This past year saw its share of ups and downs, highs and lows, and everything in between. The good news for the economy is that the year was generally filled with more highs than lows. Commercial development, investor flows, and transaction volumes have all seen upticks. Unemployment is down and demand for housing is up. Overall, the U.S. economy grew 3.2% in the 3rd Quarter of this year, the fastest rate in two years. Additionally, current estimates put growth at 2.5% over the next two years.
Even though 2016 showed us that making predictions can be difficult at times, we at least wanted to look forward to what may be in store for 2017. Here are a few issues and commercial real estate trends that we think will dominate headlines in the year ahead.
Section 1031: Tax code changes that could devastate CRE
One of the most significant, if not THE most significant topics for the real estate industry in 2017 is Section 1031 of the tax code. As we head into the new year, the newly elected Congress and President have made tax reform a top priority. Amongst that is the potential elimination of Section 1031.
The provision allows an owner to sell a property without having to initially pay the taxes on any proceeds from that sale, as long as those proceeds are being reinvested into a similar property. However, the tax owed is deferred, not erased. The property owner must eventually pay those taxes when the property is sold.
As addressed in our post Political Changes and Section 1031: The Potential Impact on Commercial Real Estate, there may be devastating effects to the entire industry and the economy in general, if this section is removed. If eliminated, real estate owners will be sorely disadvantaged and likely see their investments shrink.
The changes to the tax code and subsequent effect on Section 1031 is not only important for the real estate industry, but a host of other businesses and services as well. It’s an issue that has to remain in the forefront of real estate professionals’ minds as we begin 2017.
Raised Rates: Slow and steady wins the race
On December 14, the Federal Reserve made the call to bump interest rates 25 basis points, or 0.25%. Expectations are that we’ll see maybe three additional increases in 2017, but more than likely it will only be two.
We just have to ask ourselves: How fast will Feds raise the rates? If the Feds can take it slow and steady, the commercial real estate industry shouldn’t see too drastic of an impact. However, too steep of a rise or even successive increases pose some concerns. This will make it more expensive to finance and develop property. Additionally, we could see cap rates raised quickly, driving sales prices up, which in turn will lead to increased return requirements from investors and landlords and to higher rents for tenants. Short term, tenants may have trouble dealing with such rent increases, but long term, businesses should see a positive impact due to increased expendable income from consumers.
And while the initial thought may be to spurn rate hikes, ultimately they should be beneficial. If adjusted properly, higher rates should help to push expansion and drive optimism for continued commercial development. Simply put, rates are typically linked to a strong economy, and historically, real estate values rise in common situations of increasing rates.
The positive impacts of rate hikes may be not be seen for at least 6 to 12 months, which means a likely slowdown in the commercial real estate industry. Long term however, businesses and developers should see continued growth.
Skilled Labor and Construction Costs: Blindsided in 2016, Recovery in 2017
In some sense, a lot of groups were blindsided by increased construction costs and a shortage of skilled labor in 2016. A survey of nearly 1,500 construction firms taken by the Associated General Contractors of America in mid-2016 found that more than two-thirds of construction firms were having trouble finding skilled hourly workers.
As we head into 2017, we should see unemployment decrease and more skilled labor enter the workforce resulting in construction cost increases starting to level off. The market should start to offset costly and lengthy construction processes.
Deregulation: Loosening the reins on CRE
The common belief going into 2017, and with the Trump presidency, is that the regulatory environment surrounding commercial real estate will ultimately be loosened. From financial lending to developmental regulations, the industry could see significant changes that may lead to more capital for real estate and business development.
In turn, expect these deregulations to spur some job growth. In theory, some of this deregulation will trickle down into the local development and investment, and making the permit process faster. As people become more confident in being able to complete the development process swiftly, cities will hire more people to push plans, permits, and projects through the process faster.
While the full benefits of reduced regulation may not be fully felt until 2018 or 2019, new policies could play a significant role in 2017.
Omni-channel Approach: If you use it, they will come
Omni-channel retail has become a standard by which retailers are measured. In today’s age of technology, consumers want an immersive shopping experience. Retailers are going to have to adapt to that demand if they want to stay relevant in such a competitive retail environment. According to a 2015 study by IDC, omni-channel shoppers have 30% higher lifetime value than those who shop using only one channel.
With customer retention in mind, we’ll continue to see a shakeout in retail based on how, and if, retailers can adapt and change. In particular, soft goods retailers must do all they can to better manage the omni-channel experience, and use that to maintain their inventory. Retailers will need to tailor their stores, websites, and overall experience to meet those demands.
This coming year, as well as the current holiday season, will be a great indicator of what retailers will thrive, and how they will adapt to the changing landscape.