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Emerging Trends in Real Estate® United States and Canada 2017 G R E G G G A LB R A IT H , R E D S TU D IO N IC O M A R Q U E S Emerging Trends in Real Estate® 2017 A publication from: i Emerging Trends in Real Estate® 2017 Contents 3 Chapter 1 Playing for Advantage, Guarding the Flank 4 Context: A Kinder, Gentler Real Estate Cycle? 5 Optionality 6 Transformation through Location Choice 8 Recognizing the Role of the Small Entrepreneurial Developer 9 Labor Scarcity in Construction Costs 11 Housing Affordability: Local Governments Step Up 13 Gaining Entry beyond the Velvet Rope 14 The Connectedness of Cities 15 Ready for Augmented Reality? 17 Blockchain for 21st-Century Real Estate 18 Expected Best Bets for 2017 20 Chapter 2 Capital Markets 21 The Debt Sector 27 The Equity Sector 33 Summary 34 Chapter 3 Markets to Watch 34 2017 Market Rankings 34 Market Summaries 71 Chapter 4 Property Type Outlook 72 Industrial 74 Apartments 76 Single-Family Homes 77 Hotels 79 Office 81 Retail 83 Niche Sectors 85 Summary 86 Chapter 5 Emerging Trends in Canadian Real Estate 86 More Than Mixed Use, It’s about Building Communities 87 Affordability on the Decline 89 Renting for the Long Term 90 Technology Disruptors Hold a Competitive Advantage 90 Global Uncertainties Weigh on the Mind 90 Ongoing Oil and Gas Woes 92 Waiting for Deals 92 Economic Outlook 93 Property Type Outlook 96 Markets to Watch in 2017 102 Expected Best Bets for 2017 104 Interviewees Emerging Trends in Real Estate® 2017 ii Emerging Trends in Real Estate® 2017 Editorial Leadership Team Adam Boutros* Aki Dellaportas Alan Chu Amy E. Olson Amy Shanaman André Voshart* Andrew Alperstein Andrew Popert* Angelo Talamayan* Annie Labbé* Armando Pinedo* Bill Kropp Bill Staffieri Blake Evans Braiden Goodchild* Brett Matzek Brian J. Robertson Brian Keida Brian Nerney Bud Thomas Carlie Persson* Carlo Bruno Carol Devenney* Charles Campany Chase Evans Chris Bailey Chris Dietrick Chris Potter* Chris Vangou* Christina Howton* Christine Lam* Christopher Gerra Christopher Mill Christopher Nicholaou Court Maton Courtney Sargent Dan Boyce Daniel D’Archivio* Daniel Genter Danielle Sercu Dave Baranick David Baldwin David Baranick David Leavitt David Seaman David Voss Donald Flinn* Douglas Struckman Dwayne MacKay* E. Robert Young Elliot Kung Emily Pillars Eric Andrew* Eric St-Amour* Erika Ryback Ernest Hudson* Eugene M. Chan Frank Magliocco* Fred Cassano* Frederic Lepage* Gimena de Buen Paz* Gloria Park Gordon Matheson* Haley Anderson Heather Drysdale* Heather Lashway Hillary Boulard* Howard Ro Ian Gunn* Ian Nelson Isabelle Morgan Jacqueline Kinneary James MacKenzie James Oswald Jamie Rich Janelle Waters Janice McDonald* Jasen Kwong* Jason Pagliaro* Jeff Kiley Jenna Liou Jeremy Lewis Jillian Michaels* Jim Oswald John Bunting* Jonathan Sessa Joseph Pitsor Joseph Schechter Julia Powell Katie Braha* Keith Durand Ken Griffin* Kevin Fossee Kevin Nishioka Kristen Conner Kristy Romo Kyle Kelly Laura Daniels* Laura Hildebrand* Leah Waldrum Lee Overstreet Lee-Anne Kovacs* Logan Redlin Lori-Ann Beausoleil* Lorilynn Monty Lou DeFalco Luiza Carneiro Marcel Sow Maria Aiello* Marshall Yellin Martin Schreiber Mary Wilson-Smith* Matthew Berkowitz Matthew Manza Michael Alicastro Michael Anthony Michael Elger Michael Shields* Miranda Hardy* Miranda Tse Miriam Gurza* Mori Contreras Nadia King* Nadja Ibrahim* Naveli Thomas* Nicholas Mitchell Nick Ethier* Oliver Reichel Patrick Groome Peter Wilkins Rachel Klein Rahim Lallani* Rajen Shah* Raynald Lafrance* Renee Sarria Rich Fournier Richard Fournier Richard Probert* Rick Barnay* Rick Munn Rob Sciaudone Roberto D’abate* Ron Bidulka* Ross Sinclair* Ryan Ciccarone Ryan Dumais Sabrina Li Sam Melehani Samuel Hadley Scott Berman Scott Tornberg Sean Hiebert* Serge Gattesco* Seth Kemper Seth Promisel Shareen Yew Simon Dutil* Stan Oldoerp Stephan Gianoplus Steve Baker Steve Tyler Steve Walker Steven Weisenburger Susan Farina* Susan Smith Tim Bodner Tim Conlon Tori Lambert Tracy Howard Tressa Teranishi* Trevor Toombs* Wade Yacker Warren Marr William Hux William Keating Yousuf Abbasi Zachary Broujos Zoe Funk *Canada-based. PwC Advisers and Contributing Researchers Emerging Trends Chairs Mitchell M. Roschelle, PwC Kathleen B. Carey, Urban Land Institute Authors Hugh F. Kelly Alan C. Billingsley Andrew Warren Anita Kramer Senior Advisers Christopher J. Potter, PwC, Canada Miriam Gurza, PwC, Canada Frank Magliocco, PwC, Canada Contributors Sarene Marshall, Urban Land Institute Stockton Williams, Urban Land Institute ULI Editorial and Production Staff James A. Mulligan, Senior Editor David James Rose, Managing Editor/Manuscript Editor Betsy VanBuskirk, Creative Director Anne Morgan, Cover Design Deanna Pineda, Muse Advertising Design, Designer Craig Chapman, Senior Director of Publishing Operations Eva Su, Director, Capital Markets Emily Vaughan, Manager, District Councils Andrew Wahlgren, Intern, Capital Markets Emerging Trends in Real Estate® is a trademark of PwC and is regis- tered in the United States and other countries. All rights reserved. At PwC, our purpose is to build trust in society and solve important problems. We’re a network of firms in 157 countries with more than 208,000 people who are committed to delivering quality in assurance, advisory, and tax services. Find out more and tell us what matters to you by visiting us at www.pwc.com. © 2016 PwC. All rights reserved. PwC refers to the PwC network and/ or one or more of its member firms, each of which is a separate legal entity. Please see www.pwc.com/structure for further details. © October 2016 by PwC and the Urban Land Institute. Printed in the United States of America. All rights reserved. No part of this book may be reproduced in any form or by any means, electronic or mechanical, including photocopying and recording, or by any infor- mation storage and retrieval system, without written permission of the publisher. Recommended bibliographic listing: PwC and the Urban Land Institute: Emerging Trends in Real Estate® 2017. Washington, D.C.: PwC and the Urban Land Institute, 2016. ISBN: 978-0-87420-391-2 1 Emerging Trends in Real Estate® 2017 Notice to Readers Emerging