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Deloitte Center
for Financial Services
Contents
Foreword 1
Looking back
Looking forward
Macroeconomic fundamentals
Globalization 8
Investments 11
Financing 13
Transaction activity
15
Property-specific fundamentals
17
Sustainability 20
Technology and automation
22
25
Regulations 27
Where do CRE executives go from here?
29
Foreword
Dear colleagues:
In many ways, the commercial real estate (CRE) industry is on more solid footing than it has been for quite some time. The U.S. economy continues
to improve, although concerns remain in both Europe and some emerging markets. Investors are generally seeing solid performance, and profitability
continues to improve across most property types and markets.
The sector is poised for strong growth over the next 12 months. Availability of financing through traditional and nontraditional channels is likely to
continue to drive domestic investor interest in U.S. CRE. In addition, U.S. CRE is increasingly gaining international investor interest. Investor sentiment is a
bit cautious going into 2015, despite profitability being quite strong in many sectors.
Property fundamentals continue to improve, and owners will likely benefit from investing in redevelopment of existing properties to enhance competitiveness with newer building stock. Companies cannot afford to ignore adoption of sustainability measures and smart building technology. Leveraging
technologies such as social, mobile, and analytics will be increasingly important to drive operational efficiency and improve tenant loyalty.
But concerns some new, some old are keeping industry executives on their toes. Whether its the pressure coming from nontraditional competitors,
the evolving threat of cybercrime, or the rising cost of regulatory compliance, CRE executives have ever evolving challenges. Companies that are able to
effectively steer through these challenges and build on the positive momentum in the industry by leveraging technology will maintain a competitive edge.
We are pleased to share with you our views on industry trends and priorities for 2015 based on the perspectives and firsthand experience of many of
Deloittes leading real estate practitioners, supplemented by research from the Deloitte Center for Financial Services.
Producing Outlooks of this type has the result of exposing the authors to second-guessing; hindsight is 20/20. Nevertheless, we feel it is important to
reflect on what we said a year ago and put our prior prognostications to the test by analyzing what we got right and perhaps not exactly right in
our 2014 CRE outlook. You will find this looking back analysis leading off this years edition, followed by a looking forward summary of our views on
the coming year.
The report will then explore 10 top issues of importance for the industry over the coming year, with each including a specific look at the Focus for 2015
and a Bottom line that provides some actionable takeaways for industry leaders to consider.
We hope you find this report insightful and informative as you consider your companys strategic decisions for 2015. Please share your feedback or
questions with us. We value the opportunity to discuss the report directly with you and your team.
Bob OBrien
Jim Eckenrode
Executive Director
Deloitte Center for Financial Services
Deloitte Services LP
+1 617 585 4877
jeckenrode@deloitte.com
Looking back
Fundamentals
Rent and vacancy continued to improve across property types, while development activity
remained muted, except multifamily and hotels
Tenants technology use influencing leasing decisions
Regulatory uncertainty persists across key regulations such as TRIA, FIRPTA, and lease
accounting standards
Looking forward
Macroeconomic
fundamentals
Transaction
activity
Investments
Globalization
Financing
Sustainability
Property-specific
fundamentals
Technology &
automation
Security &
privacy
Regulations
Macroeconomic
fundamentals
Labor markets
The unemployment rate fell to 6.1 percent in August, the
lowest since the 2008 financial crisis and closer to prerecession levels.3 And the pace of employment growth
appears to have picked up. The long-term unemployed as
a percentage of total unemployed has fallen recently.4
While labor force participation remains low, a tightening
labor market is likely to bring some of those people
back into the labor force. The labor force participation
rate could rise almost a full percentage point (from 62.8
percent in August to an average level of 63.7 percent in
2019) as many of the latent unemployed re-enter the labor
market and are employed.5
Index
200
10
180
160
140
120
100
Source: Bureau of Economic Analysis, Bureau of Labor Statistics, and S&P/Case-Shiller, September 2014
600
500
571
400
409
436
408
300
359
379
298
200
100
273
235
171
244
230
169
122
65
156
165
209
264
252
192
176
131
2Q14
1Q14
4Q13
3Q13
2Q13
1Q13
4Q12
3Q12
2Q12
4Q11
1Q12
3Q11
2Q11
1Q11
4Q10
3Q10
2Q10
1Q10
4Q09
3Q09
2Q09
1Q09
4Q08
3Q08
2Q08
1Q08
20
(-10)
4Q07
40
(-8)
3Q07
60
(-6)
2Q07
80
(-4)
1Q07
(-2)
Globalization
Italy
3%
Outbound CRE
investments by U.S.
