Commercial real estate investors are among the biggest winners in the U.S. economic expansion, which reaches a record 121 months this week in a recovery from the country’s worst financial crisis since the Great Depression. But the milestone comes as transformation slams traditional retailers, technology disrupts office demand and suburbs lose their post-war grip on corporate America.
The major commercial property sectors, office, industrial, retail and multifamily, reached all-time highs in rent growth since June 2009 when the U.S. economy began recovering from the recession. The number of apartments under construction is now at an all-time record of 543,000 units, handily beating the prior decade high of 257,000 units under construction in 2000, while industrial construction is at a record annual high of 272 million square feet, beating the 242 million square feet being built in 2000 and almost double the 141 million under construction in 1999.
In fact, some of the largest commercial projects in U.S. history have unfolded over the past decade, including most of the $30 billion rebuilding of the World Trade Center following the terrorist attacks of Sept. 11, 2001; the $20 billion Hudson Yards redevelopment in New York City, the $4.5 billion Transbay Transit Center and Salesforce Tower mixed-use development in San Francisco, and Apple Park, the tech company’s $3 billion “spaceship” headquarters in Cupertino, California.
The big price tags, though, belie the sometimes wrenching shifts that have occurred within the industry during this expansion. Thousands of stores have shut since the crisis as online shopping takes hold and shopping malls and big-box power centers fall out of favor. New single-family housing construction has slowed to a trickle as rental apartment development has boomed, much of it occurring in cities and dense metropolitan neighborhoods rather than leafy suburbs. Office tenants these days no longer covet isolated suburban campuses but instead look to be part of live-work-play environments.
And many businesses lease up fewer square feet than they once did in favor of open floor plans, or they are opting for hip shared spaces, and having more workers use technology to work offsite. Industrial property, never the most glamorous sector, is suddenly the apple of the eye of the world’s richest private equity funds and other institutional investors.
“This real estate run has been remarkable,” said Jeff Diener, a San Francisco-based partner with law firm DLA Piper who started his career during the dot-com bubble in 2000 and then encountered the Great Recession of 2007 to 2009. “One of the most interesting things about it is that the record growth has happened even though lenders and investors have shown far more discipline and patience with their capital than the last time around.”
The economy has been expanding since June 2009, and July marks the longest period of economic growth on record, according to statistics from the U.S. Commerce Department’s Bureau of Economic Analysis and the nonprofit National Bureau of Economic Research. It follows a recession that was largely fueled by the collapse of the national housing market and one of the worst in U.S. history.
U.S. gross domestic product has been growing since June 2009, and May 2019 marked the 104th consecutive month of job increases, already four and a half years longer than the previous longest streak, from 1986 to 1990, according to data prepared by capital markets provider and real estate brokerage HFF research analyst Laura Haltom.
To understand how commercial real estate fared during the past 10 years compared with prior periods, it helps to know how bad things got during the Great Recession.
For example, total U.S. office sales plummeted from an all-time high of $206.8 billion in 2007 to $64.9 billion in 2008 and a historic low of $24.8 billion in 2009. The national office vacancy rate jumped from 11.3% in 2008 to 12.8% the following year, according to CoStar data.
Ten years ago in June 2009, guarded optimism was beginning to replace gloom and doom about the economy among investors that prevailed after the financial crisis of 2007 and 2008. Since then, property sales have steadily rebounded, with total sales increasing about 54% between 2009 and the second quarter of 2019 to $3.4 trillion from the $2.2 trillion in sales during the prior 10 years, according to preliminary data from markets CoStar has tracked since 1998. Record amounts of private-equity and institutional capital from around the world have fueled the long climb in sales.
Today, shopping center, apartment and industrial vacancy rates are the lowest in two decades, according to CoStar data.
Office-using employment has reached an all-time high. While office rent growth decreased to 2.4% in the first quarter, the lowest since the start of the expansion, rents have been very consistent, unlike the volatile boom-and-bust cycles of 2000 and 2007, according to CoStar managing director and senior economist Robb Calhoun.
Property prices, already an average 27% above their prior peaks, are projected for at least a couple more quarters of growth as record amounts of private equity and institutional investment capital drive U.S deal volume, said Richard Hill, a Morgan Stanley equity analyst.
The cumulative 45% increase in commercial property prices over the past 10 years, driven by robust income growth for owners and 10-year Treasury rates that remain near historical lows, is actually not significantly higher than the average 35% price increase for all 10-year periods dating back to 1984, according to Hill’s analysis.
Only four 10-year periods over the past 35 years have logged net declines in average prices, all of which occurred after major commercial real estate price declines in the late 1980s and an ensuing national recession in the early 1990s.
“That’s remarkable,” Hill said. “It’s been a bull market in commercial real estate for nearly 30 years.”
Real estate executives and investors remain very optimistic about the market and the overall U.S. economy even as the expansion gets long in the tooth, according to law firm Akerman LLP’s latest annual survey of investor sentiments. A record 70% of those surveyed said they’re more bullish about the market in 2019 than the previous year, with nearly half saying the continued improvement of the U.S. economy is the primary reason for their confidence.
Shifts in Demand
While sales have already reached their highs for the current cycle in many cities, investors continue to shell out massive amounts of capital for all types of properties, he said.
“Just when you think it’s reached a plateau in San Francisco, another huge trade happens and knocks your socks off. People are still buying,” Diener said.
The overall past decade has ranged from remarkable to mediocre for owners compared with past periods, depending on the type of property.
“There have been unprecedented things happening in industrial real estate and to a lesser degree, apartments during this cycle,” said Paul Leonard, managing consultant with CoStar Portfolio Strategy.
Industrial property has had the highest rents and year-over-year rent growth, the most construction and the largest sales volume on record over the past 10 years, powered by e-commerce demand and shifting supply chains to accommodate online shopping and next-day delivery, Leonard said.
So while demand surges for warehouses on the edge of population centers, where online sales are put into vehicles for last-mile delivery to door steps, large brick-and-mortar stores such as Sears and Kmart have fallen out of favor, hurting other stores that share their malls and shopping centers.
And the surge in urban office demand as companies move their major headquarters downtown, a trend that in Chicago alone spans from United Airlines to fast-food chain McDonald’s, means suburban planners are scrambling to fill abandoned campus properties, a move that can be seen in northern New Jersey real estate.
As a result, as the expansion moves into its second decade, analysts are focusing on how shared office space will hold up in the next economic slowdown, and whether business tenants will simply use the short-term leases to move to cheaper quarters and, ironically, back toward the suburbs abandoned during the boom times.