Trends in Real Estate® is a trends and forecast publication now in its 38th edition, and is one of the most highly regarded and widely read forecast reports in the real estate industry. Emerging Trends in Real Estate® 2017, undertaken jointly by PwC and the Urban Land Institute, provides an outlook on real estate investment and devel- opment trends, real estate finance and capital markets, property sectors, metropolitan areas, and other real estate issues throughout the United States and Canada. Emerging Trends in Real Estate® 2017 reflects the views of individuals who completed surveys or were interviewed as a part of the research process for this report. The views expressed herein, including all comments appearing in quotes, are obtained exclusively from these surveys and interviews and do not express the opinions of either PwC or ULI. Interviewees and survey participants represent a wide range of industry experts, including investors, fund managers, developers, property compa- nies, lenders, brokers, advisers, and consultants. ULI and PwC researchers personally interviewed more than 500 individuals and survey responses were received from more than 1,500 individuals, whose company affiliations are broken down below. Private property owner or developer 31.1% Real estate advisory or service firm 27.9% Investment manager/adviser 6.7% Homebuilder or residential land developer 6.6% Bank lender 4.9% Equity REIT or publicly listed real estate property company 4.8% Institutional equity investor 4.6% Private REIT or nontraded real estate property company 2.1% Institutional lender 1.2% Real estate debt investor 0.6% Securitized lender 0.3% Mortgage REIT 0.1% Other entity 9.2% Throughout the publication, the views of interviewees and/or survey respondents have been presented as direct quotations from the participant without attribution to any particular participant. A list of the interview participants in this year’s study who chose to be identified appears at the end of this report, but it should be noted that all interviewees are given the option to remain anonymous regarding their participation. In several cases, quotes contained herein were obtained from interviewees who are not listed. Readers are cautioned not to attempt to attribute any quote to a specific individual or company. To all who helped, the Urban Land Institute and PwC extend sincere thanks for sharing valuable time and expertise. Without the involvement of these many individuals, this report would not have been possible. 2 Emerging Trends in Real Estate® 2017 3 Emerging Trends in Real Estate® 2017 Chapter 1: Playing for Advantage, Guarding the Flank The game of chess is not a game of chance, but requires mastery of a complex set of skills that are both art and science. A player needs to be alert, equally aware of the strengths and weaknesses of his own position and that of his opponent. A plan is needed, most assuredly. The number of possible games that can develop, however, exceeds the number of atoms in the universe. Hence, flexibility within the plan is critical. Each move has a short-term impact and is also a step in positioning for a victorious endgame. Like chess, the real estate playing field requires an artful mix of skills, tactics, and strategies. A chessboard is limited to just 64 squares and is two-dimensional. Real estate’s domain covers a lot more space, and requires thinking across economic, social, political, and technological dimensions. Beginners may often extend themselves swiftly and aggres- sively into the fray, seeking quick advantage but overlooking the impact of countermeasures that are obvious to more experi- enced players. Strategic thinkers see beyond the “next move” and anticipate the development of a series of moves that, taken together, create a more powerful control of the board. As we consider the emerging trends going into 2017, we try to look two or three moves ahead in the fascinating and competi- tive field that is the real estate industry. And, since no single move can be considered in isolation, it will be important to see the pattern linking several trends as they evolve interactively. Playing for Advantage, Guarding the Flank “Big assets, big cities, big capital, and big competition. The U.S. is more in favor than the rest of the world right now.” Exhibit 1-2 Emerging Trends Barometer 2017 abysmal poor excellent fair Sell 2017 2016 2015 2014 2013 2012 2011 2010 2009 2008 2007 2006 2005 2004 good Buy Hold Source: Emerging Trends in Real Estate survey. Note: Based on U.S. respondents only. Exhibit 1-1 U.S. Real Estate Returns and Economic Growth –40% –30% –20% –10% 0% 10% 20% 30% 40% 2017* 2015 2013 2011 2009 2007 2005 2003 2001 1999 1997 –5% –3% –1% 1% 3% 5% In de x ch an ge G D P c ha ng e NAREIT NCREIF GDP NCREIF total expected return 7.0 NAREIT total expected return 8.0 Sources: NCREIF, NAREIT, Bureau of Economic Analysis/U.S. Department of Commerce, ULI Real Estate Consensus Forecast. *NCREIF/NAREIT and GDP data for 2016 and 2017 are based on forecasts for these indicators in the ULI Real Estate Consensus Forecast, October 2016. 4 Emerging Trends in Real Estate® 2017 1. Context: A Kinder, Gentler Real Estate Cycle? The disruption wrought by the global financial crisis violently upended financial markets around the world and hammered real estate markets in the United States. In a real sense, the rever- berations continue. Real estate transaction volume across the country rebounded, but development remains below historical norms for most property types. A major publisher of real estate news and commentary says, “We have never been in a real estate cycle like this.” Overall, there is a sense that real estate has learned painful but valuable lessons. This time, real estate will not likely be the trigger for a business cycle recession. And, as far as the number of “innings” remaining, here is what one chief executive officer (CEO) with multiple international invest- ment partnerships said: “Don’t worry about innings. This is a doubleheader.” At 85 months’ duration (as of August 2016), this business cycle was already the fourth longest in U.S. history, far longer than the average 58-month upturns since World War II. Many concurred