Diversification into real estate is interesting in many ways, but the timing of markets can also play a role. Here, we share an interview with Jay Kerner, the CEO of U.S. Realty Partners, about the current state of the commercial real estate market. Jay has over 29 years of experience in the acquisition, development, operation, leasing, and management of shopping centers, multi-family, and mixed-use properties. He also authored a comprehensive book about commercial real estate, entitled “Chasing Yield.” We asked Jay about his insights as to where we are in the major commercial real estate sectors as we approach the end of 2014, and where he thinks things might be heading.
Realty Mogul: Jay, where do you think we arein commercial real estate today? Multi-family is usually considered a pretty defensive play; where do you see that going?
Jay Kerner: In 2014, multi-family experienced strong rent growth averaging an estimated 5.9 percent in all segments: Lifestyle, Class A, B+ as well as B and C buildings across most areas of the U.S. Demand by both renters and investors was unabated. New supply coming online increased, but it did not have a material impact on vacancy rates in most markets. Washington, D.C. and Northern Virginia were the exception with no real rent growth due partially to decreases in high paying government jobs and increases in sectors with lower wage jobs. With interest rates remaining historically low, investors have found still lower cap rates and fierce demand for available properties.
2015 looks to be another banner year for the multi-family segement. Average rent growth is projected to be lower than 2014, but still strong with increases of 4 to 5% in most markets. Expectations are at the lower end of that range for Lifestyle, Class A and B+ buildings and at the higher end for Necessity, Class B and C buildings. The West (Denver to the Pacific) continues to show its dominance with 7 of the projected top 10 rent growth markets in the U.S. In high demand locations of the Bay Area rents are projected to top over 8% growth. On the other hand, new inventory will start to impact certain markets such as Charolotte, N.C. and Albuquerque, N.M. Metro Los Angeles rental rate increases are projected at 3.5% due to increased supply. For investors, cap rates are projected to remain stable (at historic lows) with a limited supply of buildings compared to high demand.
Realty Mogul: How about retail? What’s going on there?
Jay Kerner: The economy continues to slowly improve and retail continues to evolve. Stronger job growth, record low debt service burdens, lower gas prices and increasing home values are supporting increased consumer spending. However, limited wage growth is keeping a lid on the rate. As e-commerce grows, retailers have increased omni-channel solutions to further integrate their brick and mortar and online operations. The brick and mortar retailer is far from dead, just evolving. In general shopping continues to become more experiential with a focus on eating and being entertained; however, grocery and drug store anchored centers remain productive and in high demand. “Daily Needs” traffic is a powerful force. Retail sales overall are projected to have increased just under 4% in 2014, with 2015 expected to be stronger with a projected growth rate 6%. For investors, cap rates in 2014 remained at historic lows for institutional Class A metro market properties, and demand for solid properties in secondary and tertiary markets increased. 2015 looks to be more of the same with interest rates remaining low, cap rates steady to decreasing and investors seeking the higher yields to be found outside of the top major metro markets.
Realty Mogul: Are consumers shopping any more now that we’ve passed the worst of the recession?
Jay Kerner: Consumer confidence is increasing as employment growth continues and gas prices fall. Real growth in wage rates is expected to gradually increase. All of this bodes well for retailers and leads to the projected higher growth rate for retail sales in 2015.
Realty Mogul: How about office buildings? What’s the scenario there?
Jay Kerner: U.S. office vacancy rates dropped in 2014 and expected to continue this trend in 2015. Downtown and suburban markets in Denver, Houston and San Francisco are the tightest markets and building owners are seeing the lowest vacancy and increasing rents. Markets such as Washington, D.C, and Chicago are more challenging for owners and favorable for tenants. New construction in most markets was subdued in 2014, and is expected to be low overall in 2015. Overall this should result in continued rent growth and lower vacancy. Tech companies are still leading the markets in leasing activity. Business services, creative industries and financial services have also been very active.
Realty Mogul: Industrial is another major market segment – how do you see that playing out over the next few years?
Jay Kerner: This sector’s fundamentals will continue to improve; demand is increasing and vacancy rates continue to fall. The forecast for stronger growth in U.S. GDP in 2015 is very positive for the industrial sector.
In 2014 falling vacancy rates put upward pressure on rents and new supply has been growing at a restrained rate. New speculative development will continue to increase in 2015 but increased demand is expected to keep rents on a positive trajectory. The growth in e-commerce as caused a spike in demand for large warehouse and distribution space, and smaller light industrial properties have seen lower vacancy and increasing rents as well.
Jay Kerner: The hospitality sector was strong in 2014 and is projected to experience record occupancy in 2015. The improving economy and favorable supply and demand has led to significant occupancy growth and profitability. With increased occupancy, hoteliers are expected to increase their average daily rates (ADR – a key metric for determining health in the industry) at an average annual pace of over 5% from 2015 through 2017.