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CAPITAL MARKETS
Localized supply issues, butfundamentals strong overall
PROPERTY SECTORS
Financial market swings have left interestrates lower; real estate total returnsdown modestly
ECONOMYU.S. expansion facing heightened risks from global slowdown and trade negotiations
PerspectiveJUNE 2019
UN
ITED
STA
TES
Contents3 Economy
4 Financial Markets
5 Real Estate Investment
6 Apartment
8 Office
10 Retail
12 Industrial
14 Sustainability
Property Metrics
VACANCY / AVAILABILITY
ABSORPTION
NEW SUPPLY
RENT
U.S. PERSPECTIVE | JUNE 2019 2
Bentall Kennedy Research Sentiment
Positive Negative
BENTALL KENNEDY
3U.S. PERSPECTIVE | JUNE 2019BENTALL KENNEDY U.S. PERSPECTIVE | JUNE 2019BENTALL KENNEDY
Reasons for Optimism
• Workers are benefiting from extremely low unemployment and wages are rising.
• Over 2.3 million jobs were created over the past year. Numerous sectors continue to perform well.
• Recent slowdown concentrated in certain sectors, including: retail, manufacturing and government.
• Consumer and small business sentiment remain strong.
• A new North American trade agreement is within reach.
• Inflation is in check and the Fed may move to cut rates, perpetuating the expansion.
Reasons for Pessimism
• Consumption and business investment trending lower.
• The trade war with China continues to simmer.
• The tight labor market – exacerbated by immigration policy and related rhetoric – is limiting growth.
• Inverted yield curve discourages lending and is often a sign of impending recession.
Sources: Bureau of Labor Statistics, U.S. Employment & Training Administration, Moody’s Analytics
3
U.S. ECONOMY
Even with recent slower hiring, labor market reflects a healthy economy
3.6
3.9
4.2
4.5
4.8
5.1
5.4
0
50
100
150
200
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300
Jan-
16
Mar
-16
May
-16
Jul-1
6
Sep
-16
Nov
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Mar
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-17
Jul-1
7
Sep
-17
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-18
May
-18
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8
Sep
-18
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-18
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-19
May
-19
Job Growth
Weekly Unemployment Claims
Unemployment Rate
Job Growth/Unemployment Claims (000s, 3-mo. MA) Unemployment Rate (%, 3-mo. MA)
4U.S. PERSPECTIVE | JUNE 2019BENTALL KENNEDY U.S. PERSPECTIVE | JUNE 2019BENTALL KENNEDY
• As we anticipated, the stock market downturn in late 2018 did not reflect economic fundamentals and was owed to China trade tensions and Fed tightening.
• The market has rebounded in 2019, with the help of more dovish sentiment from the Fed.
• Concern over the trade war with China and potentially with Mexico produced another market dip in May, but stocks have since recovered some of those losses.
• Economic uncertainty, market volatility, and low bond yields globally have helped drive the 10-Year Treasury rate down near its lowest level since September 2017.
• U.S. rates are still relatively high in a global context, with negative yields in Germany and Japan.
• These conditions, coupled with the Fed’s steady rate hikes in 2018 have resulted in an inverted yield curve.
• Both the 3-month Treasury and Fed Funds target rate exceed the 10-Year Treasury yield at the time of this writing in June.
• As previously stated, with key inflation indicators subdued, the bond market is predicting the Fed will cut interest rates this year.
Sources: S&P Dow Jones, Federal Reserve, Bank of Canada, ECB, Bloomberg, Moody’s Analytics
4
U.S. FINANCIAL MARKETS
Stock market swings and yield curve inversion help put Fed back in play
1.9
2.1
2.3
2.5
2.7
2.9
3.1
3.3
3.5
95
100
105
110
115
120
125
130
135
Jan-17 Apr-17 Jul-17 Oct-17 Jan-18 Apr-18 Jul-18 Oct-18 Jan-19 Apr-19
S&P 500 Price Index10-Year Treasury
S&P 500 Price Index (YE 2016=100)* 10-Yr. Treasury Rate (%)*
-0.50.00.51.01.52.02.53.0
Germany Japan France Spain UnitedKingdom
Canada UnitedStates
Italy Greece
Select Global 10-Yr. Treasury Rates (%, as of 5/31/19)
* Data are smoothed using a five-day moving-average
5U.S. PERSPECTIVE | JUNE 2019BENTALL KENNEDY U.S. PERSPECTIVE | JUNE 2019BENTALL KENNEDY
• Sales volume remains strong with activity in the four major property sectors rising 12.3% from YE 18Q1 to YE 19Q1. This gain was largely owed to a strong second half of 2018.