Spain
3%
Ireland
3%
Netherlands
3%
Japan
5%
1H 2014
Others
16%
China
8%
Germany
11%
United
Kingdom
30%
France
18%
Others
24%
Canada
25%
Australia
4%
Hong Kong
6%
Japan
10%
Germany
4%
Singapore
5%
China
8%
Bermuda
7%
Norway
7%
Percentage
12
Index
200
10
180
160
140
120
100
2Q14
1Q14
4Q13
3Q13
2Q13
1Q13
4Q12
3Q12
2Q12
4Q11
1Q12
3Q11
2Q11
1Q11
4Q10
3Q10
2Q10
1Q10
4Q09
3Q09
2Q09
1Q09
4Q08
3Q08
2Q08
1Q08
20
(-10)
4Q07
40
(-8)
3Q07
60
(-6)
2Q07
80
(-4)
1Q07
(-2)
Source: Bureau of Economic Analysis, Bureau of Labor Statistics, and S&P/Case-Shiller, September 2014
600
500
571
400
409
436
408
300
359
379
298
273
200
235
171
100
244
230
169
122
156
209
264
252
192
176
165
131
65
0
2007
Americas
2008
EMEA
2009
2010
2011
2012
2013
1H 2014
Asia-Pacific
Americas includes USA, Canada, and Latin America; EMEA includes UK, Western Europe, Eastern Europe, Middle East, and Africa; Asia-Pacific
includes China, Japan, Australia, New Zealand, India, Hong Kong, Singapore, Malaysia, South Korea, Taiwan, and Others
Source: RCA, August 2014
10
Investments
Figure 6: REIT fundraising, PERE dry powder, and returns by asset class
$ Billion
90
$ Billion
REIT fundraising
250
80
70
200
63
30.7
25.7
60
150
50
40
13.8
26.8
30
10
0
10.4
18.2
20
5.2
19.9
16.1
2.3
FY06
1.8
FY07
12.3
0.8
FY08
Initial Public
Offering
22.4
40.5
45.8
35.2
21.2
3.0
FY09
35
33
19.2
100
49
51
70
84
86
45
38
47
37
34
37
36
30
50
26.2
35
95
78
93
35
36
41
33
89
106
110
18.2
2.0
FY10
Secondary Equity
2.3
FY11
1.8
FY12
5.7
FY13
.08
FY14 YTD
Secondary Debt
Dec-06 Dec-07
North America
Sep-14
Europe
Returns by
asset class
FY09
FY10
FY11
FY12
FY13
FY14 YTD*
Public REIT
(All REIT Index)
27.5
27.6
7.3
20.1
3.2
13.1
S&P 500
26.5
15.1
2.1
16.0
32.4
8.9
DJIA
18.8
11.0
5.5
7.3
26.5
2.9
Russell 2000
27.2
26.9
-4.2
16.4
38.8
-3.0
* FY14YTD for REIT fundraising is as of August 2014 and for returns is as of September 23, 2014
Source: NAREIT and Preqin, September 2014
11
12
Financing
Commercial/multifamily
mortgage delinquency rates
Percent
Index
Non-traditional sources
CMBS
Commercial Banks
Life Companies
CMBS
Freddie Mac
Green bonds
CRE companies have started to issue
innovative fixed-income instruments
such as green bonds. These bonds now
provide access to low-cost and long-term
debt capital for CRE companies to pursue
their sustainability initiatives.
