Suburban office Central-city office Medical office
Buy Hold Sell
0% 20% 40% 60% 80% 100%
45.0% 38.7% 16.3%
29.8 46.1 24.1
19.6 33.5 46.9
Source: Emerging Trends in Real Estate 2017 survey. Note: Based on U.S. respondents only.
profound ways. Floor plates with considerable space devoted to communal or nontraditional spaces are the new standard. Prepared-food and coffee centers became a stereotype of Silicon Valley, where larger firms typically occupied campuses isolated from their surroundings. This model is beginning to change, with tech firms favoring better integration with the com- munity, being part of a walkable live/work/play environment. Sites near rail transit are particularly favored. Emerging trends are normally evolutionary.
Urban models for tech and creative space involve the same open floor plan, high ceilings, and congregation space. Older cities often have an inventory of legacy office buildings and former warehouses that provide space with a lot of character. New construction is adapting to this model as well. An interest- ing example has been a social media company’s headquarters, where an emerging location in San Francisco was selected in a former merchandise mart. At first, the surrounding area was economically challenged, which discouraged food and bever- age vendors and coffee bars favored by employees, so the firm provided elaborate food and beverage operations in its space. Today, the area has blossomed, with thousands of units of new housing, restaurants, health clubs, a food market, and other trendy businesses. As a result, the company is encouraging employees to sample nearby commercial offerings, reducing the need for on-site amenities. On or off site, though, excellent coffee is a must.
Even when extra conference rooms, congregation areas, telephone booths for private conversations, and other added amenities are taken into consideration, space use has com- pressed in high-rent markets. While some firms are fiddling with this formula—some by adding very small offices for partners in professional firms, for example—this space design does not show signs of reverting to the previous layout. At a focus group in Austin, one participant said that the office space per employee “used to be 250 square feet; now it is 170 square feet.” Another participant said, “I still use 225 square feet per person; individual space that one person occupies has been downsized, but the community spaces have been enlarged.” Let the debate continue.
Lastly, “plug and play” office space has received a lot of atten- tion where space is readily available and fully equipped for flexible leasing. The product appeals to startup firms, but is also being used by established tech companies that need expan- sion space quickly. There are specific firms that specialize in this product, but other vendors and office space owners are finding this a lucrative venture.
Retail
Real Capital Analytics reports a 23 percent decline in shopping sector transaction activity, to $25 billion, through the first seven months of 2016. The sluggishness of the consumer recovery is one reason retail property has been only an average performer in recent years. Risks reported in the headlines (“the mall is dead” and “department stores are in a death spiral”) have not helped, either.
Concerns about retail continue to pop up in our annual Emerging Trends survey, which places the stores sector last among the major property types. On the investment side, retail came in dead last, even lower than last year. As for new devel- opment, its rating was rock-bottom.
However, feelings about retail are diverse, depending upon product and location. Urban/high street retail is the third-high- est-ranked subsector, while neighborhood/community shopping centers and lifestyle/entertainment centers received moderate ratings. At the other end of the spectrum, power centers and regional malls were in the cellar.
Retail properties have historically been most appreciated by focused public REITs and foreign investors. Institutional inves- tors are warier. The NCREIF universe still holds $113 billion in retail assets, although the single largest component is in the super-regional or “fortress mall” sector. A number of pension Exhibit 4-13 U.S. Retail Property Total Returns
NAREIT NCREIF ODCE
–40% –30% –50% –20% –10% 0% 10% 20% 30% 40% 50% 2016* 2014 2012 2010 2008 2006 2004 2002 2000 1998 1996 1994 A nn ua l r etur n
Sources: NCREIF Fund Index — Open-End Diversified Core Equity (ODCE); NAREIT Equity REIT Index.
fund advisers and foreign funds have provided minority equity to these REITs, which manage the properties.
Some institutional investors with a more positive view of retail properties have devoted resources to understand and man- age them. A number of these investors view high-quality retail a defensive play and continue to add to their portfolios. The ability to pass costs through to tenants makes shopping centers much less capital intensive than office properties. Over cycles, they have tended to outperform. Optimists see consumer demand likely to grow, with improving consumer confidence. With some actual reduction in supply as weaker centers are removed from inventory, retail properties could have a positive outlook. Class A malls have proved to be strong performers. A real estate corporate board member observed that “the best of these malls are owned and operated by the giants of the industry. They will figure it out and they will get tenants that are also figuring it out.” Based upon our survey of investors, this is a contrarian view. A real estate economist articulates the consensus that “we are going to see a record level of store closings as the internet con- tinues to cannibalize retail.”
Investors are focusing on smaller centers, including lifestyle/ entertainment, grocery-anchored, and even niche power cen- ters. Lifestyle/entertainment centers are often part of mixed-use development. Given the strong food and beverage orientation of these lifestyle centers, one investor observed that “going out to dinner is a 90-minute vacation” for those with hectic schedules. In the past decade, high street retail has come to prominence for institutional investors. Originally, this referred to the high fash- ion streets, such as Fifth Avenue, Madison Avenue, West 57th Street, Rodeo Drive, and a few others. In more recent years, the universe of high-profile streets has increased considerably to include such locations as SoHo and the Meat Packing District in New York, Beverly Drive and Melrose Avenue in Los Angeles, an expanded area around Union Square in San Francisco, and other locations across the United States. These properties are typically small, but are pricey on a per-square-foot basis. Investors have attempted to scale these acquisitions to create portfolios. Historically in the hands of private and family inves- tors, these assets are increasingly owned by institutions and REITs. A developer of urban retail notes “more interest by both existing brick-and-mortar retailers and some relatively pure e-retailers looking at putting stores in the urban environment.” At an Idaho focus group, a participant observed, “I have never seen downtown Boise retail as healthy as it is right now.” A consensus is emerging that e-commerce will decrease the overall demand for retail space, but will not come anywhere close
to supplanting it. Research has shown that a consumer may touch the retailer at many points along the route to transaction, possibly researching a product online, experiencing it in-store, sharing with friends for input, and then possibly buying online later for delivery or for in-store “click and collect.” A developer observed that “the really smart and sophisticated retailers are doing whatever they can to maximize both online sales and in-store experience. Some retailers are getting very good at blending bricks and clicks.” Mall owners also understand this experiential aspect, reflected by a developer who observed that “most sales increases have come from food and beverage” at malls.
Institutional investors and major REITs have largely sold off their Class B or C malls. An investment manager observes that “there is no worse investment than a poor-quality mall.” Nevertheless, opportunistic retail investors do exist, buying at low cost. While Exhibit 4-14 Retail Investment Prospect Trends
Urban/high street retail*
Outlet centers* Lifestyle/entertainment centers Neighborhood/community shopping centers Power centers Regional malls 2017 2015 2013 2011 2009 2007 2005
good
excellent
poor
fair
Source: Emerging Trends in Real Estate surveys. *First year in survey.