• Activity rose in both major and non-major markets and was also up in each of the four major property types.
• Fewer major portfolio and entity transactions occurred in early 2019 compared to the start of 2018.
• Generally, valuations are on the rise, but at a somewhat slower pace than a year ago.
• Investment returns as reported by NCREIF show only a minor deterioration over the past year versus the previous two years.
• This comes despite a dip in retail returns as property values in the sector fell over the past four quarters.
• Industrial returns have been on an upward trend, aided by both strong fundamentals and investor demand.
• With interest rates remaining low, investment activity and property investment returns should be relatively healthy over the next year.
Sources: Real Capital Analytics, NCREIF
5
U.S. REAL ESTATE INVESTMENT
Relatively attractive yields and strong fundamentals keep capital flowing
$0
$20
$40
$60
$80
$100
$120
$140
$160
$180
Apartment Office Retail Industrial
2005-07 Avg.
2014-16 Avg.
YE 2017Q1YE 2018Q1
YE 2019Q1
Annual Transaction Volume (billions)
0%
3%
6%
9%
12%
15%
Overall Apartment Office Retail Industrial
NCREIF Property Index Total Returns (year-ending Q1 of each year)
2015 2016 2017 2018 2019
6U.S. PERSPECTIVE | JUNE 2019BENTALL KENNEDY 6
Vacancy
4.8%Vacancy
Past 13 Quarter Trend
10-Yr. Average:5.5%
§ Vacancy rose in the first quarter of 2019, but tightened modestly over the past year.
§ Vacancy remains significantly below its historical average and the four-quarter moving average is at its lowest level since 2001.
§ Certain markets will face upward pressure from accelerating supply.
Sources: Axiometrics, Bentall Kennedy
Absorption
299KUnits
Past 13 Quarter Net Absorption
10-Yr. Annual Average:236K Units
§ Net absorption weakened slightly over the past year but continued to surpass historical trends.
§ The U.S. homeownership rate fell in the first quarter, as single-family home sales and construction slowed.
§ Solid demand growth prospects are supported by a healthy labor market, higher homeownership costs and changing lifestyle preferences.
New Supply
301K Units
Past 13 Quarter Net Completions
10-Yr. Annual Average:221K Units
§ Supply growth moderated over the past year and multifamily permitting suggests that it has peaked for this cycle.
§ While supply growth is leveling out nationally, it is expected to pick up in a number of Sunbelt and tech markets.
Rent
3.3%YOY Growth
Past 13 Quarter YOY Rent Growth
10-Yr. Annual Average:2.7%
§ Low vacancy and rising wages—particularly among the younger age cohort—have supported an acceleration in rent growth.
§ Elevated supply and affordability constraints will cap growth potential in select markets.
§ Sunbelt markets experienced the strongest rent gains, but increased development activity weighs on the outlook for these metros.
As of 19Q1 4-Qtrs. Ending 19Q1 4-Qtrs. Ending 19Q1 YOY as of 19Q1
U.S. APARTMENT
Fundamentals strong even as supply remains elevated
4%
5%
6%
16 17 18 19-10
30
70
110
150
16 17 18 19
Thou
sand
s
-10
30
70
110
150
16 17 18 19
Thou
sand
s
2%
3%
4%
5%
16 17 18 19
7U.S. PERSPECTIVE | JUNE 2019BENTALL KENNEDY U.S. PERSPECTIVE | JUNE 2019BENTALL KENNEDY
• Declining affordability within the for-sale housing market has supported apartment demand.
