Commercial Real Estate Outlook 2017

12. December 2016

Commercial Real Estate assets around the world maintained their allure among investors over the first three quarters of 2016. While performance differs between and within major markets, demand for retail and office space has been stable or growing in the majority of locations in Europe, Asia and North America. Demand has tapered off compared with recent years but the performance of the commercial real estate market in 2016 should give investors plenty of cheer this holiday season as well as something to look forward to heading into a new year with plenty of due diligence projects.

Economic headwinds and tailwinds influencing the market

The continuation of two primary trends sustained demand for commercial real estate from January through June.

The first was the continuation of accommodative monetary policies from global central banks. Projections at the beginning of the year that the US Federal Reserve would pursue a more aggressive path for rate increases were repeatedly pushed out into 2017 and beyond.

Lower borrowing costs supported prices in the commercial real estate by making the yield on these properties much more attractive to individual investors as well as large institutions. While the pace of monetary tightening has frustrated some economists and market analysts, projections for a more gradual rise has sustained interest in the market for such assets.

While overall investment has declined in major markets compared with the previous year, prices across the Eurozone continue to benefit from accommodative monetary policy. As long as the yield on 10-year government bonds remains near zero or even slips into negative territory in many developed economies, average returns of 4.5% on commercial real estate continued to entice investors throughout 2016.

The second trend that is supporting prices for commercial real estate is the persistent flow of funds into commercial real estate in developed economies from international investors. Continental Europe in particular has benefited from strong demand from private equity funds in Asia and America, although the appetite for such assets among domestic investors remains more subdued.

This pattern is most evident among properties in prime urban locations. As global equity prices approach or exceed historic valuations in many markets, commercial real estate is increasingly attractive to investors. 

Rental demand

Strong demand for office space in prime locations within developed economies also supported the market throughout 2016. Higher consumer and business confidence as well as economic growth in Europe and the United States led businesses to expand and hire more.

Office properties in London continued to fetch the highest prices as of the end of the second quarter, with space in the West End going for almost 1,500 Pounds sq ft per year. While the Brexit vote did have a noticeable impact on prices, the city continues to lead all other competitors on the continent and beyond.

In the aftermath of that country’s decision to leave the EU, large financial firms have begun to explore shifting jobs to other cities in order to maintain access to the single market. Frankfurt, Paris and Dublin remain are all vying to attract the large banks and well paid jobs that sustain prices in London but, as of yet, nothing has materialized to influence the market in any of these cities.

Demand for retail space cooled off in 2016, although performance among individual markets varied significantly. Upper 5th Avenue in New York City was the most expensive location in the world with store fronts averaging $3,000 sqft/year; Causeway Bay in Hong Kong is second with Paris’s iconic Champs Elysees taking a distant third.

Regional Analysis and Differences

Many locations in Europe did generate impressive retail growth throughout 2016. Across the continent, retail demand increased in 70% of markets and prices were stable in an additional 25%. Prices in Covent Garden in London outperformed all other major locations in Europe, Asia, and North America with 32% retail growth.     

In North America, the majority of markets were stable however 21% experienced declines across retail properties. This year, investment volumes in European commercial real estate fell by 16% compared with the first three quarters of 2015.

Some countries within the Eurozone that had been laggards performed relatively well in 2016. Investment in Italy and France both rose with demand for commercial space increasing in Paris by close to 20%. Major markets across Asia also experienced growth year to date with properties in China, Australia and Japan continuing to receive high valuations.

Real estate Due Diligence in 2016

Prices for large commercial projects in prime locations set records in 2016 with eye watering valuations. The acquisition of Asia Square Tower 1 for $2.45 billion by the Qatar Investment Authority was the single largest acquisition ever in the Asia Pacific Region.

Private equity firms, sovereign wealth funds and real estate holding companies were part of the largest transactions in many major markets. A South Korean-German partnership purchased the Safeco Plaza in Seattle this July for $387 million making it the single biggest deal in that city this year amid strong demand for commercial assets among international investors.

Anbang Insurance was the largest single player in the commercial real estate market throughout 2016. Following the Chinese companies purchase of the iconic Waldorf Astoria Hotel in Manhattan last year, the company has continued to shell out billions for prime retail properties, office buildings and hotels in Europe, Japan and North America throughout 2016.    

Lessons from the year and looking ahead to 2017

The optimistic picture described so far as well as the outlook for next year is tempered by recent geopolitical events. Although the long term impacts remain to be seen, the result of the Brexit has already caused many investors and employers to reevaluate their position in the country. However, many investors on the continent are hoping London’s loss may become their gain in 2017 and are therefore positive about the transaction market.

One clear lesson from 2016 is that low interest rates globally have continued to sustain demand for commercial real estate assets, thereby fostering the deal market. Since the surprising election of Donald Trump, investors around the world have begun to bid up yields on American 10-year bonds, which form the benchmark rate for many large loans.

Higher rates may squeeze the spread on many properties subject to financing as well as negatively influence valuations. Recent changes may prove to be temporary and interest rates will stabilize or even fall in 2017, however, this will be an important trend for investors to keep on eye on in the year.