Largely upbeat about 2017, real estate executives face new uncertainties
Late January brought into the executive branch of the United States a pro-business, pro-growth, tax-averse real estate developer. And yet discerning what comes next has been difficult. The first 100 days of the Trump administration have presented a cautionary picture of the business world, which tends to crave, among all things, a predictable hand at the tiller.
President Trump is looking to implement a number of business-friendly, fiscally expansionist campaign promises—changing the tax code, unwinding the lending regulations in Dodd-Frank, privatizing part of the nation’s infrastructure, and repatriating some of the $2.6 trillion in cash now held overseas by corporations.1 Moves like this should benefit the real estate sector, according to Akerman’s Richard Bezold. “Tax policy, for instance, can drive real estate activity,” says Bezold. However, Bezold, along with many other sector observers, see the likely changes to come as less revolutionary and more in line with traditional Republican fiscal priorities.
Amid the clamor, the signal for changes to fiscal policy has begun to emerge. Trump’s announcement that he intends to unwind Dodd-Frank regulations, for example, comes as welcome news to commercial banks, for instance, which have faced risk-retention restrictions under Dodd-Frank and have ranked, according to one survey, dead last in terms of “debt capital availability” compared with all other commercial real estate lending institutions.2 But this will likely change soon. Deregulation will also improve the situation for construction loans, which have had to meet 150 percent risk-weighted capital requirements under Dodd-Frank, and the CMBS market, after hitting the “wall of maturities,” is likely to revive as well.3 But according to Akerman’s Jane Hinton, the residential market was probably the sector most affected by Dodd-Frank regulations, which turned lending business away from smaller localized and private lenders and drove the residential mortgage game to government lending programs. “Any relaxation of the Dodd-Frank rules,” says Hinton, “is likely to open up that pipeline again, resulting in a pickup in consumer lending and allowing the smaller middle-American markets to feel the effect.”
A welcome increase in debt availability is one thing, of course, but nowhere is the real estate sector more expectant than in the realm of likely changes to the federal tax code. Indeed, the sector has kept a laser-like focus on President Trump’s proposal to slash corporate taxes from their present level, 35 percent, to a 15 percent tax rate. In effect, the 15 percent proposal would be 5 percent less than the current capital gains rate enjoyed by the real estate sector. Additionally, President Trump’s tax plan would allow companies to immediately write off capital investment expenses—as opposed to writing off those expenses over time. This onetime immediate investment write-off, if enacted into law, could combine like a powerful one-two punch for real estate companies to knock taxes down even further. That’s because the existing tax code already allows companies a deduction for the interest paid on investment debt. In effect, President Trump’s proposed immediate deduction for investment, when combined with the current code’s deduction for interest on that debt, will allow real estate companies to significantly screen themselves from tax liabilities on earned income.4 Then there’s President Trump’s plan to repatriate some of the $2.6 trillion in corporate cash held overseas as well as his stated goal to invest $1 trillion in a 10-year plan to improve the nation’s infrastructure. And while much of this may look like the real estate equivalent of The Big Rock Candy Mountain, many observers maintain that such proposals will be slow in coming and could be complicated to put into effect.5
“Any relaxation of the Dodd-Frank rules likely results in a pickup in consumer lending.”
The general contours for the sector, nevertheless, are good. “We’re all thinking it’s probably going to be favorable for real estate,” says Bezold about business in 2017 under a Trump administration. “The business community is waiting to see what changes will come.” But forecasting what a new president will do for the economy is not going to be easy, Bezold admits. “We’re all trying to predict the unpredictable.”
The annual 2017 Akerman U.S. Real Estate Sector Survey of 200 real estate executives, conducted before and after the 2016 presidential election, reflects a mixture of hopefulness and anxiety for real estate prospects in 2017. It’s a complex response that combines the major-chord appeal of robust prospects ahead—a full-on, bullish signal echoed by other sector surveys—with minor-chord variations that color the landscape and convey, against a backdrop of excited expectations, the cautionary notes of uncertainty. A large majority (64 percent) of respondents interviewed after the election, for example, say that a Trump administration will likely have a moderately positive or significantly positive impact on the real estate sector—with over a quarter (27 percent) saying that a Trump presidency would be significantly positive for real estate in 2017. Executives were bullish for Trump even before the election, with a majority (51 percent) saying President Trump would be moderately or significantly good for the real estate sector.