with an institutional equity investor describing this as “a mature phase of the cycle.” As is so often the case, averages are of little help in understanding business cycle duration. Cycles have been lengthening over the past half-century, and both the 1980s and 1990s saw growth phases of 92 and 120 months, respec- tively. In a word, cycles do not die of old age. Little in the U.S. macroeconomic data suggests overheat- ing, the primary symptom of trouble ahead for the cycle. Real gross domestic product (GDP) growth has settled in at about 2 percent per year, and job growth—monthly aberrations notwith- standing—is running at about a 1.7 percent pace, approximately 2.5 million annually. The Federal Reserve has been exception- ally cautious about raising interest rates, due to volatility in the data, in financial markets, and in the geopolitical climate. The Fed has shown little inclination to “take away the punchbowl.” A major factor in seeing the real estate cycle extending even deeper into the future is the difficulty of securing construc- tion financing. This is effectively keeping the oversupply that is typical of a late cycle from emerging this time around. An inter- national investment executive notes that bank regulators and new risk rules have enforced discipline on lending, a primary factor in the development slowdown. The volume of available capital that is seeking “core properties” has pushed pricing past prior peaks in many markets, making some moves on the chess board costly. Reduced leverage ratios have shifted more risk toward the equity investor. As one longtime observer of institutional investors put it, “We are in the ‘white knuckle’ phase of the cycle. Champagne is not flowing at closings.” Traditional sources of capital are favoring a “risk-off” approach. Acquisitions are extremely selective, with cap-rate compression having spread into secondary markets over the last two years. “Risk is on the demand side,” in the view of a West Coast–based investment manager. Exhibit 1-3 Firm Profitability Prospects for 2017 0% 20% 40% 60% 80% 100% 2017 2016 2015 2014 2013 2012 2011 2010 Good–excellent Abysmal–poor P er ce nt ag e of r es po nd en ts Fair Source: Emerging Trends in Real Estate surveys. Exhibit 1-4 Real Estate Business Prospects 1 Abysmal 3 Fair 2 Poor 4 Good 5 Excellent 2017 Real estate security investors Real estate lenders Real estate investment managers/advisers Real estate services Commercial real estate developers Real estate equity investors Residential builders/ developers Real estate owners 3.90 3.67 3.67 3.64 3.58 3.58 3.47 3.33 Source: Emerging Trends in Real Estate 2017 survey. 5 Emerging Trends in Real Estate® 2017 Chapter 1: Playing for Advantage, Guarding the Flank Where many felt a year or two ago that real estate cap rates had no direction to go but up, an emerging consensus believes that such a move is not likely in the near term and that the current level of risk premiums could sustain a modest further decline in going-in cap rates. This alone is a sign of how unusual the cur- rent cycle has become. 2. Optionality Both on the investor side and the user side of the market, optionality—not just one use, not just one user, not just one user profile—may be gaining favor as a way to navigate the cross-currents of volatile markets. The potential extent of such optionality is as wide as the industry itself. Says one interviewee, the principal of a boutique investment holding company, “The developer/financier that understands optionality in their projects is the winner. Optionality will be of great value over the next generation.” Optionality from a user standpoint allows for the adjustment of space needs to vary in terms of size, location, and use on an as-needed basis. This has already been the attraction of gig workers, sole proprietors, and perhaps very small firms to cowork space, where the provider of that space is most defi- nitely pursuing more than “just one user.” The ultimate optionality would eliminate the need for even large firms to lock into a lease that is tied to a set amount of space in a predetermined location. And this has now happened. A Fortune 500 communications company recently entered into a deal with an international pro- vider of shared-office space. The tenant in this case proposes to cut its occupancy costs in half within five years. In addition to the cost savings, the tenant touts the strategy to employees as promoting productivity, collaboration, and community in its noncampus administrative centers. The office provider gains a set amount of cash flow from the user, but also maintains the option of backfilling any unused space that may not be used by the core tenant that month. Optionality gives property owners the ability to maximize highest and best use, based on immediate tenant demand. Pursuing “not just one use,” a Washington, D.C., investor/developer has launched a prototype operation in Alexandria, Virginia, where 1,000-square-foot units can be, at the tenant’s discretion, either housing, office space, or both. Common-area amenities abound, including a pet spa, sports and recreational facilities (indoor and outdoor), and even a soundproof music studio. The property is a suburban 39,000-square-foot office building that was empty at acquisition and was bought at a 65 percent dis- count to its original valuation. The promoter believes that dozens of such opportunities can be found across the United States, provided that zoning is flexible. The opportunities are real, but the execution could be compli- cated. There are so many moving parts, as a large institutional investment manager pointed out: “We look at technology and the inroads of the sharing economy. Take office sharing: what is the cyclical risk for an office-sharing lease in a downturn? Take retail space that is shifting from chain stores to restaurants—res- taurants require higher TIs [tenant improvements], as do service tenants like gyms, spas, medical uses—but what is the credit behind those leases?” Optionality can have an impact on what could be appropriate for a market. Consider the multifamily sector, in rental apartments Exhibit 1-5 Time Horizon for Investing 0% 10% 20% 30% 40% 2016 2017 10+ years 5–10 years 3–5 years 1–3 years Percentage of total survey respondents 10.4% 32.7% 30.5% 26.4% 9.0% 31.7% 32.9% 26.4% Source: Emerging Trends in Real Estate surveys. Note: Based on U.S. respondents only. Exhibit 1-6 New Commercial Square Footage as Percentage of Inventory 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 0 2 4 6 8 10 12 14 16 2016 2012 2008 2004 2000 1996 1992 1988 1984 1980 Completions as percentage of inventory Vacancy rate V ac an cy r at e C om pl et io ns a s pe rc en ta ge o f i nv en to ry Source: REIS Inc. Note: Includes industrial, office, and neighborhood and community retail space. 