• For-sale housing inventory remains tight compared to history, which has pushed the U.S. median home price well above its prerecession level.
• At the same time, mortgage rates rose throughout 2018.
• As a result, housing sales slowed considerably year-over-year and homeownership fell in the first quarter of 2019.
• Mortgage rates are trending lower again in 2019, but high prices remain an obstacle for many would-be homebuyers.
• Affordability constraints—along with changing lifestyle preferences and rising consumer debt—should keep homeownership rates relatively low.
Sources: Axiometrics, National Association of Realtors (NAR), Moody's Analytics
7
U.S. APARTMENT
For-sale housing market trends remain supportive of apartment demand
-2.0%
-1.5%
-1.0%
-0.5%
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
-20%
-15%
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19
Apartment Demand Growth (Y/Y)Change in Housing Affordability Index (Y/Y)
Housing Affordability Index
Apartment Demand
8U.S. PERSPECTIVE | JUNE 2019BENTALL KENNEDY 8
Vacancy
12.5%Vacancy
Past 13 Quarter Trend
10-Yr. Average:14.5%
§ Vacancy declined by 50 basis points over the past year, approaching its prerecession low.
§ Declines were strongest in key tech markets with tight vacancies and robust demand growth, such as San Francisco, San Jose and Denver.
§ Vacancy is expected to rise steadily as net completions pick up over the next year.
Sources: CBRE-EA, Bentall Kennedy
Absorption
64Million SF
Past 13 Quarter Net Absorption
10-Yr. Annual Average:32.7 MSF
§ Net absorption gained momentum driven by stronger office-using job growth.
§ Office leasing was dominated by tech-related firms along with life sciences and coworking tenants.
§ Labor constraints temper demand growth prospects in the year ahead.
New Supply
49Million SF
Past 13 Quarter Net Completions
10-Yr. Annual Average:32.4 MSF
§ Annual net completions remained stable in the first quarter, but supply growth is expected to pick up.
§ Office construction activity accelerated recently, with the strongest levels in high-growth Sunbelt and tech markets.
§ However, development activity remains well below levels of previous economic expansions.
Rent
3.2%YOY growth
Past 13 Quarter YOY Rent Growth
10-Yr. Annual Average:0.8%
§ Annual rent growth accelerated to nearly double its year-ago pace.
§ Tech markets, including the Bay Area, Austin and Raleigh, have surged back to the top in terms of rent growth.
§ Rent growth prospects will likely be restrained by a continued rise in construction activity.
As of 19Q1 4-Qtrs. Ending 19Q1 4-Qtrs. Ending 19Q1 YOY as of 19Q1
U.S. OFFICE
Rent growth has accelerated, but labor constraints and supply cloud the outlook
12.0%
12.5%
13.0%
16 17 18 190
10
20
16 17 18 19
Thou
sand
s
0
10
20
16 17 18 19
Thou
sand
s
0.0%1.0%2.0%3.0%4.0%5.0%
16 17 18 19
9U.S. PERSPECTIVE | JUNE 2019BENTALL KENNEDY U.S. PERSPECTIVE | JUNE 2019BENTALL KENNEDY
• National office development activity is steadily accelerating, with the strongest construction rates in high-growth Sunbelt and tech markets—led by Austin, Charlotte, San Jose and Seattle.
• Over half of the total space underway among listed major office markets is preleased, but rates vary widely by metro.
• San Francisco and San Jose boast preleasing rates of 75% or more driven by major tech expansions, such as those by Uber, Facebook and Google.
• Unleased space makes up a significant share of construction in Charlotte, Austin, Seattle and Miami—which could negatively impact fundamentals in these markets.
• The New York metro’s supply growth rate is similar to the national average, but development is dominated by speculative activity in Midtown Manhattan—which presents downside risk to key submarkets.
