut their doors in 2018 and 8,139 that closed in 2017. Those closures have been offset by a strong number of openings -- especially by digital retailers adding brick-and-mortar stores -- but it's not an equal trade.
Big box stores and larger mall retailers including Sears, J.C. Penney, and Payless have either closed a lot of stores or, in the shoe-seller's case, gone out of business entirely. Those chains operate large stores that, in the case of the first two, anchor malls and shopping plazas and in the case of Payless take up big chunks of real estate inside the mall.
Most companies adding mall locations need 2,000 to 3,000 square feet. That means you need a lot of new tenants to fill a shuttered Sears or any space once occupied by department stores. This situation has forced mall owners to be more clever and diversify what it means to be a mall.
That trend will continue in 2020 and beyond. Yes, top-tier malls will add physical locations for digital brands. They will also add non-retail alternatives. That could mean gyms, entertainment venues, expanded restaurant areas, co-working spaces, hotels, and more. This is likely a good thing for mall and shopping plaza owners in the long-term -- diversity will protect them from closing retail stores -- but in the short-term, there will be pain as landlords struggle to find tenants and deliver the right mix for consumers.
Rent control will spread more widely, eating into investor interest in higher-cost markets
Aly J. Yale: This year was a big one for rent control. It all started with Oregon's statewide rent control bill, which passed in February, capping rent hikes at 7% annually. New York and California followed suit later in the year with similar bills (7.5% in NY and 5% in Cali).
The reform caused multifamily investments to dip in many of these states' major markets. In New York City, for example, multifamily investing has fallen 9.2% over the year, while Los Angeles saw a 9.8% drop.
Experts largely expect other high-cost housing states to follow suit. In fact, according to commercial real estate firm CBRE, both Illinois and Washington state are on its "watch list" for rent control legislation in 2020. Throw in that many of the 2020 Democratic candidates are talking about the subject on their campaign trails (some even on the national level), and it's clear that next year will be one of rent reform in some shape.
The trend naturally has investors worried. A recent survey from the National Multifamily Housing Council shows that 58% of multifamily investors say their jurisdiction has already imposed rent control or is "seriously" considering doing so. As a result, 34% of those investors have already cut down on their investments and nearly half are considering it in the near future.
According to Jim Lapides, VP of strategic communication at NMHC, "Rent control would freeze investment nationwide and eliminate property owners' ability to recoup costs and reinvest in maintenance and upgrades." He also says it would hurt renters, explaining, "Such policies would further stretch the imbalance between supply and demand and cause the housing we already have to fall into disrepair."
Mortgage rates will fall to record lows
Matt Frankel, CFP: This is admittedly a bold prediction. The average interest rate for a 30-year fixed-rate mortgage is 3.99% as of December 10, and the all-time low (reached in 2012) is approximately 3.3%. Plus, the latest projections from the Federal Reserve show no further cuts in the federal funds rate in 2020, and the U.S. economy is generally strong by most metrics -- unemployment, wage growth, and GDP growth are looking good.
However, I feel like the economy will be weaker than most experts expect in 2020. Although we keep hearing about progress toward a trade deal, the reality is that the trade war is dragging on much longer than anticipated. In addition, global economic growth is projected to reach its lowest level since the Great Recession, and if a Democratic candidate wins the presidency, it could be a negative economic catalyst, at least in the short term.
So, I think there's a good chance the Fed will end up cutting interest rates at least a couple of times in 2020. Plus, I think that the weaker economy will cause consumer interest rates to generally drift lower as well. While I don't think we'll see interest rates quite as low as we're seeing in Europe (Denmark actually has negative mortgage rates in some cases), I wouldn't be surprised to see mortgage rates fall to a new all-time low in 2020.
Homebuilders will keep focusing on starter homes
Jason Hall: Coming out of the Great Recession, homebuilders didn't spend much time -- or capital -- building starter homes. And for good reason. Young people were buying homes at record-low levels, and the only money to be made was building custom homes aimed at well-to-do buyers in the upper and upper-middle classes.
Fast-forward to now, and young people are buying houses again. Or that is to say, many want to; there's just not enough inventory to meet so many years of pent-up demand. That's been a boon for homebuilders specializing in entry-level properties like LGI Homes (NASDAQ:LGIH) and Meritage Homes (NYSE:MTH). So far in 2019, LGI Homes has sold 18% more homes than in 2018, while Meritage's closings are up 7% and orders are up 17% through the third quarter.
I see little reason to expect that to change in 2020. The economy continues to perform reasonably well, and unemployment has stayed near record lows as companies continue to need highly skilled and highly educated workers. It just so happens that Millennials meet these qualifications and are also now getting married, starting families, and looking to take part in the American dream of homeownership.
With interest rates near record lows, and a solid economy, I expect LGI and Meritage, along with most of the other large builders, to continue investing much of their capital into starter home communities in 2020.
Venture capital will fund new real estate models in 2020
Deidre Woollard: In 2019, billions of dollars from venture capital was invested in a variety of new business models in both commercial and residential real estate from data visualization services to the iBuyer platforms. This has also been a year of some concerns about overinvestment, specifically around SoftBank's support of proptech unicorns such as WeWork and Katerra. In 2020, venture capitalists may start to be more cautious about their investments in real estate but the continued robustness of the market will still fuel new bets on proptech.