2Q14
3Q13
4Q12
1Q12
2Q11
2Q14
3Q13
4Q12
1Q12
2Q11
3Q10
4Q09
1Q09
2Q08
3Q07
4Q06
1Q06
2Q05
3Q10
100
4Q09
200
1Q09
300
2Q08
400
3Q07
500
4Q06
600
1Q06
10
9
8
7
6
5
4
3
2
1
0
2Q05
Traditional sources
700
Fannie Mae
Crowd funding
CRE companies, especially the private ones, are using
crowd funding, which essentially provides a mechanism
to raise capital for diverse project needs directly from
accredited investors.
Source: Mortgage Bankers Association, September 2014 and Deloitte Center for Financial Services analysis
13
14
Transaction activity
$ Billion
600
20
16
14
15
500
10
400
5
0
300
1
(3)
(5)
200
(0) (1)
(4)
(9)
(10)
(11)
(15)
100
Apartment
Hotel
Industrial
Office
Retail
1H13
Unknown
User/other
Private
Listed/REITs
FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14
YTD
Inst'l/Eq Fund
(18)
Cross-Border
(20)
1H14
15
M&A activity
M&A activity declined by 50.3 percent YOY in the first
seven months of 2014.45 This follows a rather strong year
of M&A activity in 2013 as many companies sought to
leverage discounted valuations in the listed REIT space,
resulting from a rise in interest rates after the Federal
Reserves decision to taper its quantitative easing
program. In fact, at the end of 2013, all property sectors,
except hotels and health care, were trading at a discount
to their net asset values.46 In addition, there is an increase
in spin-off activity, especially by REITs, as they capitalize on
the healthy transaction market to refine their portfolio.47
16
Property-specific fundamentals
Tenants sustainability focus and technology
use redefines space demand and supply
Leasing activity continues to gain momentum. As a
result, CRE fundamentals, including rent growth and
occupancy levels, are now witnessing sustained improvement across property types (Figure 9). Technology and
sustainability measures are increasingly influencing
tenants leasing decisions and vary across most property
types. Increasingly, tenants are considering the positive
impact of sustainability measures on employee morale,
productivity, and well-being. According to the 2013 World
Green Building Council report titled The Business Case
for Green Building, certain design attributes of a green
office building enhance occupant health and well-being,
therefore resulting in healthier, happier, more satisfied, and
ultimately more productive workers. Consequently, CRE
owners need to assess the usability of existing space and
new supply in context of the changing demand dynamics.
Industrial
Increase in online shopping, international trade, and manufacturing activity continue to have a positive impact on
industrial fundamentals rent growth for industrial space
inched up to a solid 4.5 percent in 2Q14 from 1.6 percent
in 2Q13, and vacancy declined to 10.8 percent, compared
to 11.9 percent during the comparable prior year period.48
Net absorption was a strong 53.4 million square feet in
2Q14, compared to 49.4 million square feet in 2Q13.49 The
increased use of technology and online sales in particular
is redefining the supply chain. As omni-channel retailers
with e-commerce activity focus on speed of delivery to
improve competitiveness, location of the warehouse and
distribution centers is likely to play a more critical role than
before. Warehouse owners should collaborate and plug
into the tenants supply chain and strategically determine
location for new developments. Further, industrial real
estate owners need to be more flexible and responsive to
the dynamic inventory levels and space requirements of
17
Office
Industrial
Retail
Apartment
Office
Industrial
Retail
2Q20
2Q19
2Q18
2Q17
2Q16
2Q15
2Q14
2Q13
2Q12
2Q11
2Q10
2Q09
2Q08
2Q20
2Q19
2Q18
2Q17
2Q16
2Q15
2Q14
2Q13
2Q12
2Q11
2Q10
2Q09
2Q08
2Q07
2Q06
2Q05
2Q04
2Q03
2Q02
2Q01
-15
2Q07
-5
-10
2Q06
2Q05
Forecast
2Q04
10
20
18
16
14
12
10
8
6
4
2
0
2Q03
Percentage
2Q02
Forecast
15
2Q01
Percentage
Apartment
Tenants sustainability focus and technology use redefines space demand and supply
The increase use of technology
and online sales in particular is
redefining the supply chain
Industrial real estate owners need
to be more flexible and responsive to the
dynamic inventory levels and space requirements
of their tenants
18
Office
Improved business sentiment and employment prospects
have led to sustained recovery in office vacancy rates and
rental growth. In 2Q14, vacancy rates and rental growth
were 14.5 percent and 3.1 percent (compared to 15.2
percent and 2.5 percent, respectively, in 2Q13),53 and
net absorption was approximately 15.4 million square
feet (compared to 10 million square feet as of 2Q13).54
However, new development activity is likely to remain
low as tenants continue to focus on flexible work spaces
through efficient space utilization. Therefore, office
property owners will potentially benefit from including
design features that meet their tenants flexibility and
sustainability requirements, as redevelopment and refurbishment of existing space will likely prevail in the near to
medium term.
