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Monday, December 23, 2019

The Ups and Downs of Houston’s Commercial Real Estate Market in 2019


By Rand Stephens (Houston)


The commercial real estate market in Houston had another good year in 2019. Houston’s economy and job growth remain healthy, despite a lackluster energy market. Industrial continues to be the top-performing sector of commercial real estate while the recovery in the office market is still moving at a snail's pace.

Energy Industry Recovery Hits the Pause Button
The energy industry has a big impact on the office market. Recovery for the oil and gas market slowed to a standstill in 2019, with stock prices down and oil prices in the $50 - $60 range. When oil prices took a nose dive in 2014, the ripple effect trickled into job growth and the office leasing market. It seems to be two steps forward and one step back ever since. Back then, capital markets provided the liquidity for recovery, but today energy companies must restructure and finance themselves. An upswing of the office market is contingent upon job growth in the energy sector and while there were some flickers, it was not sustainable throughout 2019.

Vacancy Rates Spur Positive Changes
Houston office vacancy rates hovered within the scale of 16% most of the year and construction was limited with 1.3 million square feet (msf) completed in 2019, as of mid-December. Employers continue to woo younger employees with amenity-rich office buildings, including food services, mobility services and environmentally-friendly components. Older class A buildings have responded to the newer, modernized buildings, like Capital Tower and 609 Main, by undergoing upgrades and transformations. While this bodes well for tenants, in the long run, it’s not clear whether making significant investments to older buildings will prove out from an investment standpoint.

The trend of tenants upgrading their facilities while becoming more efficient with their space continued in 2019. For example, Direct Energy left their 191,000-square-foot (sf) space in Greenway Plaza for a 105,000-sf office space in Houston Center, which is undergoing a facelift. Companies are now expanding their headcount while using considerably less space. Overall, the better buildings will be the winners, but this trend is a loser for the market as a whole.

Industrial Leads the Way
The industrial market continued to be the driving force for the commercial real estate sector in Houston in 2019. E-commerce and Port Houston maintain their “bread-and-butter” status for the industrial sector. We saw major distribution center commitments by big retailers such as Home Depot and Costco. As was the case in 2018, the fundamentals of Houston’s industrial market had a strong year and are consistent with the performance of the market nationally. Currently, there is close to 20 msf of industrial construction in the works which is expected to be completed in 2020, and more than 50% of that space is unoccupied. The industrial market undoubtedly has a healthy supply of industrial product going into 2020 but absorption continues to be excellent.

Summary
Houston’s commercial real estate industry had a solid year in 2019 despite a stagnant energy sector Our local economy stood strong due to increased population and job growth. What challenges and successes are in store for commercial real estate in 2020? Stay tuned for forecasts and predictions for 2020 in January’s blog. Happy holidays and cheers to a prosperous new year!

(Rand Stephens is a Principal of Avison Young and Managing Director of the company’s Houston office.)

Tuesday, December 17, 2019

Toronto Real Estate Forum: 2020 Outlook for European Investment Markets

By Tim Francis (London, U.K.)

Last week, I attended Canada’s largest annual national conference on real estate capital markets and investment management. The Toronto Real Estate Forum provides an international outlook on major trends, strategies, risks and opportunities in real estate, including insights on European real estate investment markets. Global geopolitical factors, investment appetites and emerging sectors were at the forefront of conversations.

Current geopolitical and economic drivers influence the risk premiums that are being applied to the required returns investors care about. Factors like Brexit, new European Central Bank leadership and a new European Parliament are increasing levels of uncertainty. Global investors are looking at Europe, which has traditionally been viewed as a safe haven for real estate investment, with a new perspective. While continuously low interest rates have served to sustain investment and compress yields across the continent (2% is the new 3% for core assets), many investors voiced concerns over the high values of European real estate and the current position of the global economy, 12 years out of a 10 year cycle post the previous global financial crash.

However, sustained positivity and appetite to invest were clear throughout the forum. With extremely low, sometimes negative, bond yields, investors are increasingly looking for stabilised income producing assets, which is driving the real estate markets. On top of low bond yields, strong rental growth in many core and secondary markets is alleviating the effects of low real estate yields and driving investment flows. Take Stockholm: the central business district has seen c.40% rental growth in the last three years, providing investors with huge uplift to their return profile. Another driver of demand is the undersupply of Grade A office space across all major European cities. Vacancy rates remain below 2% in most locations, resulting in assets that are still performing well, despite trading at low yields.

