TIGHT MARKET CONDITIONS CAUSE MORE RENEWALS
The U.S. industrial market will see some dramatic shifts in 2020. Absorption gains will be difficult to achieve with extremely low vacancy rates and limited space options in several markets. Consequently, net absorption will be lower than in previous years. Anecdotally, we are seeing higher-than-normal renewal rates, particularly in the markets with the lowest vacancy rates, and this trend should continue if not accelerate in the near term. Overall, the market will remain stable as e-commerce penetration continues to impact supply chains. As operations become more complex for occupiers, there will be a heightened focus on outsourcing, paving the way for growth in the third-party logistics (3PL) sector.
SHIFT IN SUPPLY/DEMAND FUNDAMENTALS
Considering there will be more renewal activity and fewer leases for new space, the consensus between CBRE Research and CBRE’s I&L business is that supply will outpace demand by 20 million to 30 million sq. ft.—the first time there will be an overhang of space since the 2008 recession, albeit representing only 0.2% of total industrial inventory. The vacancy rate may increase slightly, but should remain near historic lows in 2020.
STRONG RENT GROWTH FROM NEW CONSTRUCTION AND INFILL
Despite some softening in the market, CBRE forecasts rent growth of 5% in 2020, on par with previous years. Rising rents will be driven by newer product and infill industrial space in supply-constrained markets. High-quality, first-generation Class-A warehouse space typically generates a rent premium. And demand for light-industrial warehouses of less than 120,000 sq. ft. will accelerate as e-commerce companies race to offer same-day delivery to customers. These properties have seen rents rise by 30% in the past five years, whereas big-box rents rose by 15%. Considering that space is very limited in the smaller-size segment, rent growth is expected to continue over the next 12 months.
FIGURE 10: HISTORICAL AVERAGE ASKING RENT GROWTH & FORECAST
Source: CBRE Research, CBRE Econometric Advisors, Q3 2019.
LIMITED EFFECTS OF TRADE CONFLICT
Should the U.S.-China trade conflict persist or deepen, economic growth may suffer and have a negative impact on I&L markets. Nevertheless, I&L market fundamentals remain extremely strong, and trade with China—while important—is not the only demand driver.
If trade tensions continue, two factors must be watched: consumer spending, which has a direct impact on industrial market dynamics, and supply chain restructuring, whereby import sourcing shifts largely from China to other countries like Vietnam, Malaysia and India. Uncertainty will drive growth in the 3PL segment of the industrial market as companies outsource their operations. This will translate into more 3PL leasing activity—a trend that is already underway.
MARKETS TO WATCH
As user dynamics change with supply-chain growth requiring more facilities across industrial hubs, several secondary markets are becoming desirable from an investment perspective. The major risk to investors in smaller, secondary markets is oversupply and lack of liquidity. Based on an examination of key metrics,1 CBRE has identified Charlotte, Cincinnati, Denver, Louisville, Orlando, Portland, St. Louis and Tampa as key secondary markets that will offer strong liquidity and relatively high income returns in 2020.
1.New industrial supply relative to the amount of existing inventory, 2014-2018; NCREIF income returns, 2014-2018; net absorption vs. construction completions, five years; current Class A cap rates, Q2 2019; RCA liquidity score, 2014-2018.
FIGURE 11: KEY EMERGING MARKETS, SUPPLY VS. DEMAND
Source: CBRE Research, Q3 2019.
U.S. Outlook by Sector
U.S. GDP growth will slow to between 1.5% and 2% in 2020, down from an average of 2.5% over past five years.
U.S. GDP growth will slow notably next year as various issues create higher levels of uncertainty, including the ongoing U.S.-China trade conflict, slowing global growth and a presidential election. Barring any unforeseen risks, we assess that a recession will be avoided, thanks in large part to the stimulatory effects of the Fed’s rate cuts in 2019. Slow growth will continue in 2020, broadly supporting already strong property market fundamentals.
Investment volume in 2020 should total between $478 billion and $502 billion, making it one of the strongest years on record.
Amid slower economic growth and global uncertainty, U.S. commercial real estate will remain a haven for investment in 2020. Greater investor caution and buyer-seller disconnects on pricing could moderately reduce volume from 2019 levels. Cap rates should be broadly stable, with slight compression for multifamily assets and slight increases for the other major sectors for an average spread of about 260 bps over 10-year Treasury yields next year. Investors should not count on significant appreciation returns, but income returns will remain steady.
Demand for office space will remain strong in 2020. Flexible space inventory will continue to increase, but at a slower pace.
Despite continued positive absorption of office space in 2020, rent growth will slow and vacancy will increase. Leasing activity will remain driven by tech tenants, benefiting markets like San Jose, Austin and Salt Lake City. Flexible office providers will strategically expand their footprint but a drawback by WeWork will significantly slow expansion from previous years. CBRE’s forecast is for 51.1 million sq. ft. in completions, a 70-bps increase in vacancy and 1.6% rent growth.
Absorption gains will be limited in 2020, with available supply outpacing demand. Nevertheless, rents will rise by 5%.
Despite some softening in the industrial & logistics (I&L) market, overall fundamentals will remain strong due to continued e-commerce penetration and demand for logistics space. Rent growth will be driven by newly constructed facilities and infill properties. Although there are potential trade-related risks, resilient consumer spending will buoy the I&L market and mitigate any tariff effects on major hubs relying on port activity.
Total U.S. retail sales increased by 3.5% year-over-year in Q3 2019 to $1.57 trillion, however more modest growth is expected in 2020 to $1.55 trillion.
Total U.S. retail sales growth is expected to slow in 2020, as consumers become more cautious. Positive net absorption and rent growth in most U.S. markets will be spurred by a lack of new supply and thousands of retail store openings. Malls are benefiting from the refreshing influence of Generation Zers, who prefer to shop in stores and are driving traffic back to brick-and-mortar retail. Many retail assets will convert to mixed uses, creating communities and thriving town centers.
The multifamily vacancy rate will edge up by 20 basis points to 4.5% in 2020, remaining under its long-term average of 5.1%.
Multifamily is positioned for continued favorable performance in 2020 but will experience some cooling due to new supply outpacing demand. Completions will match peak levels of recent years. New and potential rent control legislation will remain an industry concern. The best opportunities are in suburban markets, smaller metros and metro leaders, including Austin, Atlanta, Phoenix and Boston.
Interest in specialty sectors will continue, with alternatives accounting for more than 12% of all commercial real estate investment in 2019.
Investment in alternative or specialty sectors has risen steadily in recent years and will continue to attract high levels of investor interest and capital in 2020. Total investment in 2020 will come close to the annual average of $59 billion since 2014 and represent 12% of all commercial real estate investment, up from only 6% at the peak of the last cycle. Alternatives acquisition volume in 2020 likely will match this level.
New deliveries will increase the primary data center markets’ total inventory by 17.3% in 2019, increasing the competition between certain markets in 2020.
The wholesale data center sector continues to evolve as flexibility and agility within IT and real estate strategies drive decisions. Transaction volume remains driven by the adoption of Hybrid IT/multi-cloud access strategies by users. Adding momentum headed into 2020, network connectivity should remain a critical component of overall IT and real estate decisions. Demand will continue as users right-size and adapt their portfolios to handle current and future technologies, such as high-performance computing (HPC) and 5G.