Multifamily
The improving job scenario continues to support apartment-sector performance, with vacancy rates down to
4.4 percent in 2Q14 compared to 4.6 percent during
2Q13.55 However, rent growth was 2.6 percent compared
to 3.1 percent in 2Q13.56 Net absorption totaled 145,429
units compared to 119,805 units in 2Q13.57 The sector
continues to witness a strong development pipeline. This
will likely be supported by changing tenant preferences
for multifamily homes over single-family ones, particularly
among younger and older generations, in the medium
term. While apartment owners/operators are comparatively less impacted by the onslaught of technology from
a demand-supply perspective, they need to continue to
leverage it in the leasing and tenant service processes to
establish better rapport with existing and potential tenants.
Lodging
The lodging sector continues to post strong growth.
In 2Q14, higher occupancy (+3.6 percent YOY to 68.1
percent) and average daily rates (+4.4 percent YOY to
$115.5) led to an 8.2 percent YOY growth in revenue per
available room.58 However, hotel owners should consider
19
Sustainability
155
98
Minimum
550
Mean
Maximum
Source: *IRR represents the unlevered internal rate of return on the overall building investment.
Source: Deloitte Center for Financial Services analysis
20
have lower sensitivity to energy and operational and maintenance cost savings compared to top-line benefits arising
from higher rental and occupancy rates and an eventual
rise in property values. Further, the relatively higher LTV
ratios provided to finance a LEED-certified building have
a significant impact on the post-retrofit IRR of the equity
investment.
According to Jon Lovell, director of sustainability, Deloitte
Real Estate, United Kingdom, "strong sustainability
performance has become a prerequisite for prime market
expectations of quality, and the narrowing of capital flows
to core product in recent years has arguably inflated values
to the extent that some of the subtleties of sustainability
performance have become hidden in the competition
for stock. Moreover, it is reasonable to expect that rental
growth will be more heavily suppressed in properties in
which energy and other utility costs are high compared to
rental levels. In this sense, sustainability is driving a greater
divergence between prime and non-prime property. That
said, these effects remain clouded by a deficit in proper
in-use performance data across the sector."
Along with adopting sustainability measures, it is equally
important for companies to measure internally and report
externally (implementation and results) in a credible and
reliable manner, and in accordance with recognized frameworks that demonstrate commitment to transparency
around sustainability performance. For instance, investors
require increasing levels of disclosure of credible narrative
and nonfinancial information and greater rigor in related
risk management processes.
The impact of measurement and reporting is also visible
on brand value. Impact on brand value is at two levels
building and enterprise. This impact will vary across
companies, and each CRE company needs to have the
right metrics in place to measure its green performance.
21
Tenants
IT
systems
Connected
ecosystem
Seamless
communication
Vendors
IT
systems
Business systems
Enterprise resource planning (ERP),
Material requirements planning (MRP),
Customer relationship
management (CRM), etc.
Source: The Institution of Engineering and Technology, UK, and Deloitte Center for Financial Services analysis
22
Mobility
Mobility continues
to significantly
influence peoples
behaviors related
to how one works,
where one lives,
and how one shops.
