Brick by brick: How US real estate is constructing its future

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The U.S. real estate industry is strong today due largely to the health of the country’s economy, which is boosting demand for residential and commercial property. Demographic factors in the U.S. are also creating new types of demand, and various real estate sectors offer good growth prospects now and into the future.

What's more, international capital, in search of a safe haven, is flowing into the U.S. and being invested in real estate, and it's not just because of the UK's Brexit vote to leave the EU.

REIT Prospect for GrowthLow interest rates are generally positive for real estate. They have suppressed the yield on 10-year U.S. Treasurys to below 1.7% (as of June 10), making the yield on real estate all the more attractive on a relative basis.Favorable economic drivers The number of Americans filing for unemployment has recently fallen to its lowest rate since 2007, which could be a sign of the sustained strength of the labor market. And there’s little to suggest a recession: GDP growth looks set to continue, albeit at a modest 2% to 2.5% annual rate.

There are, however, some small reasons for concern and possible caution. For example, a strong U.S. dollar hurts exports, moderating corporate profits and resulting in lower capital expenditure.

Ever cautious about damaging the long, slow recovery that has followed the global financial crisis, the U.S. Federal Reserve continues to keep interest rates low. Uncertainty about trends in U.S. jobs creation, doubts about the EU’s stability following the Brexit vote and a slowdown in China’s economy are holding rates at a historically low level of 0.5%.

“There is still such a wide gap in the 10-year Treasury yield and the overall return for real estate,” says Lorraine White, a partner in Tax Services at Grant Thornton LLP. Any “little incremental increase” in interest rates over the next year or two is not going to affect the market negatively, she adds.

“Every time there is sentiment that the Fed will increase rates, you can see the particular impact on the public stocks,” says Donald Wood, president and CEO, Federal Realty Investment Trust. While there is a correlation between the underlying real estate value and the value of the stock, it is not one-to-one, so the two need to be differentiated, he explains.

Across the U.S. there is a great deal of optimism and a collective desire to see interest rates remain low into the future. The timing of any rate hikes could create headwinds for real estate developments if they are half-completed when interest rates rise.

“Just about anywhere I go in the U.S., it’s amazing to see the number of cranes,” says Alvin Wade, national managing partner, Construction, Real Estate, Hospitality and Restaurants at Grant Thornton. “But I think we’ll see a softening in some of those larger markets sooner because they started developing before other cities.”Emerging optimism CBRE Global Investors forecasts returns from U.S. commercial real estate to be in the 6% range over the next five years. This is expected to be slightly higher for the industrial market and slightly lower for the apartment market.

Construction has been a familiar sight across U.S. cities for much of the current development cycle — notably in trophy-asset cities such as New York and San Francisco, and in fast-growth cities such as Dallas and Seattle.

While it is difficult to foresee the end of the current real estate cycle, according to Wade, the eventual cresting of the market may raise some questions about certain properties and the “level of debt that was used to finance them.”

The pace of recovery Sectors within U.S. real estate are rebounding individually.

“The office and industrial markets are still only in the middle of a recovery cycle,” says Anthony Wirth, head of EMEA logistics strategy and research, CBRE Global Investors.

“The retail market is still very early into any sort of a recovery as it sorts out larger structural challenges, while the apartment market is at a much more advanced stage of its recovery and is less likely to see as much rent growth ahead of it,” he adds. However, the hotel market has made more than a full recovery and CBRE is advising “only selective investments where the opportunity is right,” says Wirth.

A look ahead Events outside the U.S. have the potential to affect the industry, as do changes in the regulatory environment. On balance, many investors are heading to the U.S. and investing in real estate for the safe haven benefits it offers.

“The economy and more capital attraction has been supportive of the real estate industry in 2016,” says Smith. “I think this trend will continue for some time.”
Millennials and seniors are shifting demand U.S. demographic trends are shaping demand for tailored real estate developments. “If we talk about growth, owners and operators have to understand and be proactive about how real estate is changing, and what their customers need and want,” says Chris Amato, principal, Business Advisory Services at Grant Thornton.

“If we talk about growth, owners and operators have to understand and be proactive about how real estate is changing, and what their customers need and want,” says Chris Amato, principal, Business Advisory Services at Grant Thornton.

Millennials (those born between 1980 and 2000) are leading the urbanization trend in the U.S., creating new demand for living, working and leisure in downtown locations. “Smart developers are really out in front and accommodating what the millennials want,” says Richard Smith, Industry Advisor at Grant Thornton.

Meanwhile, baby boomers (those born between 1946 and 1964) are creating increased demand for health care facilities and service providers, as well as dedicated retirement communities. “We have a very large aging population in the U.S. that’s shaping demand for new types of real estate,” explains White.

Contact Greg Ross
Partner, Audit Services
T +1 704 632 6817