5 Trends in Commercial Real Estate for 2017: Pt. 1

The U.S. property market landscape in 2017 will be characterized by continued strong fundamentals, increased investor flows, and high transaction volume. As for the economic landscape, the U.S. continues to grow moderately and add jobs. U.S. employment gains continue to be strong, with unemployment dropping below 5 percent earlier last year, and adding to demand for commercial real estate in a variety of sectors. Many are surprised we have not reached the end of the current economic growth cycle. The fact that the recovery was so protracted and that growth relatively anemic over the last seven years leads me to believe that we may have another two years left in the current growth cycle. 

The U.S. Federal Reserve made it clear last December that the central bank sees U.S. growth as relatively stable, notching the federal funds rate higher by a quarter point in early December. This is only the second time since 2006 that the Fed has raised rates (the last time was in December 2015). “Economic growth has picked up since the middle of the year,” said Janet Yellen, the Fed’s chair. “We expect the economy will continue to perform well.” Nevertheless, underlying inflation is extremely tame in the United States and in major emerging markets (with worries of deflation in some sectors and countries), providing no impetus for significantly higher rates. Lending rates and fixed-income rates of return will still be very low by historical standards, inducing continued levered purchases of real estate assets.

Now for the elephant in the room—what are potential impacts of a Trump presidency?

Over the last two months, many in the public and private sectors have been scrambling to speculate on what a Trump administration will bring. Trump has pledged to make massive changes in our economy, regulatory environment and government, but it remains to be seen, even with a Republican majority in both houses, how much change can really take place. While Trump is famous for making, then changing and even retracting statements, many see a few common themes in his rhetoric that could play out in the economy over the next year or two.

His focus on the economy, economic competitiveness and initiating a long-term trend in higher infrastructure spending could trigger slightly higher GDP growth, higher inflation and a stronger dollar. Higher inflation would cause the U.S. Federal Reserve to increase rates, even more than the gradual and protracted pace today. Higher rates will be good for banks and savers, but not so good for bonds and assets that are typically levered such as real estate. He has also committed to lower corporate and personal tax rates and granting a one-time tax holiday for U.S. corporations to repatriate profits to the U.S. at a lower tax rate. Lower tax rates could spur investment and savings which could lead to growth across the board in commercial real estate.

However, if public sector spending is not cut at the same time, it could lead to massively more government debt, which could depress economic growth and inflation causing the Fed to pause in their rate hike regime. If firms with profits abroad repatriate the huge pool of capital, estimated to be around $3.5 trillion, we might see a significant stimulus for the economy, particularly if it goes towards new investment and personnel and not simply stock buybacks. 

Trump has also promised to dramatically reduce regulation. U.S. business are some of the most regulated in the world. Reduced and simplified regulations at all levels of government would allow business to operate with fewer constraints, potentially reducing costs, opening new areas of business and making the business environment easier to negotiate particularly for small and mid-size businesses, the bulk of U.S. private sector employment. He has threatened to increase the capital gains tax to the higher corporate tax rate. This would create a huge disincentive to invest in private real estate, where investors typically benefit from long-term capital gains tax treatment. He has made it clear he would like to reduce regulation on coal, shale and oil industries, which could lead to higher profits and growth for firms in this industry and could benefit those regions with a higher concentration of energy activities such as Texas and the upper plains states.

These five trends will play a significant role in commercial real estate in 2017 (Trends 1-3 are presented here, with Trends 4-5 in Part 2):

1. Global Economic and Political Uncertainties

The Brexit vote in the United Kingdom has added new uncertainties that will not be fully understood, much less resolved, in the near term. Trump’s election in a way signaled the continuing populist revolt of the West, with governments in France, Italy and Germany potentially leaning more towards a nationalistic policies and leaders. Trump has been very vocal in his disapproval in trade agreements. Expect higher tariffs for several countries including China, Mexico and South Korea and potentially many others. This could usher in a new wave of deteriorating relationships with these countries. Higher tariffs would also mean higher prices for a wide variety of consumer and industrial goods that the U.S. imports, putting pressure on higher inflation. The International Monetary Fund (IMF) has downgraded global growth twice since January as uncertainties blur the outlook.

For U.S. markets – real estate in particular – the impact is likely to be largely positive as U.S. assets become more attractive and valuable to global investors. We can probably expect enhanced inbound foreign investment in U.S. real estate markets as the U.S. becomes even more of a safe haven. The IMF predicts higher economic growth in the world as emerging markets find their footing and commodities continue their recovery. Stronger global growth is likely to provide more real estate inflows into the U.S. market.