Social media
Social media can act
as the perfect tool to
increase tenant and
employee
engagement and is
gaining traction.
23
24
Software vulnerability
Access management
Security
and
privacy
Business continuity plan
Comprehensive strategy
Employee awareness
25
26
CRE companies can consider taking a step-bystep approach (Figure 13) to address the abovementioned security and privacy concerns. To begin
with, companies should develop a robust and
comprehensive security and privacy framework,
with specific strategies for unique risks related to
individual technologies to be secure, vigilant, and
resilient. For example, companies can consider
appropriate tools for advanced user authentication; applications and data encryption; malware
protection; and rigorous threat monitoring
systems. Next, companies need to increase
employee awareness by proactively educating
them about the importance of strong passwords
to reduce system vulnerability and accessing
seemingly unsecure content or downloading freely
available external apps. Third, companies should
have a business continuity plan whereby, in case
of a hacking incident, systems and processes
can be restored with minimal business disruption and appropriate communication protocol is
followed with partners, clients, regulators, and
law enforcement agencies. Similar to technology
adoption, a one-size-fits-all approach will likely
not work with implementing security and privacy
measures. Hence, it will be critical for companies
to identify the appropriate course of action based
on different assessment criteria such as size and
complexity of the organization, interconnections
with tenant and vendor systems, existing security
systems, and plans to adopt new technologies.
Regulations
Continued uncertainty!
Likely impact
Short-term extension
27
FIRPTA
Lease Accounting
Standards by IASB
and FASB
Issue
Likely impact
Risk of non-renewal
Capitalization of operating
leases
28
29
Contacts
Industry leadership
Bob OBrien
Vice Chairman and Partner
Global and U.S. Deloitte Real Estate Leader
Deloitte & Touche LLP
+1 312 486 2717
robrien@deloitte.com
Deloitte Center for Financial Services
Jim Eckenrode
Executive Director
Deloitte Center for Financial Services
Deloitte Services LP
+1 617 585 4877
jeckenrode@deloitte.com
Authors
Lead author
Surabhi Sheth
Research Leader, Real Estate
Deloitte Center for Financial Services
Deloitte Services India Pvt. Ltd.
+1 615 718 8364
susheth@deloitte.com
Co-author
Saurabh Mahajan
Assistant Manager, Real Estate
Deloitte Center for Financial Services
Deloitte Services India Pvt. Ltd.
30
Endnotes
ibid.
ibid.
31
32
33
37
38
ibid.
39
ibid.
10
ibid.
40
11
ibid.
41
ibid.
12
42
13
14
ibid.
43
15
ibid.
44
ibid.
16
45
Kasia Sielewicz and Lulu Y Yang, The Great Wall of Money, DTZ
Research, March 19, 2014.
18
19
Jennifer Popovec, REITs spin off and slim down to extract value,
wealthmanagement.com, May 23, 2014.
47
49
ibid.
50
21
ibid.
51
ibid.
22
52
ibid.
23
53
24
25
ibid.
27
29
30
ibid.
ibid.
57
ibid.
Hotel Year Book 2014: Foresight and Innovation in the Global Hotel
Industry, Hospitality Financial and Technology Professionals, February
25, 2014.
59
ibid.
55
31
Endnotes (cont.)
U.S. Building Automation Market Primed for Growth, Electrical
Construction and Maintenance, January 17, 2014.
61
65
67
ibid.
Top 10 Things for REALTORS to Know About the Camp Tax Reform
Proposal, NAR, February 28, 2014; Comments on Cost Recovery and
Accounting Staff Discussion Draft, NAREIT, January 17, 2014.
68
69
32
33
Deloitte Center
for Financial Services
The Deloitte Center for Financial Services offers actionable insights to assist
senior-level executives in the industry to make impactful business decisions.
This publication contains general information only and Deloitte is not, by means of this publication, rendering accounting, business, financial,
investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should
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business, you should consult a qualified professional advisor. Deloitte shall not be responsible for any loss sustained by any person who relies on this
publication.
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