6 Emerging Trends in Real Estate® 2017 and condominiums, and the pursuit of “not for just one user pro- file.” The head of a REIT sees an emerging millennial market for ownership units, but one whose growth is bounded by a “keep- ing our options open” attitude: “Jobs are no longer careers, and millennials are not yet looking for the commitment of owning a home. They are footloose in the job market, and footloose as to roots in the community.” Developers hedge their bets by build- ing condo quality into rentals—an option that makes sense at today’s ultra-low cap rates—knowing that market demand can shift swiftly between the two forms of product. Another multifam- ily option being discussed in the market is the development of projects that appeal to multiple generations—millennials and baby boomers, for example. The two groups are looking for similar amenity packages but differ on the desired size and price point of the units Keeping your options open has never seemed to be a wiser approach. 3. Transformation through Location Choice A new breed of CEOs has been turning a widespread economic development approach on its head, transforming some cities in the process. Instead of negotiating for the most generous pack- age of public incentives possible, these business leaders take the tack that private employers can catalyze civic revivals and, in benefiting communities, can benefit their enterprise as well. CEOs speak of the “triple bottom line” of financial, social, and environmental success. A recent study counted nearly 500 companies whose downtown location choices have been a potent factor in urban revitalization. Corporate leaders under- stand the impact, but also stress the self-interested economic case: attracting talent, penetrating urban markets, and the supe- rior returns obtainable in live/work/play locations. Diverse cities, ranging from Cleveland and Oakland to San Diego and Raleigh, have benefited. The first wave shows us what this is really about. The two most prominent efforts with track records under their belts have been in Las Vegas and Detroit. With several years of history, we can see that successes and struggles have occurred in both ventures. Not every gambit proves fruitful and the measure of decades is more appropriate for evaluating results in revitalizing cities. Even now, however, we can see what trends are more promising and what we can learn from stumbles. The downtown Las Vegas efforts have displayed the kind of trial- and-error experimentation that epitomizes the venture capital approach. About $150 million has been spent on Las Vegas’s Exhibit 1-7 Importance of Issues for Real Estate in 2017 1 No importance 2 Little importance 3 Moderate importance 4 Considerable importance 5 importance 1 2 3 4 5 Great Economic/financial Issues Real estate/development issues Sharing economy Taxes and regulation Income inequality Global economic growth Macroeconomic issues (inflation, dollar strength) Interest rates and cost of capital Job and income growth Social/political issues Political landscape Education (cost and availability) Availability of qualified labor Immigration Government budget issues (local/state/federal) Social inequality Terrorism/war/epidemics Risks from extreme weather Wellness health features State and local water regulation Environment and sustainability Housing costs and availability Infrastructure/transportation Capital availability Land and construction costs 4.45 4.04 3.62 3.44 3.44 3.36 2.68 3.87 3.54 3.47 3.35 3.18 2.75 2.69 4.30 3.99 3.91 3.87 3.20 2.99 2.63 2.47 Source: Emerging Trends in Real Estate 2017 survey. 7 Emerging Trends in Real Estate® 2017 Chapter 1: Playing for Advantage, Guarding the Flank Climate Change and Real Estate The Emerging Trends in Real Estate® survey asks respon- dents about the importance to their business over the next year of risks emanating from environmental issues (including climate change). For the second straight year, the response was tepid. While the importance of general sustainability did increase very slightly, specific climate change implica- tions—including water regulations, or risks from extreme weather—continue to be ranked very low compared with job growth, land costs, and capital availability (see exhibit 1-7). Climate impacts, in creeping forms such as drought or sea- level rise, or acute forms like severe storms, can destabilize entire regions. The U.S. National Security Strategy “is clear that climate change is an urgent and growing threat . . . contributing to increased natural disasters, refugee flows, and conflicts over basic resources such as food and water.” Interestingly, immigration and conflicts (war/terrorism) ranked more highly by Emerging Trends respondents than climate impacts themselves. E.T. respondents’ low ranking of most climate-related topics may be attributed, at least in part, to the questions’ one-year time frame. Nevertheless, there is growing alarm among leading investors, insurers, business leaders, and policy makers and increasing evidence of the potential impacts of climate change (or actions to address it) on real estate: ● ● Lloyd’s City Risk Index illuminates the financial risks of flooding in some top U.S. real estate markets: ● ● These losses are not all insured or insurable. SwissRe says that there is a widening “protection gap”: “On aver- age, only about 30 percent of catastrophe losses have been covered by insurance over the last ten years. That means that about 70 percent of catastrophe losses—or $1.3 trillion—have been borne by individuals, firms, and governments.” ● ● In 2015, 195 nations