Proptech money will follow big data start-ups that use artificial intelligence to automate various components of the real estate experience, from AI leasing assistants to mobile buying platforms. Virtual and self-guided tours will become more of a part of both the leasing and buying experience, and start-ups that develop these technologies will receive additional attention.
Look for start-up iBuyers such as Knock, Offerpad, and Opendoor to seek additional funding rounds to fuel their entry into new markets (all three raised millions in 2019). The increasing adoption of iBuyers in the residential space may also lead to the development of faster and more automated leasing and buying platforms on the commercial side.
One more prediction: Although there's a lot of speculation around an initial public offering for Freddie Mac and Fannie Mae, I suspect it won't happen in 2020 and the mortgage giants will remain under government control a while longer.
The private sector will bring new solutions to the affordable housing crisis
Liz Brumer-Smith: The current affordable housing crisis is not breaking news. The need for low-cost housing is at an all-time high -- and not just for the lowest income earners but for median income, blue-collar wage earners, too. According to the National Low Income Housing Coalition (NLIHC), the United States needs more than 7 million affordable homes to meet the current housing demand.
Traditionally this problem was left for government entities and not-for-profit companies to solve, but with new local and federal tax incentives and looming rent control laws spreading to more high-rent metro areas, the private sector is finding a way to become part of the solution without compromising profits.
According to the Economic Innovation Group (EIG), "as of October 2, 2019, 115 listed funds have identified affordable and workforce housing, as well as community revitalization, among their investment priorities—a nearly four-fold increase since the beginning of 2019." Most of these developments are focused on providing affordable housing for wage earners who make around 40% to 70% of the area median income.
As construction and development for investment projects in Opportunity Zones (OZ) begin, I expect more private firms to follow suit. We are already seeing a growing number of private companies outside of OZ investment areas focus their efforts on constructing new housing projects, converting existing housing into affordable housing, or creative new adaptive reuse projects, where they convert old, vacant buildings like factories, schools, and office space into residential housing.
As long as incentives for investors like the low-income housing tax credit (LIHTC) are around in 2020, private investment participation in affordable housing will likely increase.
Investor appetite for Opportunity Zones is going to weaken after a 2019 rush
Tyler Crowe: Investors and developers will sniff out every possible way to get a tax break, and those tax breaks can cause a rush in spending if they have a time stamp tied to them. December 31, 2019, is a critical date for the tax breaks related to Opportunity Zone (OZ) investments, and that element of the program going away will likely mean less investor appetite in early 2020.
There are two key elements to the tax benefits related to opportunity zones:
- Capital gains invested in opportunity zones get a step-up in basis.
- The gains made on the OZ itself are tax-free if held for over 10 years.
The one that has caused a rush of investment in opportunity zones lately is the capital gains step-up in basis. If you made an investment of $100 that went to $200, you would get taxed on that $100 gain. The cost basis step-up for OZs means that if you take that $200 and invest it in an OZ, the cost basis "steps up" to $110, and you're only taxed on a $90 gain. To be eligible, you have to hold that OZ for five years before the end of the program on December 31, 2026.
However, if you are able to invest in an opportunity zone before December 31, 2019, you are eligible for a 15% cost basis step-up because your holding period until the end of the program is greater than seven years.
With that five percentage point increase in your cost basis set to expire, there has been a mad dash for investors to get into OZ funds lately. With so much capital deployed to get that extra tax break, it wouldn't be surprising if investor appetite for OZ investments is significantly lower in the coming months.
That may sound like a bad thing, but it could also mean that valuations for opportunity zone investments will drop significantly. So even if you only get a smaller cost basis step-up, there could be more lucrative investment opportunities that will generate better returns over the life of the investment.
Clashes over multifamily housing developments will increase and get more heated. Can social responsibility prevail?
Lena Katz: Developers are typically cast in the villain role when they appear in a neighborhood with plans to tear down single-family homes and historic abandoned buildings for new construction high-rises. But thanks to the aforementioned affordable housing crisis, it's not so clear who's on the right side ethically anymore.
This year, the Governor of California stepped in to override single-family zoning, and the supposedly progressive homeowners in LA and the Bay Area's wealthy communities rallied to resist transit-oriented community (TOC) development, higher-density development, or anything else that could provide a solution to low- and mid-income demographics.
It's pretty clear that change must come but hard to say who the heroes are in this story that's unfolding in localities across the nation. For example, in Los Angeles, where TOC incentives have inspired a flurry of new development, you see a mix of true innovators looking to create solutions, longtime multifamily investors and developers testing small projects that are in the spirit of the program, and luxury condo developers allocating the bare minimum of extremely low-income units to qualify for the incentives.
Some cities are pulling together in hopes of a more socially equitable future, though. Just look at the boom in Newark, where Mayor Ras Baraka's 2017 ordinance "Inclusionary Zoning for Affordable Housing" has protected its vulnerable communities while still keeping the welcome mat out for tech communities, multifamily developers, and a $2.7 billion airport renovation.
So, my prediction is that we'll see many more bitter fights between NIMBY factions and their own elected representatives -- as well as justified outrage in gentrifying areas from low-income community members who are being displaced.
But my other prediction -- which is also a hope -- agrees with Liz's. Smart investors will turn away from luxury multifamily and identify the opportunity in socially responsible development. Whether that means working with community members in Opportunity Zones to figure out adaptive reuse projects to benefit whole neighborhoods or finding a path to bring workforce housing into affluent areas, savvy investors at any level should realize that a community can't thrive sustainably unless its workforce has adequate shelter within their means.
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