The year 2014 may be the year that the commercial real estate market fully recovers from the Great Recession. There are several economic factors and commercial real estate trends that suggest that this will happen.

Economic Trends – expected to improve further into the new year

  • Oregon’s economy finished 2013 in its best condition since 2008
  • State unemployment has dropped to 7.3% from its peak of 11.6% in May of 2009
  • Home prices in the Portland area have climbed 12% in the past year
  • Underwater mortgages have dropped from about 25% in 2010 to 10% today
  • The state’s biggest employers – Nike, Intel, Oregon Health & Science University are thriving
  • New Oregon legislation in 2013 to create a lower tax rate for S corporations should boost the small business climate

As you can see several economic trends for the state of Oregon are pointing in the right direction. I wish the rural areas of the state were doing better but that won’t happen until sanity returns in Salem and Washington D.C. that allows the harvesting of state and national forests at modest volumes. If that were to occur, family wage jobs would return to our rural communities and prosperity would follow. But I digress. Are economic factors in the state improving at a robust pace? No that would be an overstatement but they are improving at a slow but steady pace.

Emerging Trends in Real Estate 2014® is a highly regarded trends and forecasting publication in its 35th year of production. It is a joint effort by Price Waterhouse Coopers and the Urban Land Institute and reflects the views of over 1,000 real estate professionals that were interviewed to generate the 2014 report. There are four key trends identified in this year’s report:

Four Key Commercial Real Estate Trends for 2014

  • Increasing Interest Rates – Interest rates will continue to rise in 2014 but it is believed that the market can handle an orderly increase in interest rates without a serious disruption to the recovery. The real concern is how long will interest rates stay low? What happens in five years when rates are up? What will be the exit strategy for investors when capitalization rates rise? But for 2014 the consensus is that the increased borrowing cost due to rising interest rates will be offset by higher rents.
  • Real Estate Fundamentals Strengthen – Immediately following the Great Recession properties were purchased at historically high cap rates with the hope that cap rates would compress over time resulting in appreciation growth. We are now beginning to see a new trend where market fundamentals have slowly improved to the point that real income growth is likely to occur over the next couple of years. Occupancy rates and rental rates are expected to rise, improving property cash flows. The more attractive properties are now those with upside potential – a shift from recent trends where buying occupancy and safety was the primary criterion.
  • Plenty of Sources for Capital – the availability of debt and equity capital is on the rise in 2014. There are more sources of capital and they are becoming more willing to risk their capital in smaller demographic markets and a wider variety of property types.
  • Generation Y Impacts America – There are 72 million gen Yers in the United States, only slightly smaller than the baby boom generation. They are the most ethnically and racially diverse of all the generations and they are characterized as the most urban and the most transient. When you think of Gen Yers think Northwest Portland and the Pearl District. Gen Y takes transit, walks and bikes. They prefer the advantages of living in the downtown core – walking to work and to all their favorite shopping and entertainment spots. They have seen the recent disaster of home ownership and prefer renting over owning because of the freedom to be able to move whenever it suits them.

So how will the Gen Yers affect commercial real estate? Going forward there will be more demand for rental housing and retail uses in the urban areas. There will also be a shift to working at home and more demand for office space in the downtown core and less demand than in years past in the suburban markets.

Conclusions

I anticipate that economic growth in 2014 will be sufficient to generate a growing demand for commercial real estate across most property types. Returns on commercial real estate will result from improving market fundamentals (rising occupancy rates and rental rates) and/or operational improvements and will replace returns through cap rate compression. And as a result I believe 2014 will be the best year we’ve seen for commercial real estate since the boom years prior to the Great Recession. What do you think? Am I being too optimistic?

Sources: Progress in the new year, The Oregonian Editiorial Board, December 24, 2013; Emerging Trends in Real Estate 2014® by Price Waterhouse Coopers and the Urban Land Institute.