signed the U.N. Paris Agreement on climate change, which sets out bold policy plans to reduce climate-change-causing carbon emissions. Real estate is a prime target for these reductions, since energy used in buildings is the largest source of carbon pollution worldwide (nearly one-third). ● ● Access to capital is increasingly likely to be affected by investor and lender perceptions of climate risk, too. Four hundred investors, representing $24 trillion in assets, have pledged to “ensure that they are minimizing and disclosing the risks and maximizing the opportunities presented by climate change.” ● ● ULI’s Greenprint Vol. 7 Performance Report, Tenant Energy Optimization Program, and Returns on Resilience show how real estate leaders are taking action to address climate change and achieving bottom-line success. ULI.org/sustainability. US Cities’ GDP at Risk from Flooding Global rank City GDP at risk ($B) 3 Los Angeles 13.3 4 New York 13.1 12 Houston 7.8 16 Chicago 6.2 20 San Francisco 5.5 Total 45.9 Homes at Risk from Sea-Level Rise State Homes potentially underwater (no.) Housing stock affected (%) Value at risk ($B) Florida 934,411 12.56 413.0 New Jersey 190,429 7.35 93.1 New York 96,708 2.1 71.0 Massachusetts 62,069 3.1 51.2 California 42,353 0.44 49.2 South Carolina 83,833 4.42 45.0 Hawaii 37,556 9.07 25.3 Washington 31,235 1.32 13.7 Texas 46,804 0.61 12.0 ● ● Zillow, looking at the impact of sea-level rise on homes across the United States, concluded that 1.9 million homes—worth a combined $882 billion—are at risk of being physically underwater by 2100, with some markets being severely affected: 8 Emerging Trends in Real Estate® 2017 old City Hall; the development of a retail store, restaurant, and entertainment venue called “the Downtown Container Park”; and the Airstream Village, where residents live in the classic trailers or in distinctive RVs called Tumbleweed Tiny Houses. Another $150 million was dedicated to interest-free loans for startups, which have had a range of success. On the whole, the trajec- tory is upward. Las Vegas’s downtown is no longer given up for dead, but stands as a much more vibrant—and safer—district. These days, it seems as though everybody wants to see what’s happening in downtown Detroit. The relocation of a company’s headquarters from suburban Livonia, Michigan, to downtown first placed 1,700 employees into Detroit’s depressed central business district (CBD). That number now stands at 12,500. With one company controlling an entire district, attention is paid to how all the pieces fit together so that great synergies are created These were bold and inspiring moves and impactful invest- ments; big businesses can be catalytic. What’s left to do to and by whom? A complete 21st-century urban transformation into a live/work/play environment requires special attention to “live”— that is, to housing density, since the “work/play” components depend upon a residential base for expansion and growth. These, of course, are the same key ingredients of success that are transforming 18-hour cities across the United States. For those places still struggling, in the meantime, there is great opportunity in the existing inventory of vacant land, much of which is held “in rem” by the city. A portion of this could be placed in a land trust for future development, which would enable future affordable housing to be developed without future land price inflation. Developer-investors could hold shares in the trust, and local banks with Community Reinvestment Act obliga- tions might be able to provide financing. Collaboration with city government and the experienced devel- opment community can promote a more unified and long-lasting successful approach. The longer-term test will be the degree to which the initial corporate/government collaboration acts as a catalyst for other investment. The object is not to create a 21st- century “company town.” It is to redevelop a diverse and vibrant urban center. Here is where leadership supplies what impersonal market forces may neglect or where they may go more slowly. The genius of leadership is, in the words of George Bernard Shaw, “to dream things that never were, and ask, ‘Why not?’ ” 4. Recognizing the Role of the Small Entrepreneurial Developer Tall buildings, “starchitect” projects, the upper-echelon market. It is human nature to focus on the properties that capture the glamour of development. It is likely that the headlines and prizes will always gravitate to the biggest and brightest new buildings. At some point, however, we will probably look back and find that problem-solving innovation emerges from the small-scale project developer. Today’s environment seems to conspire against the small developer, with risk-averse capital favoring the most expensive locations and lenders timid about advancing project funds lest their regulators pounce. As one southeastern developer put it, “There aren’t 30-year-old developers anymore because capital is too hard to come by.” Bigger is not always better. Nimbleness and local knowledge are not commodities, and several factors suggest that small and midsized developers have an increasingly significant role in the industry. First of all, consider the structure of the building construction industry. In 2015 (the most recent year for which figures are available), there were 46,843 firms in the commercial property building industry whose employee count was less than 20 per firm. That is 86.5 percent of all the firms in the industry. For firms focused on the multifamily segment, the numbers are even more skewed to small companies, at 91 percent of firms. When it comes to total jobs, however, employment is well distributed in all establishment sizes up to and including the 100-to-249- employee category. That distribution—share of total develop- ment industry jobs by size of firm—has stayed remarkably Exhibit 1-8 Prospects by Investment Category/Strategy, 2017 2017 2016 2 Poor 4 Good 1 Abysmal 3 Fair 5 Excellent 3.66 3.53 3.48 3.42 3.83 3.82 3.68 3.53 Core investments* Opportunistic investments Development Value-add investments Source: Emerging Trends in Real Estate surveys. Note: Based on U.S. respondents only. 9 Emerging Trends in Real