But minor chords emerged as well. When respondents were asked before the election to rank the most significant factors affecting real estate, three uncertainties topped the list this year:
These factors, far and away, outranked other concerns, including “rising purchase prices or reduction in cap rates” (12 percent), “availability of institutional credit” (9 percent), “decreased foreign investment in the U.S.” (4 percent), “need for new infrastructure” (4 percent), and the “availability of equity and mezzanine financing” (3 percent). Indeed, it might be said that prior to the election, 67 percent of respondents to the annual Akerman Survey were significantly concerned, at its broadest circumference, about uncertainties generated by the intersection of federal government–level policy making (or the lack thereof) and the effect of these actions/inactions upon the economy.
By mid-December, of course, Chair of the Federal Reserve Janet Yellen had gone a long way in dispelling uncertainty about interest rates. We know now that they will rise—and by how much: by .25 percent at least three times in 2017, to 1.4 percent. And we also know from the minutes of the Fed’s December meeting that any expansionist policy measures from the Trump administration—tax cuts or spending increases in infrastructure, for instance, which would likely heat up the economy—will prompt the Fed to accelerate the pace of those interest rate hikes. It seems the Fed, like everyone else, is in a wait-and-see mode. These quickly enacted changes confirm that issues of interest uncertainty were hot button issues that required immediate attention.
As for the issue of federal gridlock—with a Republican president and a Republican-controlled Congress, federal gridlock may no longer be the problem it once was. Or perhaps it might be said—as ever with a change in administrations—that the outgoing problems of one administration will be exchanged for new, incoming uncertainties.
We cannot predict whether the new administration’s expansionist fiscal policy will lift the GDP to 4 percent and bring back American manufacturing jobs. For one thing, rising interest rates will have their intended effect and, along with a stronger dollar, will restrain economic growth. Tax cuts, moreover, may help lift the economy but may have only a small impact for average Americans and may not create more jobs—a key factor for real estate.6 “Tax cuts are unlikely to boost labor participation rates,” observed one U.S. economist at Barclays. And some observers suggest that protectionist trade policies could end up hurting many American industries and workers.
“It may be worth asking, with clear eyes, how the U.S. economy has fared under Republican administrations in the past.”
History may inform what might happen under a Trump administration. With its emphasis on tax cuts and on reforming entitlement programs, for instance, the incoming administration looks to be very much in line with standard-issue Republican fiscal policy. So it may be worth asking, with clear eyes, how the U.S. economy has fared under Republican administrations in the past. Correlation is not causation of course, but historically, according to a study published last year by Princeton University, recessions—an economic feature seldom far from the minds of those in the real estate business—have happened four times as frequently under Republican presidents than under Democratic presidents.7
Figures like this provide a sobering context for the ongoing, open question in real estate circles about the liklihood of an economic reset or a recession. Most observers say that a reset is coming, and it may happen in 2017— but when and where is another matter. “It’s probably not just a matter of one large, overarching cycle coming to an end,” says Bezold, “but rather, for the real estate sector, it will be a number of different cycles— corresponding to different real estate sectors—each making its separate market correction.” Facing such questions squarely will help investors and all others in the sector make the best decisions in 2017.
With that in mind, the Akerman Survey addressed which sectors would likely be the most active for real estate transactions this year, and topping the list might be a surprise: Residential—singlefamily homebuilding, received 43 percent of the Akerman Survey respondents’ “most active sector” votes, followed, less surprisingly, by multifamily housing (including senior living, condo, luxury condo, and apartment development), which 37 percent say will be the “most active” sector. Industrial (6 percent) and hospitality (5 percent) ranked a surprising—and distant—third and fourth, respectively, for sectors that will be most active this year.
At first, the high vote of confidence for the residential sector may seem out of place. Nationally, residential homeownership this year reached a 50-year low.8 So why the bullishness for the single-family residential sector? Market observers say it’s because people are still choosing to live in single-family homes—but instead of buying those homes, they’re renting. “Remember,” says Akerman’s Steven Polivy, “this is about real estate transactions—and so the numbers also reflect the activity of investors in the single-family residential rental marketplace.”