Source: CBRE-EA
9
U.S. OFFICE
Construction moderate nationally but risks rising in certain Sunbelt and tech markets
0
2
4
6
8
10
12
14
16
18
20
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
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Under Construction (SF)
Milli
ons
UC as % of Stock - Leased UC as % of Stock - Unleased Total Space Underway (SF)
Under Construction (% of Stock)
10U.S. PERSPECTIVE | JUNE 2019BENTALL KENNEDY 10
Availability
8.8%Availability
Past 13 Quarter Trend
10-Yr. Average:11.1%
§ Retail availability has fluctuated over the past two years, but fell in 2019Q1 to its lowest level since 2007.
§ Improvements in retail fundamentals will be aided by the repurposing of existing obsolete stock.
§ A recession would likely have an outsized effect on retail availability relative to other property types.
Sources: CBRE-EA, Bentall Kennedy
Absorption
24Million SF
Past 13 Quarter Net Absorption
10-Yr. Annual Average:19.1 MSF
§ Demand growth has been muted throughout this economic cycle as many retailers have shifted sales strategies and reduced store sizes.
§ More store closures have been announced in the first five months of 2019 than in all of 2018, outpacing openings.
§ Brick and mortar retail still plays a key role in most retailers’ strategies and many online-first companies have begun opening stores.
New Supply
10Million SF
Past 13 Quarter Net Completions
10-Yr. Annual Average:17.4 MSF
§ Less retail space was delivered over the past four quarters than at any point in CBRE-EA’s history, dating back to 1980.
§ High population growth metros will see the lion’s share of retail development as these are the metro areas where single-family home development persists.
§ Retail development in mature metros will be focused on destination retail and mixed-use projects.
Rent
2.2%YOY Growth
Past 13 Quarter YOY Rent Growth
10-Yr. Annual Average:-0.3%
§ Rent growth slowed year-over-year but will likely continue at or near an inflationary pace.
§ Rent trends are divergent among high and low quality centers. High visibility, high foot traffic centers remain sought-after.
Note: Retail data reflect neighborhood and community centers only
As of 19Q1 4-Qtrs. Ending 19Q1 4-Qtrs. Ending 19Q1 YOY as of 19Q1
U.S. RETAIL
Economic growth bringing benefits, but shrinking tenant footprints and bankruptcies remain headwinds
8%
10%
12%
16 17 18 19-5
10
25
16 17 18 19
Thou
sand
s
-5
10
25
16 17 18 19
Thou
sand
s
0%
3%
6%
16 17 18 19
11U.S. PERSPECTIVE | JUNE 2019BENTALL KENNEDY U.S. PERSPECTIVE | JUNE 2019BENTALL KENNEDY
• Retailers across segments saw annual sales growth cool in the first quarter of 2019.
• Headline growth slowed to 3.6%, while brick and mortar sales expanded at a much more tepid 2.4%.
• Ecommerce sales growth slowed as well, to 12.4%, down from its 5-year average annual growth rate of 14.4%.
• Strong performance in the bars & restaurants and health & personal care sectors has supported brick and mortar demand.
• Home furnishings outperformed earlier this cycle, but recent growth has slowed along with home sales and increased ecommerce competition.
• Commoditized industries, like electronics, toys, sporting goods, and hobbies continue to suffer. General merchandisers have benefitted from bankruptcies in these segments.
Source: U.S. Census Bureau
11
U.S. RETAIL
Retail sector sales trends reveal winners and losers
-10%
-5%
0%
5%
10%
15%
20%
Reta
il & Fo
od S
vcs (
Ex: V
ehicl
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as)
Reta
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Ex: E
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ts an
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Ecom
merce
: All C
atego
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Good
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Sales Growth (YoY; 2019Q1)
5-Yr. Average Annual Growth
12U.S. PERSPECTIVE | JUNE 2019BENTALL KENNEDY 12
Availability
7.1%Availability
Past 13 Quarter Trend
10-Yr. Average:10.6%
§ National availability increased in 19Q1 for the first time in 37 quarters.
§ Availability may rise further due to strong supply growth.
§ The national market should remain very tight relative to historical trends for the foreseeable future.