Estate® 2017 Chapter 1: Playing for Advantage, Guarding the Flank stable since 1990. Bottom line: commercial and multifamily building in the United States has a broad and very solid base of small and midsized providers. These smaller firms are capable of addressing a range of cur- rent needs: affordability for users across the property types, infill in older neighborhoods, and attention to smaller markets of lesser interest to the larger firms. With construction costs a crucial issue, smaller developers who build product on sites outside the core CBD can create new offices, stores, and housing less burdened by extreme land cost inflation. “Contextual zoning” encourages flexibility of use and compatibility with existing neighborhoods, and the small developer is likely to be alert to manageable infill opportunities with more modest project size, both in the cities and in older mixed-use suburbs. While money center banks are finding it difficult to add new development loans to their books, some of the void is being filled by regional and community banks. These are the institu- tions that smaller developers have long depended upon, banks that are experienced in local market conditions and that have the capacity to underwrite smaller deals skillfully. As one devel- oper remarked, “They like the fact that it’s small scale, which mitigates the lease absorption risk.” In Emerging Trends, we often bring our spotlight to the large- scale trends. But much change is incremental, the sum of many contributors whose efforts, taken together, can make a huge difference. The enormous number of firms composed of 20, 50, and 100 employees provides the industry with an ideal labora- tory for entrepreneurial innovation. 5. Labor Scarcity in Construction Costs The crossover point where more baby boomers are retiring than millennials entering the labor force is upon us. A Bureau of Labor Statistics (BLS) analysis released in December 2015 projected labor force change for the ten years ending 2024 as being only 0.5 percent per year. Emerging Trends has sketched the big picture in previous editions. The key change in the population cohorts from 2014 to 2024 looks like this: the number of Americans in the 25-to-34-years-old age group, the prime early-career working years, will be up by 3.2 million; meanwhile, the 65-to-74-years-old age group, those most likely to exit the labor force in retirement, will be up by 9.4 million. Between the boomers and the millennials, gen Xers are solidly in their mid- career years, but this is a smaller cohort—another reason the labor pool is somewhat shallower. The driving factors are age demographics and the labor force participation rate, and the two are related. Many believe that the labor force participation rate—the per- centage of the civilian population 16 years or older who are working or are actively looking for work—has dropped as one of the consequences of the global financial crisis. However, the participation rate peaked in 1997 at 67.1 percent and has been falling since 2000. As of July 2016, it stood at 62.8 percent. For men, the rate has been in steady decline since the late 1940s. Female labor force participation peaked at 60.0 percent in 1999 and has been declining for a decade and a half. Obviously, a lot more is happening than just displacement stemming from the Great Recession. Exhibit 1-9 Profile of U.S. Development Firms, by Size of Firm and Sector, 2015 500–999 employees 50–249 employees 0–49 employees 500–999 employees 50–249 employees 0–49 employees 500–999 employees 50–249 employees 0–49 employees Land Subdivision Residential Commercial 0% 20% 40% 60% 80% 100% % of total firms in sector % of total employees in sector 20–49 employees 0–19 employees Source: U.S. Bureau of Labor Statistics. 10 Emerging Trends in Real Estate® 2017 As more young people seek higher education, they remain out of the workforce for a longer period, putting downward pressure on labor force figures. As more of the baby boom generation moves into the age-65-plus cohort, its participation rate also drops. BLS projections call for the overall participation rate to dip to 60.9 percent by 2024. We do not have to wait to feel the effects on real estate. Our interviewees are telling us that they feel the pinch right now, and they expect it will get tighter over time. A multifamily housing specialist says, “Labor availability and shortage will continue to have a significant impact on the market. The shortage ranges from laborers to more skilled labor. This is pushing up the development time on projects and is cutting into returns. The shortage of labor has slowed the number of units being delivered to markets and may have helped prevent overbuilding in 2016.” Executives for a firm intermediating offshore wealth into the U.S. real estate market note that they see “five-to-seven-month construction delays due to labor shortages, while costs are inflating.” An institutional investor from the Midwest adds that rising costs push apartment development toward luxury units: “We can’t afford not to develop apartments at the high end due to a run-up in construction hard costs. The run-up in labor outpaces construction materials’ costs, though, especially in the locations we find attractive, where the land basis has also gone up considerably.” Exhibit 1-11 U.S. Construction Employment, 1990–2016 4.0% 4.5% 5.0% 5.5% 6.0% 6.5% 7.0% 7.5% 8.0% P er so ns (m ill io ns ) P er ce nt ag e of to ta l e m pl oy m en t 4.0 4.5 5.0 5.5 6.0 6.5 7.0 7.5 8.0 Persons Jan 2016 Jan 2014 Jan 2012 Jan 2010 Jan 2008 Jan 2006 Jan 2004 Jan 2002 Jan 2000 Jan 1998 Jan 1996 Jan 1994 Jan 1992 Jan 1990 Percent of total employment Source: U.S. Bureau of Labor Statistics, “Current Employment Statistics.” Exhibit 1-10 Percentage of U.S. Working-Age Population Participating in Labor Force, 1950–2020 Total Male Female Forecast 30% 40% 50% 60% 70% 80% 90% Jan 2020 Jan 2015 Jan 2010 Jan 2005 Jan 2000 Jan 1995 Jan 1990 Jan 1985 Jan 1980 Jan 1975 Jan 1970 Jan 1965 Jan 1960 Jan 1955 Jan 1950 P er ce nt ag e of w or ki ng -a ge p op ul at io n pa rt ic ip at in g in la bo r f or ce Sources: U.S. Bureau of Labor Statistics, “Current Population Survey”; Moody’s Analytics forecasts. 