“The fundamentals for the hospitality sector remain solid, but they can vary greatly from region to region.”
And that market for single-family rentals is expected to grow nationally. Institutional investors bought more rental home properties in 2016 than in 2015, for instance, with 2.9 percent of all the single-family homes bought in the U.S. in the first half of 2016, up 11.5 percent from 2.6 percent last year.9 This, combined with other data showing that there are 18 million non-owner occupied single-family homes nationally—or one in every four homes—suggests a sustained single-family rental market. Indeed, institutional investor share of single-family homes increased in 68 percent of markets tracked.10 In Florida, the fundamentals for single-family home rental investors are strong across the state. Annual gross rental yields in Brevard, Clay, Citrus, Polk, Hernando, and Lake Counties, for example, exceed or are near 10 percent. In Polk County alone, which includes Lakeland and Winter Haven, more than 32 percent of the single-family homes are investor owned, jumping 62 percent from January to July 2016.11
Other surprises from the Akerman Survey include a low estimate from respondents regarding the level of transactional activity expected in the industrial sector, with only 6 percent saying this sector will be the “most active,” and the hospitality sector, at 5 percent. “We are seeing a range of activity in the hospitality sector,” says Bezold. “In some local markets, for instance, the level of transactional activity is much higher than the market as a whole.”
Indeed, the fundamentals, nationally, for the hospitality sector remain solid, but they can vary greatly from region to region. One key indicator for hotels, the revenue per available room, or the RevPAR growth rate, has slowed down after six years of growth, falling by 52 percent nationally to 3.2 percent compared with a year ago (6.7 percent).12 That number is projected by analysts to rise in 2017 by 3.8 percent to 18.7 percent—but, again, markets vary regionally, with Los Angeles and San Francisco performing very strongly, and Orlando and Tampa/St. Petersburg ranking 5th and 14th, respectively, out of the top 26 hotel markets nationally.13 New hotel room construction, as a percentage of existing rooms, has risen during the past year, from 2.6 percent to 3.5 percent—a nearly 35 percent jump, which will, according to analysts, put downward pressure on RevPAR, as will other emerging factors, such as a 70 percent resurgence in select-service-hotel construction nationally, which will compete with established hotels. Hotel transactions, which nearly doubled in the third quarter of 2016 to $10.5 billion, from $5.6 billion in Q3 2015, are nevertheless down by more than half the total transaction volume compared with last year. Still, private equity funds that bought hotel properties in 2012 may be nearing the end of their typical five-year hold period, and international investors, especially from China, show no diminishment in their appetite for the sector.14
“Industrial investment metrics remain robust—with net absorption outpacing completions, cap rates and vacancy rates dropping, and rent growth.”
Industrial isn’t going anywhere anytime soon, actually—and nobody’s really worried about the sector falling off an economic cliff. Indeed, investment metrics for the sector remain robust—with net absorption outpacing completions, 12-month cap rates dropping 19 basis points to 5 percent in the third quarter of 2016 and vacancy rates dropping 70 basis points during the same time to 9.2 percent, and rent growth at 8.2 percent per square foot.15 These positively glowing figures may indicate why people are holding on to industrial properties—and why Akerman Survey respondents say there will be fewer transactions in 2017—because nobody wants to sell. One recent analysis of industrial, in fact, suggests only four of the nation’s top 20 markets are places where it might make a modicum of sense to actually sell an industrial property—in Baltimore, Indianapolis, New York/Manhattan, and Boston. For every other major market, the “buy” or “hold” signals have never been stronger.16 For investors, industrial makes a solid defensive play against a possible downturn–compared with office properties, for example–but industrial also offers a chance to move strongly into e-commerce and potential growth of big infrastructure initiatives in port and hub cities.
It’s taken some time for the narrative to become clear, but millennials are turning into apartment dwellers and not home buyers, and in the process they have become the multifamily sector’s market movers. Spooked by what happened to home-owning parents during the Great Recession, saddled with up to $1 trillion in outstanding student loans, faced with an economy in which too many earn far less than they had hoped (at least half of 36-year-olds, by one estimate, make less than their parents did), and imbued with a predisposition against the large sunk costs of automobile and homeownership, millennials (who went a long way toward inventing the shared economy) have retreated from home ownership.17 Not only that, in a startling development, more young adults in America are likely to live at home with their parents now (a quarter of young adults aged 25 to 29 and 13 percent of those age 30 to 34), according to Pew Research—a number not seen since 1880.18
“Downtown and suburban markets across America have seen new apartment construction grow 5 percent on average per year, a pace that is expected to continue through most of 2017.”