The alternative sector has emerged in the last five years as a pathway to achieve opportunistic and core plus returns in Europe. The defensive attributes of alternatives like residential, senior living, or hotels, provide an attractive option for global investors, especially North American capital, due to an under-established investment market when compared to the US. Interestingly, global investors are looking at London as the biggest opportunity in Europe right now. The uncertainty derived from Brexit and the general election has provided opportunity in the market across all sectors. The current discount on Pound Sterling is considered by global investors as providing a ‘double return’, as the currency will inevitably bounce back to higher values in the coming years, although this is not being priced into transactions.

Finally, sustainable investment is growing globally. Many fund managers now have commitments to their own investors to attain certain targets around environmental, social and governance issues. Sustainable investments must align with a commitment to promote sustainable business practices and the conservation of natural resources. Impact investing practices are at the centre of this shift, illustrated through the rise of investment portfolios increasing their exposure to GRESB (Global Real Estate Sustainability Benchmark) assessed infrastructure assets, which increased from 51 global funds in 2016 to 107 in 2019, totalling $471bn this year.

Tim Francis is a Financial Analyst at Avison Young’s London office

Tuesday, December 10, 2019

What the BTR sector can learn from tech

By Arthur Zargaryan (London, U.K.)

Built to Rent (BTR) has been taking over the real estate market and pushing both traditional house builders and institutional investors into this emerging sector. BTR brings along a major paradigm shift, a move from a primary focus on the physical space, to placing increased importance on the provision of a service.

Why would someone pay what might seem a premium for a BTR unit over a regular flat? The answer is almost always the same – convenience. This trend for convenience and bundling is happening across many industries, including tech, where all-you-can consume content providers offer a new level of service to users. While the underlying economics of tech and real estate companies are different, there are still many transferrable lessons. Here are a few.

Economies of scale

Bundling services is only possible at a certain scale. Netflix for instance is only able to make its operation profitable because it has 158 million users worldwide. Real estate can also benefit from economies of scale and bundled experiences.

BTR works best at large scale, with the average size of a completed site in 2019 encompassing 133 units. The average size under construction is 245 units and for schemes currently in planning this rises to 325 units. Larger schemes are better able to support the cost associated with operating such buildings, allowing landlords to negotiate better per unit deals for utilities, furniture and more.

Significant benefits also exist when expanding a portfolio geographically and creating a network of buildings. As people move from city to city, change jobs or start a family, they can always remain within a provider’s BTR ecosystem. This reduces customer acquisition costs while increasing occupancy rates.

Big Tech Data in BTR

Gathering and analyzing the right data can greatly benefit the Built-to-Rent sector, as it has the world of tech. Netflix, for example, uses the data it gains from millions of users to understand what content becomes popular and why, and consequently creating its own shows and movies in its in-house studio.

BTR has huge data opportunities, covering both how physical assets behave, as well as how tenants interact with a building. BTR developments need to be built to a standard that minimizes maintenance and repair costs, while offering attractive design. It is therefore crucial to find materials, appliances and furnishings at the best best price to performance ratio. Key metrics such as power usage or life time of an appliance are crucial in calculating costs and informing future fit-out decisions.

The second data point covers how tenants interact with a space. Key card access or sensors on furniture can track the movement of tenants throughout the building in an anonymised manner. This allows landlords to calculate the occupancy of different common areas and understand how amenities are used. For example if tenants aren’t using spacious common areas as much as anticipated, additional qualitative data collection can help operators understand how to improve spaces in the current and future developments. Capturing and analyzing available data benefits the developer / operator’s bottom line, as well as improving the tenant experience.

Brand Premium

Brand premium charged on BTR is not necessarily achieved through physical design or prime locations. While these help, brand premium is built by putting into place certain processes that ensure better customer service and facilities.

Services such as a concierge or receptionist can add significant value towards the brand premium. Some of the most requested services from front of house staff are parcel management, key management, and security. Parcel Tracker, an app developed by Deepfinity, which is part of Avison Young’s Entrepreneurs in Residence scheme, ensures parcels can be processed more efficiently. Thanks to the simplification of the internal process, up to 70% of staff processing time is saved.

There are a range of software applications such as Parcel Tracker that introduce processes that are simple to implement and can be scaled up from a single building into an entire portfolio, ensuring great and reliable services to tenants and further building upon the brand premium.

Arthur Zargaryan is Co-Founder of Deepfinity Ltd and an Entrepreneur in Residence at Avison Young’s London office

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