11 Emerging Trends in Real Estate® 2017 Chapter 1: Playing for Advantage, Guarding the Flank ULI district council focus groups convened for Emerging Trends® 2017 (see chapter 3) identified labor shortages as an issue in markets as diverse as Atlanta, central Florida, Cleveland, and Nashville. Large metropolitan areas such as Denver, Phoenix, and Orange County, California, have seen double-digit construction job gains in the past year, depleting the remaining pool of workers. The causes of the labor shortage are many. One West Coast consultant suggested that the clampdown on Mexican immigra- tion alone reduced the labor pool by several hundred thousand construction workers. As development seized up after 2008, others pointed out, workers moved to the booming opportunities in the oil and gas industries. (Reports from the energy industry indicate that workers let go in the oil and gas slump are typically migrating to fields like alternative energy, or are enrolling in com- munity college for retraining.) Skilled craft workers are retiring more quickly than they can be replaced. Project managers are also in short supply. As of April 2016, there were over 200,000 unfilled job openings in building construction, according to the Bureau of Labor Statistics Job Openings and Labor Turnover Survey (JOLTS). So we have an “emerging trend” identified in past editions now biting business in a painful way. What are the next moves on the chess board? In a way, this is a real opportunity for the real estate industry to lead a way toward solutions. Real estate in all its guises— construction, property management, brokerage, and even finance—offers ample opportunities to create entry-level jobs that are not “dead-end jobs,” but the first step on a career path. Given the exceptionally high cost of a college degree, many young people might opt for a blue-collar occupation in the trades if an upward path to greater responsibility and commen- surately greater income were foreseeable. While the first moves might seem counterintuitive to many— increased public funding for vocational/technical education, support for apprenticeship programs that are typically adminis- tered by labor unions, funding for public infrastructure projects that develop entry-level skills—taken together they make a starting point for attracting younger workers of all stripes to the business. In addition, immigration reform that would encour- age, not discourage, blue-collar workers is vital. America’s labor force needs replenishment at all levels, not just the high-tech programmers and software engineers who now get the plum H1-B visas almost the day they become available. 6. Housing Affordability: Local Governments Step Up Nowadays, the affordable housing conversation makes a distinction between “big-A” and “small-A” affordability. Big-A affordability refers to housing for low-income households and looks at familiar subsidy programs such as Section 8, the low- income housing tax credit, and a panoply of state and local programs seeking to address 12 million households paying more than 50 percent of their income for housing. Small-A affordability concerns recognize that, in many markets, middle-income households—those in the second to fourth quintile nationally, averaging between $31,000 and $87,000 in yearly income—are “housing stressed,” spending more than a third of their income on housing costs. An August 2016 report from the Washington, D.C.–based National Association of Home Builders (NAHB) indicated that just 62 percent of all new and existing homes sold in the second quarter were “affordable” to the median U.S. household. With home prices rising at a 5 percent annual rate—more than twice as fast as incomes in recent years—and apartment rents on pace to grow 4.5 percent in 2016, the level of stress will likely increase in the near future. Housing costs and availability were rated by Emerging Trends survey participants as being “considerably important” issues for real estate, increasing in importance this year when compared with the “moderate importance” given to future home prices and affordable/workforce housing in our survey a year ago. The related strain on the social fabric is getting high-level atten- tion. As one longtime CEO of a publicly traded company said, “We’re not paying enough attention to affordable housing, and I Exhibit 1-12 Age of U.S. Working Population, by Cohort and Year 35 37 39 41 43 45 47 49 2021 2020 2019 2018 2017 2016 2015 2014 2013 2012 2011 2010 P er so ns (m ill io ns ) 55–64 45–54 35–44 25–34 15–24 Forecast Source: U.S. Census Bureau. 12 Emerging Trends in Real Estate® 2017 don’t mean low-income or government-subsidized. Just regular rents. No new buildings are providing that kind of product. Time will tell if that’s going to come back to haunt us. Not everybody makes $75,000 to $100,000 a year.” Affordable housing may be the real estate industry’s vulnerable flank on the chessboard. Or it might be a strategic opportunity to move creatively toward a large and growing market, with incremental profits rather than large windfalls. Local governments are not waiting on the sidelines; they are moving more aggressively than at any time in memory to incentivize—or compel—the private sector to meet worsening housing affordability needs. A handful are pushing development impact fees and even considering rent control. The most widely used approach by far, though, is an old idea (dating to the early 1970s) that has roared back to life: inclusionary zoning. Through such zoning, cities require or encourage developers to create below-market-rate rental apartments or for-sale homes in connection with the local approval of a proposed market-rate development project. New York City has the nation’s most far-reaching policy. The mayoral administrations of Michael Bloomberg (2002–2013) and Bill de Blasio (2014–present) have used inclusionary zon- ing to meet affordability targets, recognizing that the sharply upward movement of land prices compromise affordable housing feasibility without some form of public incentive. San Francisco, another booming economy, passed a ballot initia- tive to expand its requirements for affordable units in new developments from the