Friday, November 30, 2018

Strong Economy Keeping All Asset Classes Riding High

Demand for industrial facilities for distribution of goods to consumers continues to rise and hit historic benchmarks across the board, according to William Hankowsky, CEO of Liberty Property Trust, which is in the midst of a portfolio rotation away from office properties to a singular focus on the industrial sector.

Hankowsky’s message of a strong economic lifting all sectors of commercial real estate was echoed by other speakers at the annual Real Estate Outlook sponsored by the Urban Land Institute Philadelphia Thursday.

“Obviously, it’s the most dramatic, strongest market industrial space has ever seen in its history no matter what statistic you look at,” Hankowsky told more than 500 attendees at the Union League Club. “You’ve had 34 consecutive quarters of positive net absorption in many markets, you’re seeing the highest rents you’ve ever seen, and the converse of that is in many markets you’re seeing the lowest cap rates you’ve ever seen. Properties are trading in Southern California starting with a three, or North Jersey, and even in secondary markets, most of the trade now starts with a five in terms of a cap rate.”

The strong demand is largely a product of an unusually strong economic recovery, but layered on that, Hankowsky says, is the rising need for distribution facilities for e-commerce retailers.

“E-commerce has been a unbelievable structural change element in terms of the industrial space,” he says. “Ten years ago, most of us didn’t know we needed something delivered to our house in two days. Five years ago, you didn’t even know you needed it in a day, and you didn’t know three years ago you needed it today in an hour. That change in the customer consumer expectation about delivery times has had a dramatic fundamental effect on industrial space.”

The design of warehouse buildings has also been affected by the rising demand for rapid delivery, Hankowsky says. Warehouses now tend to accommodate 40-foot heights for more efficient racking of stock, and tenants need more land under the buildings because of the increased need for employee parking at large distribution centers, he says. Another significant change in the market is a greater focus on correlation of location and labor, he says. Warehouses now need to be close to an accessible workforce, so much so that “the HR person is often on the first visit to the location,” he says. “That never happened five years ago.”

In the retail sector, Joseph Coradino, chairman and CEO of PREIT, highlighted changes in the product mix at his firm’s malls, which used to allocate as much as 75% of their space to apparel sales, but are now redeveloping more experiential retail like restaurants, entertainment, and fitness.

Contrary to the constant barrage of obituaries for traditional retail that he faces, even from family and friends, Coradino noted that traffic at PREIT malls so far this holiday season is running above last year. The company issued a press release on traffic—timed to coincide with Coradino’s appearance at the Union League Club gathering—indicating that traffic at its Viewmont Mall in Scranton, PA was up 11 percent, and at the Moorestown, NJ, Mall, traffic rose significantly, even though a large space once occupied by Macy’s has only been partially filled with smaller retailers HomeSense and FiveBelow.

“Those two small stores occupy about 50,000 square feet of that 260,000 square feet,” Coradino says. “Traffic is up 9 percent.”

Many mall retailers now offer a service Coradino described as “BOPUS,” which means “buy online and pickup in store.” The service has the added effect of encouraging additional purchases, too.

“When someone picks up something at one of our properties, there’s a 73 percent chance that they’re going to make an ancillary purchase at the property,” Coradino says.

In the hospitality sector, customers are looking for luxury and willing to pay for it, according to Jay Shah, CEO of Hersha Hospitality Trust.

“We find that lifestyle and luxury today are the two segments where we have the greatest ability to drive rate and pricing power,” he says. “They seem to differentiate themselves in a way away from the commodity hotel products, and that’s what we’re finding that the markets are really seeking and willing to pay for.”

Hersha acquired the Philadelphia Westin about a year ago, Shah noted, and the property is fulfilling its promise, with the third quarter showing especially good performance, he says.

“That was driven primarily by continued strength in Philadelphia’s life science sector and the corporate sector, and leisure visitation to Philadelphia continues to be very strong,” he says.

Expansion of the definition of the modern office is one of the biggest adjustments taking place in the office sector, says Jerry Sweeney, president, CEO and trustee of Brandywine Realty Trust.

“In office, it used to be that you went to a definitive place to work,” Sweeney says. “With technology and other alternatives, the city really has now become the workplace, not one specific location.”

Brandywine’s portfolio today has less square footage but a higher quality overall product today compared with five years ago, Sweeney says.

“Our internal focus in our company right now is on preleasing some of our development pipeline and perfecting all of our approvals, including running all of those developments completely through the design development process,” he says. “Unless we fully price out our deals, it puts us at a real disadvantage in terms of attracting a corporate client, because we need to know—in this environment of rising construction costs and pricing volatility—what we can actually deliver.”

Real estate markets across the country are being driven by the search for talent, according to Lauren Gilchrist, senior vice president of research for Jones Lang LaSalle Philadelphia.

“Unemployment in the US right now is 3.7 percent, unemployment for people with a bachelor’s degree or more is two percent,” she says. “This is far beyond the conditions of full employment at this point in time, which means that competition for people is fierce.”

The talent pool is one of the factors that led to the Amazon decision to locate part of its HQ2 project in Long Island City, NY, she says. New York and Washington, DC are graduating students trained in technology fields at a much higher rate than the Philadelphia market, she says.

“When you look at the fact that New York and DC have graduated 31,000 advanced degree holders in one year, and you think about the fact that this company is looking for 50,000 people in technical occupations, you begin to understand, despite everything else, why our 6,000 STEM degree holders might not cut it,” she says.

The event also serves as the launch every year for the Emerging Trends in Real Estate Report jointly produced by ULI and PricewaterhouseCoopers, now in its 40th year.

Mitch Roschelle, PwC partner and business development leader, says this year’s report ranks Philadelphia in the top five cities for both hotel and industrial investment.

Building on Gilchrist’s remarks about the talent search, Roschelle expressed concern that job openings are going unfilled.

“We have seven million job openings, we have just under six million unemployed,” he says. “So there are a million people that we don’t have, for the job openings that we do have.”

Top trends from this year’s report include:

  • The rise of the “18-Hour Suburb” and that the millennial question is starting to be answered: many are looking for suburbs with urban amenities and good
  • Retail space is not dead, and it is a good time to repurpose space for alternative
  • New office buildings and multifamily assets are going above and beyond to meet a range of tenant needs through “amenities gone wild”.
  • Disruptors ranging from package delivery to autonomous vehicles are forcing redesign and amenity shifts for residential and commercial
  • Environmental, Social and Governance Practices are important to investors. Sensitivity to these issues has increased and funds with these strategies in mind could see an
  • Last mile industrial development is in high demand with the expansion of e-commerce far from over and the need for facilities to accommodate a dense distribution network

“ULI Philadelphia is proud to share this national research and bring together a high-level discussion and projection about the local real estate market led by our industry leaders in hotel, industrial, office, multifamily and retail development,” says Paul Commito, chair of ULI Philadelphia, a senior vice president at Brandywine Realty Trust. “Building on last year’s record-breaking program and attendance, today’s speakers gave our community a lot to think about as we tackle a fascinating year in development. I am proud of the progress we have made the ULI Philadelphia District Council and look forward to continuing to engage with new and established members, growing committees and serving the broader industry through our ULI Philadelphia advisory and impact projects.”

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