Top 10 CRE Investment Predictions for 2020

At this moment, 2020 looks well positioned for further growth for commercial real estate, albeit perhaps not as much as the pace seen in the last few years. Following are 10 investment predictions for the year that will help shape this year’s growth.

1. Rent Control Will Spread in the US

New rent control laws were enacted in Oregon, California and New York in 2019 and will spread to other states in 2020 and beyond. Look for IL, NJ, MD, VA, MA, MN and other states to adopt new and disastrous rent control laws in the next few years. As discussed in a prior column, the US apartment market will evolve into two tiers. The A tier will be states without rent control and pro-real estate policies and the B tier will be the states with rent control and anti-real estate policies. Cap rates will rise 1.0%-1.5% in the tier B states due to the negative effects of rent control.

2. Interest Rates Will Increase

Due to the booming economy, low unemployment and higher inflation expectations, long term interest rates will rise. The 10-Year T-Note which is currently 1.84% will increase to 2.75%-3.0% in 2020.

3. REIT Returns Will Soften

REIT returns for 2019 as measured by the FTSE-NAREIT All Equity Index will be up over 26% and one of the highest returns since 2014. This is up from annual returns of -4.04% and 8.67% in 2018 and 2017, respectively. We expect 2020 returns to moderate with a total return of 10% consisting of a 3.5% dividend and 6.5% price appreciation. Although returns will decline, all individual investors should allocate 10%-20% of their 401K or total portfolio in a diversified equity REIT fund.

4. CRE Investment Returns Will Decelerate

The high and robust returns in CRE the last several years will begin to decline as many properties are overpriced, especially core assets, which are trading at sub 4.0% cap rates. Many properties have seen rents double or triple since the Great Recession and some of these high rents are not sustainable. The retail sector in Manhattan is one example of ultra-high rents that are coming back to reality, with rents on the storied Fifth Ave. and Park Ave. sections, down by over 20% during the past year.

5. Consolidation Among Data Analytic/Software Firms Will Accelerate

The CRE data analytics and software sectors will see more consolidation as the larger and well-capitalized firms gobble up their smaller and weaker competitors. The larger firms see acquisitions as a quicker way to scale their business and cross-sell their suite of products. In the data analytics space, look for two public firms to be the industry leaders and acquirers, CoStar Group and Real Page. In the property management software space, look for Yardi, MRI, Skyline and Real Page to be the key players. So far this year, over $1 billion in deals have been completed with CoStar’s acquisition of Smith Travel Research, the largest hotel data/consulting firm, for $450 million and Real Page’s acquisition of Buildium, a property management software firm, for $580 million.

6. Cap Rates for Apartments in CA Will Increase

Cap rates for apartments in CA will increase .5% to 1.0% due to the new rent control laws and higher interest rates. Many long-term apartment owners in the state will be net sellers in 2020 and the ensuing years to realize profits before cap rates begin to rise.

7. The Shadow Lending Market Will Take More Market Share from Regulated Lenders

The shadow lending market in the U.S. is comprised of CRE lenders that are unregulated and include; REITs, private loan funds, hard money lenders, mortgage bankers and CMBS originators. The shadow lending market which typically provides short term, bridge, permanent, mezzanine and high yield construction loans will increase its market share from approximately 15% of total loans to 20% of total CRE loans. The total volume of new loans originated in 2018 was a record $574 billion with the shadow lending market accounting for approximately $75 of the total. See also, the section below on the collateralized loan obligation market.

8. 2020 Will be Another Record Year for New CRE Transaction and Loan Activity

In 2018, $574 billion in new loans were originated and overall transaction volume was $811 billion, both records. We predict that the 2020 amounts for both loans and transactions will rise by about 5% to new records. This is very good for the real estate brokerage industry as exemplified by the stock prices of the two largest brokers, CBRE and Jones Lang LaSalle, which are at or near record highs.

9. National Cap Rates Will Rise

Due to the booming economy and higher inflation and interest rates, average cap rates will rise across the U.S. We expect the increase in cap rates to be 1.0%-1.5% depending on the property type and location. This will be good news for buyers and the $200+ billion is capital that is sitting in private equity funds looking for new deals.

10. The Retail Apocalypse Will Begin to Subside

The retail apocalypse of store closures and bankruptcies will begin to moderate. There were major retail bankruptcies in 2019 including; Sears, Payless Shoes, Barneys, Forever 21, Shopko, Gymboree and many more. According to Coresight Research, store closings in 2019 will hit approximately 10,000, while store openings will be about 4,000. Most analysts and research firms expect 2020 store closures to dip to around 5,000 and store openings to be about 4,500.

Joseph J. Ori is executive managing director of Paramount Capital Corp.