previous 12 percent to 25 percent of the project. However, feasibility studies have suggested an 18 percent requirement, which is likely to be implemented. Proposals to put inclusionary zoning in place or strengthen existing policies are advancing in Atlanta, Baltimore, Detroit, Los Angeles, Nashville, Pittsburgh, Portland, Seattle, and Washington, D.C., among other cities. Recent research by the ULI Terwilliger Center for Housing found that the most effective inclusionary zoning policies provide developers with flexibility and an array of incentives to mitigate the policies’ potential negative impacts. Redevelopment efforts also are affected by affordability issues. Jurisdictions frequently frame their objectives as “creating and preserving” affordable housing. Montgomery County, Maryland, is trying to develop a program for downtown Bethesda whereby Exhibit 1-14 Moderate and Severe Housing Cost Burden on Households with Annual Incomes below $50,000 0 10 20 30 40 50 Renters Owners All households 2014 2001 Percentage of total households Source: Joint Center for Housing Studies of Harvard University tabulations of U.S. Census Bureau “American Community Survey” data. Note: Moderate burden is defined as housing costs of 30 to 50 percent of household income; severe burden is housing costs of more than 50 percent of household income. Households with zero or negative income are assumed to be severely burdened; renters paying no cash rent are assumed to be unburdened. Income cutoffs are adjusted to 2014 dollars by the Consumer Price Index for urban consumers for all items. Exhibit 1-13 Change in Median Existing Home Price vs. Change in Median Household Income -6% -3% 0% 3% 6% 9% 12% 15% Median existing home price Median household income 2Q 2016 1Q 2016 4Q 2015 3Q 2015 2Q 2015 1Q 2015 4Q 2014 3Q 2014 2Q 2014 1Q 2014 4Q 2013 3Q 2013 2Q 2013 1Q 2013 4Q 2012 3Q 2012 2Q 2012 1Q 2012 4Q 2011 3Q 2011 2Q 2011 1Q 2011 4Q 2010 3Q 2010 2Q 2010 1Q 2010 Y ea r- ov er -y ea r c ha ng e Sources: U.S. Census Bureau; National Association of Realtors. 13 Emerging Trends in Real Estate® 2017 Chapter 1: Playing for Advantage, Guarding the Flank The State of the Suburbs: Residential Development Opportunities and Challenges In the coming decades, U.S. suburban housing markets are poised to maintain their relevance and predominance. A new analytic framework for classifying suburbs reveals significant dif- ferentiation between cities and suburbs and wide variety among different types of suburbs in terms of housing characteristics and conditions. These differences could substantially affect future residential demand and development in every major mar- ket in the United States. Key insights include the following: ● ● The United States remains a largely suburban nation. In America’s 50 largest (and most urbanized) metropolitan areas, suburbs account for 79 percent of the population, 78 percent of households, 32 percent of land area, and—despite popular and media perception—75 percent of 25- to 35-year-olds. ● ● Suburban growth has driven recent metropolitan growth. From 2000 to 2015, suburban areas accounted for 91 percent of population growth and 84 percent of household growth in the top 50 U.S. metro areas. ● ● The large majority of Americans work in suburbs, although job growth has been more balanced recently. As of 2014, 67.5 percent of employment in the 50 largest metro areas was in the suburbs. Between 2005 and 2010, employment in suburban areas remained stagnant with 0 percent growth, while it increased by 8.2 percent in urban areas. But between 2010 and 2014, jobs increased by 9 percent in suburbs versus 6 percent in urban areas. ● ● American suburbs as a whole are racially and ethnically diverse. Fully 76 percent of the minority population in the top 50 metro areas lives in the suburbs—not much lower than the 79 percent of the total population in these metro areas. ● ● The variety of types of suburbs creates a wide range of development opportunities. The report identifies development trends, issues, and innovative product examples in five distinct types of suburb within the 50 largest metro areas: “Established High-End,” “Stable Middle-Income,” “Economically Challenged,” “Greenfield Lifestyle,” and “Greenfield Value.” Housing in the Evolving American Suburb, RCLCO and the ULI Terwilliger Center for Housing, November 2016. older apartment buildings could sell excess zoning capacity (unused floor/area ratio [FAR]) as “priority sending sites” in exchange for committing to retain 30 percent of their units at targeted affordability rents. California legislation permits com- munities to allow higher densities in exchange for meeting affordable housing objectives. Similarly, in cities of lesser density and in older suburbs, plan- ning officials can work with a new breed of players pursuing strategies to maintain or only modestly increase current rent lev- els in the existing rental housing stock. By making only the most necessary improvements and having laser focus on property management, these firms deliver 100 percent occupancy and competitive current income returns, while helping meet a press- ing social and economic development need. The strategy is especially effective in markets where the spread between Class A and Class B/C apartment rents is fairly wide. Population increase, upward pressure on land and building costs, and persistent wage stagnation challenge government and the private sector to devise a menu of solutions. The trend to meet that challenge is gathering momentum. This is a “long- game” conundrum whose immediate difficulties are prompting an array of responses now. 7. Gaining Entry bey
Emerging Trends in Real Estate® is a trends and forecast publication now in its 38th edition, and is one of the most highly regarded and widely read forecast reports in the real estate industry. Emerging Trends in Real Estate® 2017, undertaken jointly by PwC and the Urban Land Institute, provides an outlook on real estate investment and development trends, real estate finance and capital markets, property sectors, metropolitan areas, and other real estate issues throughout the United States and Canada.
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