Real Estate In 2016: Opportunities, Pitfalls and Trends

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America’s real estate market contains many niches, with tremendous diversity of participants and asset types. When it comes to real estate in America, size definitely does not fit all. That diversity is a key strength because it promotes liquidity, price discovery, and opportunities to enter or exit the market. The following are my views on some of this year’s top trends affecting real estate that you should definitely be aware of.

Interest Rates

After years of anticipation, we are now living in the era of rising rates. The underlying question is how the generation whose entire business careers have been shaped by a low interest rate environment will respond to the upward movement in the price of money. The higher the price of money will undoubtedly cut into investors’ profits and future cash flow. And it is my belief that higher rates will alter behaviors, but to what degree? And at what threshold?

Statements by Federal Reserve officials emphasize that their plans are data dependent. That is, if the economy falters, then the interest rate hikes will be postponed. If the economy strengthens, the rate hikes could be sooner and more pronounced. Keep an eye on this as higher interest rates will certainly slow progress in the real estate market.

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Water

The historic drought afflicting the western United States has brought cascading impacts to the region and to the nation. The availability and cost of water will have a major impact on pricing and future development. Cities whose economic energy has been driven by population increases must confront limits on growth that are defined by water availability and cost. Although a strong El Niño for winter 2016 brought much needed rain, the water deficit west of the 100th Meridian is a factor that real estate should watch closely in the years ahead.

Semiconductor plants require enormous amounts of water for operations, as do the “cloud storage” data centers now so integral to the our Internet connectivity. Even something minuscule like the snow-making machines at ski resorts (which become even more essential when mother nature is uncooperative in providing the white stuff) draw large quantities of water to keep the region’s resort and recreation businesses humming.

As water for irrigation has become more problematic and costly, so too have food prices for crops ranging from almonds and artichokes to pistachios and raisins. As output is constrained, signs of declining farmland values are being seen. Most Americans tend to think of a “water crisis” as something that happens in very dry places such as Africa or the Middle East, but the truth is that almost the entire western half of the United States is historically a very dry place. Look for U.S. water bills to likely to soar in the coming years, thus affecting population growth and movement.

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Affordability

Primarily in the multi-family arena we have seen substantial rental growth over the last several years in some high-demand markets. This has resulted in rental rates increasing as much as fifty percent. This puts the strain on rental affordability. Renters have responded with doubling up via roommates (an increasing trend), and/or moving to smaller more affordable units. Watch for developments moving away from cities to more rural areas where land is cheaper. Wage growth has simply not followed this rental growth and we are seeing the beginning of some massive changes to come in making housing more affordable.

On another very serious note, the Supreme Court has affirmed that local communities can take legal action to address disparities in housing, even if they are the unintentional result of actions rather than conscious discrimination. This is a massive change in the law. This could alter where affordable housing is built, and where households in need of such housing may move. The primary barriers to affordable housing production remain local regulation, development costs (labor and materials), and land costs. Watch for a heated debate on multi-family development against the background the U.S. Supreme Court and HUD rulings.

One positive trend (and one of the ways the affordable housing stock is being increased efficiently and effectively) is the support of the new single-family rental companies. Look for this to be an emerging industry this year. These companies own single family houses, they maintain them, and they rent them out with a pretty big chunk as affordable housing. This is really an emerging industry, one that I think is going to come into its own in the next 18 months.

Senior Housing

The Baby Boomers have long been anticipated as a huge market for senior housing choices. Yet, as in so many other instances, this generation has confounded expectations. Right now, in early retirement (or deferred retirement), Boomers are more likely to be empty nesters than seek their long-range housing solution. But this will change with time.

Today the average age of someone in senior housing is about 85. That’s up significantly and continues to increase. We are seeing people live longer, and with higher acuity. Senior housing is still a lifestyle choice, but it’s a necessitated lifestyle choice. People are selling their home to make a different lifestyle choice. It’s like going back to apartment living, except that you’ve got food, entertainment, companionship, and healthcare. The option is appealing, and many Baby Boomers will elect assisted living.

But the oldest Baby Boomer is still under 70 years of age right now, so it’s on the horizon. We can glimpse the future opportunity and still recognize execution issues for now. Selling the existing home is, for now, not a “given.” Shortfalls in savings are a problem for many households, and fewer than half of U.S. households have retirement accounts. Those who are near retirement age and have such accounts have a median balance of only $104,000, according to a 2015 study conducted by the National Institute of Retirement Security. Those without such accounts have median savings of just $14,500. In light of such economics, senior housing (like so many other investment segments) requires careful scrutiny and acutely targeted selection.

Secondary Markets

Some of MC Companies’ strategies for 2016 involve experts in key secondary markets. Over time we have found that pricing resistance has been an issue for primary markets. Secondary markets, especially “18-hour” cities, are emerging as great relative value propositions. Such markets are hip, urban, walkable, and attractive to the millennials, while providing better future opportunities for rising net income and appreciation more so than the “24-hour” city markets that led the post-financial crisis real estate recovery.