Sources: CBRE-EA, Bentall Kennedy
Absorption
232Million SF
Past 13 Quarter Net Absorption
10-Yr. Annual Average:171.6 MSF
§ Absorption softened in the most recent quarter, but demand growth has been robust over the past year.
§ Uncertainty created by trade disputes with key partners could continue to suppress near-term demand growth.
§ If economic uncertainty erodes consumer confidence, retail sales, and by extension industrial demand, may suffer.
New Supply
213Million SF
Past 13 Quarter Net Completions
10-Yr. Annual Average:120.1 MSF
§ Supply growth was similar in each of the past two years; both totals were the strongest of the current cycle.
§ Recent completions have been roughly in line with the peak of the prior cycle (2006), despite tighter fundamentals.
§ According to CBRE-EA, supply growth is set to accelerate by nearly 15% over the next four quarters.
Rent
4.1%YOY growth
Past 13 Quarter YOY Rent Growth
10-Yr. Annual Average:1.0%
§ Rent growth has moderated from prior outsized rates, but remains the strongest of the four major property sectors.
§ Rent growth is expected to continue, but is unlikely to accelerate.
§ Most markets are clustered between 0%-5% but several outliers, including Philadelphia and Orange County, are seeing more dramatic growth.
As of 19Q1 4-Qtrs. Ending 19Q1 4-Qtrs. Ending 19Q1 YOY as of 19Q1
U.S. INDUSTRIAL
A number of factors held back demand growth in 2019Q1
6%
8%
10%
16 17 18 190
75
150
16 17 18 190
75
150
16 17 18 19
Thou
sand
s
3%
5%
7%
16 17 18 19
13U.S. PERSPECTIVE | JUNE 2019BENTALL KENNEDY U.S. PERSPECTIVE | JUNE 2019BENTALL KENNEDY
• Availability is near its historical low. In the unlikely event that demand growth shuts down over the next year for economic reasons, and net absorption over the next four quarters is zero, national availability would remain below its 20-year average.
• If supply continued to grow at current rates in the absence of any demand growth, national availability would not eclipse its long term average until mid-2021.
• Many major US industrial markets are positioned to remain tighter than they have been historically as they benefit from growth in ecommerce. Tight conditions should allow them to weather this downside scenario.
• Markets such as New York, Detroit, San Jose, Boston, and Atlanta each have several years of runway before availabilities return to historical levels, even if demand were to shut down.
• A few markets are delivering enough supply currently to impact fundamentals in the short term. Dallas-Fort Worth, Houston, and Baltimore are among the metros at greatest risk of eclipsing their long term average rates in this downside scenario.
Sources: CBRE-EA, Bentall Kennedy
13
U.S. INDUSTRIAL
Stress testing industrial markets: Most markets should remain structurally tighter
2%
4%
6%
8%
10%
12%
14%
16%
Los
Ange
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Coun
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San
Fran
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New
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Availability
CurrentLong Term AverageNext Year - (Demand Shutdown)
14U.S. PERSPECTIVE | JUNE 2019BENTALL KENNEDY 14
SPOTLIGHT
Sustainability
As Co-Chair of the UNEP Fl Property Working Group and a member of the Investment Committee, we advance a global mandate to drive adoption of sustainability in real estate investment and property management.
In 2018-2019, Bentall Kennedy, UNEP Fl and the Real Property Association of Canada (REALPAC) conducted an ESG survey of global real estate investors and fund/asset managers representing over $1 trillion USD of assets under management. This survey was one of the largest ever conducted of its kind, and it revealed a near consensus view on the importance of weighing ESG criteria in real estate investment decision-making.
Global ESG Real Estate Investment Study
90%plan to further analyze ESG criteria over
the next 12 months_____________________
93%of investors, including fund and asset managers, include
ESG criteria in real estate investment decisions_____________________
85%are highly or very highly motivated to use
ESG criteria to lower risk_____________________
83%have experienced an increase in investor demand
for sustainability disclosure
Download the Global ESG Real Estate Investment Survey report here
15U.S. PERSPECTIVE | JUNE 2019BENTALL KENNEDY
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