FUNDAMENTALS WILL REMAIN STEADY
Office-using employment is expected to increase by 0.3% or 45,700 jobs in 2020, down from 1.5% between 2018 and 2019. The expected top-three markets for 2020 jobs growth are Austin (2.4%), Dallas/Ft. Worth (1.9%) and Houston (1.6%). Office completions will decrease to an annual total of 51.1 million sq. ft., representing 1.3% of total inventory and down from the 56.4 million sq. ft. total in 2019. Despite the moderate decline, completions will outpace forecast net absorption of 20 million sq. ft., 70% of which is expected in suburban markets, according to CBRE Econometric Advisors (CBRE EA). As a result, the suburban and downtown vacancy rates are expected to increase modestly by 60 and 70 bps, respectively, after generally declining since 2009. Rent growth will slow to 1.6% as a result of moderately weaker market fundamentals.
FIGURE 7: OFFICE RENT GROWTH VS. VACANCY
Source: CBRE Research, CBRE Econometric Advisors, Q3 2019.
TECH TENANTS TO DOMINATE 2020 LEASING ACTIVITY
The technology industry, which accounted for 21.6% of overall leasing activity in H1 2019 (Figure 8), should continue to dominate office demand in 2020. As of mid-2019, approximately 4,000 tenants were seeking more than 174 million sq. ft. of office space, with tech tenants representing the largest share.
FIGURE 8: OFFICE LEASING ACTIVITY
Note: The above categories account for more than 90% of leasing activity in 2018 and H1 2019. Projections for H2 2019 were based on actual distribution of leasing activity in H1 2019. Aerospace & Defense is combined with Mfg. & Transportation. Health Care and Education are combined with Life Sciences. Categories not included are Confidential/Undisclosed/Unknown, Other, Retail and Telecom.
Source: CBRE Research, Q3 2019.
HOT MARKETS IN 2020
The tech industry is driving strong construction activity in certain markets. Austin, San Jose, Salt Lake City, San Francisco and Nashville will see the highest rates of completions due to increased demand in 2020. San Jose, Salt Lake City and Austin will also have high rates of net absorption next year. A relatively low amount of office completions in Los Angeles will make it the nation’s strongest market for rent growth in 2020.
FLEXIBLE OFFICE SPACE GROWTH WILL MODERATE
Per CBRE’s recent report, flexible office space inventory had been expected to grow exponentially this year, largely driven by major flex office provider WeWork. Since that report, WeWork has significantly tempered its growth strategy. Given this development, CBRE has adjusted its growth forecast of flex space to 23% this year and 13% in 2020. Flex office inventory should total approximately 87 million sq. ft. by year-end 2020. This growth will come from flex operators with sound operating models that increase their offerings in strategic markets.
The model of engagement between landlords, occupiers and flex operators will continue to evolve in 2020 as the risk tolerance of occupiers and landlords lessens. To hedge this risk, partnership or service agreements between landlords and flex operators will be a prime driver of flexible office space expansion in 2020, allowing landlords more insight into and control over flex operations in their buildings. Occupier demand for flex space should remain strong in 2020 as companies deal with headcount uncertainty and decentralized workforces. Speed, flexibility and low capital outlay will remain at the heart of flexible office space occupancy demand in 2020 and beyond.
FIGURE 9: FLEX OFFICE PENETRATION FORECAST
Source: CBRE Research, Q2 2019.
U.S. Outlook by Sector
U.S. GDP growth will slow to between 1.5% and 2% in 2020, down from an average of 2.5% over past five years.
U.S. GDP growth will slow notably next year as various issues create higher levels of uncertainty, including the ongoing U.S.-China trade conflict, slowing global growth and a presidential election. Barring any unforeseen risks, we assess that a recession will be avoided, thanks in large part to the stimulatory effects of the Fed’s rate cuts in 2019. Slow growth will continue in 2020, broadly supporting already strong property market fundamentals.
Investment volume in 2020 should total between $478 billion and $502 billion, making it one of the strongest years on record.
Amid slower economic growth and global uncertainty, U.S. commercial real estate will remain a haven for investment in 2020. Greater investor caution and buyer-seller disconnects on pricing could moderately reduce volume from 2019 levels. Cap rates should be broadly stable, with slight compression for multifamily assets and slight increases for the other major sectors for an average spread of about 260 bps over 10-year Treasury yields next year. Investors should not count on significant appreciation returns, but income returns will remain steady.
Demand for office space will remain strong in 2020. Flexible space inventory will continue to increase, but at a slower pace.
Despite continued positive absorption of office space in 2020, rent growth will slow and vacancy will increase. Leasing activity will remain driven by tech tenants, benefiting markets like San Jose, Austin and Salt Lake City. Flexible office providers will strategically expand their footprint but a drawback by WeWork will significantly slow expansion from previous years. CBRE’s forecast is for 51.1 million sq. ft. in completions, a 70-bps increase in vacancy and 1.6% rent growth.
Absorption gains will be limited in 2020, with available supply outpacing demand. Nevertheless, rents will rise by 5%.
Despite some softening in the industrial & logistics (I&L) market, overall fundamentals will remain strong due to continued e-commerce penetration and demand for logistics space. Rent growth will be driven by newly constructed facilities and infill properties. Although there are potential trade-related risks, resilient consumer spending will buoy the I&L market and mitigate any tariff effects on major hubs relying on port activity.
Total U.S. retail sales increased by 3.5% year-over-year in Q3 2019 to $1.57 trillion, however more modest growth is expected in 2020 to $1.55 trillion.
Total U.S. retail sales growth is expected to slow in 2020, as consumers become more cautious. Positive net absorption and rent growth in most U.S. markets will be spurred by a lack of new supply and thousands of retail store openings. Malls are benefiting from the refreshing influence of Generation Zers, who prefer to shop in stores and are driving traffic back to brick-and-mortar retail. Many retail assets will convert to mixed uses, creating communities and thriving town centers.
The multifamily vacancy rate will edge up by 20 basis points to 4.5% in 2020, remaining under its long-term average of 5.1%.
Multifamily is positioned for continued favorable performance in 2020 but will experience some cooling due to new supply outpacing demand. Completions will match peak levels of recent years. New and potential rent control legislation will remain an industry concern. The best opportunities are in suburban markets, smaller metros and metro leaders, including Austin, Atlanta, Phoenix and Boston.
Interest in specialty sectors will continue, with alternatives accounting for more than 12% of all commercial real estate investment in 2019.
Investment in alternative or specialty sectors has risen steadily in recent years and will continue to attract high levels of investor interest and capital in 2020. Total investment in 2020 will come close to the annual average of $59 billion since 2014 and represent 12% of all commercial real estate investment, up from only 6% at the peak of the last cycle. Alternatives acquisition volume in 2020 likely will match this level.
New deliveries will increase the primary data center markets’ total inventory by 17.3% in 2019, increasing the competition between certain markets in 2020.
The wholesale data center sector continues to evolve as flexibility and agility within IT and real estate strategies drive decisions. Transaction volume remains driven by the adoption of Hybrid IT/multi-cloud access strategies by users. Adding momentum headed into 2020, network connectivity should remain a critical component of overall IT and real estate decisions. Demand will continue as users right-size and adapt their portfolios to handle current and future technologies, such as high-performance computing (HPC) and 5G.