These secondary markets (think Austin, Portland, Nashville, Charlotte…) boast lower costs of living (particularly in housing), and strong growth potential. As the cost of living and housing prices
have risen in the core gateway markets, it is apparent that a fresh look at suburban opportunities is gaining investor favor. In the top 40 U.S. metro areas, 84 percent of all jobs are outside the center city core and that’s the basis for optimism for the suburban future. Asset selection in secondary markets should pay off as a 2016 strategy.

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2016 EXPECTATIONS BY ASSET CLASS

Industrial

Industrials will be at the top of the commercial property sector for investment and development prospects. Investors like the value-for-price relationship in a property type where the average cap rate is about seven percent, the downside protection afforded by the triple-net leases that are typical in this sector, and the cash-in-hand quality of industrials.

Apartments

The multi-family sector has enjoyed a long run of success during this decade, and while we still rate this prospect highly, the high prices and low cap rates in many locations are giving some investors pause as they contemplate the future. There may be a shift in investment and development outlook in 2016 and beyond, although the demand
appears to be good for several more years. Truthfully I have never seen the apartment sector so good. That will change. There is too much building in some markets. High rent increases will have to come down. In many cases, this is a great market to sell. Investing is more challenging.

Office

The breadth of the U.S. office market is one of its greatest strengths and having options always provides value. For that reason, secondary office markets are experiencing higher levels of investment. We are seeing somewhat greater volatility priced by higher yields, and the ability to accommodate fast-growing companies with a volume of new construction at a cost much lower than that available in the primary downtowns. Investors are looking for “pocket markets,” conversions, redevelopments, and opportunities to reposition struggling suburban office parks with vast parking into more effective mixed use.

Hotels

A rising U.S. dollar is making international travel to the United States more costly for tourists and business visitors. This could show up in lower occupancy in 2016 for the hotel sector, especially for full-service facilities. While the overall development and investment outlook for both of those segments is up from 2015, many investors are considering selling before the anticipated reduction of cash flow due to potential lower occupancies. Take notice.

Retail

For neighborhood/community centers, investors are once again considering 2016 as a recovering year for smaller shopping centers, potentially giving them new life. This is the biggest change in over a dozen years. At malls, institutional returns on the top tier have surpassed the performance measures of the smaller shopping centers by a considerable margin. For technology, e-commerce, and multichannel retailing, the “bricks and clicks” discussion will get sharper; stores are adapting e-commerce while internet retailers have increasingly been dabbling in physical stores as a supplement to online sales.

Single-Family Housing

Quite a hangover still remains from the U.S. housing market collapse, epitomized by the subprime mortgage-induced bubble a decade ago. More than 7.4 million homeowners are still seriously underwater as of mid-2015, with the market value of the homes still lower than 25 percent or more than the outstanding mortgage balance, according to Realty Trac. Based on such data, some investors still see a slow recovery in the suburban housing markets and a disincentive for home buying.

On a positive note, residential starts came in at 1.2 million for the months of June and July 2015 — the best construction activity for
housing since late 2007. Even more telling, the growth was spurred by single-family housing after apartment development had provided the momentum during the past several years. The elements of a housing development that trend toward greater normalcy are falling into place, after the catastrophic collapse a decade ago.

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The inventory of finished new homes for sale is 5.4 months, right in line with historical averages, and price increases are beginning to reflect scarcity on the supply side. This condition sets the stage for further gains in 2016, since there is a shortage of ready-to-build housing lots. Banks are still skittish about land and development loans which was a major source of losses for them during the financial crisis. This has been good for the supply side and has meant that builders have not been able to get the pipeline for production anywhere near historical capacity.

The highly-favored multi-family rental sector has enjoyed a long run of success during this decade. Our emerging trends survey’s respondents still rate its prospects well, yet the extraordinarily high prices and low cap rates in many locations are giving quite a few of our interviewees pause as they contemplate the future.

We may well be seeing the beginning of a shift in investment/development outlook as we go forward in 2016 and beyond. Pay close attention to all these trends as they may greatly affect and help augment your portfolios.

Ken McElroy is the co-partner of MC Companies, a real estate investment, development and management company located in Scottsdale, Ariz. He is the author of the best-selling books, The ABC’s of Real Estate Investing, The Advanced Guide to Real Estate
Investing, and The ABC’s of Property Management. McElroy is also a contributor for The
Real Book of Real Estate by Robert Kiyosaki, and The Midas Touch by Donald Trump and Robert Kiyosaki. McElroy’s fourth book, The Sleeping Giant, is dedicated to the new class of entrepreneurs who are emerging in today’s economy.

About The Author

Ken McElroy

Ken McElroy is the co-partner of MC Companies in Scottsdale, Ariz. He is the author of the best-selling books, The ABC's of Real Estate Investing, The Advanced Guide to Real Estate Investing, and The ABC's of Property Management. McElroy is also a contributor for The Real Book of Real Estate by Robert Kioysaki, and The Midas Touch by Donald Trump and Robert Kiyosaki. McElroy's fourth book, The Sleeping Giant, is dedicated to the new class of entrepreneurs who are emerging in today's economy.

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