And those who have managed to leave the nest have become serial renters. Indeed, the surge in rental households in America, which reached 36.6 percent last year (the largest share since the late 1960s) is driven by renters from under 30 to 44 years of age—a demographic that constitutes 55.3 percent of all rental households.19 Downtown and suburban markets across America have seen new apartment construction grow 5 percent on average per year, a pace that is expected to continue through most of 2017. And the suburban multifamily sector is expected to continue to grow, as the suburbs, in contrast to continued media stories about urban infill, become more attractive to millennials as they age.
Not surprisingly, Akerman Survey respondents ranked multifamily second only to residential single-family as the sector likely to be most active for real estate transactions in 2017, with almost half (49 percent) saying that apartment development would be the most active multifamily subsector, followed by senior living, which received 20 percent of the most active subsector votes. Cap rates for multifamily in 2016 experienced modest declines and remained the lowest of all the asset types, with San Francisco and Los Angeles seeing the lowest cap rates in the country, at 3.75 percent.20
But Akerman Survey respondents also seem to sense an oversupply in the multifamily market, especially in certain cities like New York, Los Angeles, Houston, and Miami—where rents for downtown Miami condos, for instance, declined 3.2 percent in the third quarter of 2016 and newly constructed multifamily rental units in the downtown area are projected to nearly double Miami’s existing supply.21 “Multifamily continues to be a hot sector across the country,” says Hinton, who offered an anecdotal observation that many others have confirmed. “If I look out my window in Los Angeles, I think I can see probably ten construction cranes on my side of the building alone—and a lot of this is either multifamily, condo, or mixed use.” Others have noted the buildup, too, and this may be why 63 percent of Akerman Survey respondents project an increase in multifamily cap rates for 2017.
Foreign investment in the U.S. commercial real estate market was slightly down compared with last year but was still robust, with more than $80 billion invested as of Q3 2016 and more expected in 2017, primarily from China. Indeed, the pace of Chinese investment last year was so strong—with one analyst describing it as a “relentless capital outflow” and others have called it an “exodus”: $21 billion from Q3 2015 to Q3 2016—that in late November of last year, three key finance entities in China issued a regulatory statement that seemed intended to stem the flow of cross-border transactions.22 Most analysts project that the U.S. real estate market will remain very attractive to foreign investors—citing stability, transparency, and robust market fundamentals. Gateway cities will remain important, but foreign investors are becoming more comfortable in secondary and even tertiary marketplaces.23
What seems most surprising from the Akerman Survey, however, is the respondents’ sense of where foreign investment will be coming from in 2017. While most feel that China will be the major player in all real estate sectors, they also seem to project a diminished expectation for foreign investment from all other countries or regions: Canada, Europe, Latin America, and the Middle East. Take everybody’s hot sector, multifamily: Akerman Survey respondents see the multifamily sector receiving most of the foreign investment in 2017, with nearly two-thirds saying that China will be the biggest investor; 73 percent say that China will contribute most to the office sector; and 71 percent say China will be the big player in the industrial sector.
“It’s as if all the regions were lined up in a row for inspection and then all of the countries except China took one big step back, leaving China out in front.”
By comparison, Akerman Survey respondents’ expectations for foreign investment in multifamily from other regions are low: 12 percent say Canada will contribute to multifamily; 25 percent see multifamily investment coming from Europe; 23 percent see it coming from Latin America; and only 17 percent see multifamily investment coming from the Middle East. The same pattern is true for all other real estate sectors—with China leading the way, and everyone else contributing but clearly in the distance. “It’s as if all the regions were lined up in a row for inspection, for example, and then all of the countries except China took one big step back, leaving China out in front,” says Bezold. Latin America will still make its impact felt, according to Akerman Survey respondents—with 28 percent saying that Brazil will be the biggest U.S. real estate investor. It’s not surprising that Akerman Survey respondents picked Cuba to top all others in receiving U.S. investments into Latin American real estate.