2. mo • men • tum
noun: impetus and driving force gained by the
development of a process or course of events
Regulatory Issues...
6
3. A CohnReznick Report 3
The Relentless Search for Opportunity......................................1
• Fundraising ............................................................................................ 1
• Operations............................................................................................. 3
• Market Sectors ...................................................................................... 6
Conclusion .................................................................................10
..
Table of
Contents
4. When we surveyed the commercial real estate industry one year ago, we predicted
that, in 2015, investor enthusiasm would continue and capital availability would remain
high. We also thought that the market would be increasingly defined by insufficient
supply with industry participants needing to leverage strategic acumen, operational
savvy, and investment discipline to move ahead.
As we believe this 2016 Commercial Real Estate Outlook shows, our forecast was
accurate. In looking at the market now, we see the relentless search for opportunity
to be the dominant theme. The continued quest to create work/play/live communities
has brought life back to the suburbs. Foreign investors seek safe havens in partnering
with smaller funds focused on secondary and tertiary markets. Other investors, confronted
with ongoing cap rate compression, are redefining “real estate” to include cell phone
towers and outdoor advertising. All of this activity bodes well—not just because it
demonstrates the industry’s famous entrepreneurialism, but because it illustrates that
the lessons of the past have not been forgotten. Supply constraints have not caused
bubbles, but rather the discovery of new areas of opportunity.
On the following pages, the members of CohnReznick’s National Commercial Real
Estate Industry Practice share their perspectives on how they see various key areas
of this dynamic market developing, as well as strategies and tactics to consider as
you plot your course for the year.
We hope you find Momentum 2016: Commercial Real Estate Outlook to be a useful
guide to the state of the industry and look forward to your comments.
David Kessler
Partner
National Director, Commercial Real Estate Industry Practice
Preface
February 2016
David Kessler
5. A CohnReznick Report 1
Fundraising
Last year proved to be another strong fundraising
year, with $108 billion raised in the first three quarters
of the year representing a 14% rise over the same
period in 2014. The move toward mega funds
continues. The 41 funds that closed in the third quarter
did so with an average fund size of $1.3 billion.1
Among our fund clients, North American funds held
the spotlight with global funds in a close second. In
terms of strategy, opportunistic and value-added
funds continued to do particularly well, reflecting
the forces discussed in this report that we see driving
much of today’s commercial real estate activity.
In other words, the industry continues its upward
path. The question is, for how long? The Federal
Reserve’s interest rate increase was both modest and
The
Relentless
Search for
Opportunity
1
PERE Q3 Fundraising Report, p.3.
completely expected. There is a line of thinking that
suggests that the first rate increase after a downturn
starts a two-year countdown to the next market peak.
But such generalizations need to be measured against
the specifics of the environment. This includes capital
flows, the overall health of the economy, employment,
political stability (and instability), and pervasive,
ongoing demographic trends. The fact is that the
fundamentals for commercial real estate across all
sectors remain strong. The overall health of the U.S.
economy is improving. There is a great deal of capital
that needs to be deployed and a limited range of
investment options. Most importantly, there continues
to be a wealth of opportunity for commercial real estate
to reconfigure existing properties to meet fundamental
changes in how people live, work, and play.
6. Momentum 2016: Commercial Real Estate Outlook2
Inbound Foreign Investors
The U.S. real estate market continues to be a very
attractive safe haven for foreign investors. This trend
will only continue throughout 2016 and well into next
year as the easing of certain FIRPTA requirements goes
into effect.
Many of our smaller fund clients that are looking to
move up to the mid-tier bracket are partnering with
small or midsized banks or foreign syndicates looking
to make their first U.S. investments. For these investors,
repositioning multifamily properties or office buildings
are particularly attractive. It is our view that there is
tremendous untapped potential in bringing together
smaller foreign entities with their U.S. counterparts to do
deals in the $30 million to $300 million range. These may
be deals that are too large for a small U.S. fund to do
on its own, and too small to warrant the attention of a
larger player. The foreign bank or fund can offer their
investors off-market deals with a more appealing return
possibility than those investors could get by investing
with larger funds or REITs. Further, the U.S. fund gets the
critical mass needed to move to the next level.
Bringing more of these cross-border pairings
together—for example, bringing a midsized Kuwaiti
bank together with a $25 million friends-and-family
fund based in Atlanta seeking a deal in Nashville—
calls for two things. First, bridges need to be built
between networks that simply don’t have many points
of overlap. For both sides, then, the key comes down
to making a conscious effort to tap into new networks
and then having the patience needed for those
networks to form.
Second, both sides must be able to work together
to identify and structure deals that have enough
headroom to allow the dealmakers to get paid, and
for the individual investors to get a better return than
they would get by investing the capital with a REIT.
Foremost here is deep local knowledge on the part of
the U.S. fund.
As an additional note, U.S. funds in discussion with
Middle Eastern investors might want to encourage
them to increase their capacity for development risk,
which investors from this part of the world typically
shy away from. The problem is that there are only
so many garden apartment complexes in need of
upgrading, particularly now that this sub-class has
caught the attention of the large investors. Aversion to
development—combined with Sharia restrictions that
eliminate malls, hotels, and other sizable categories—
closes a considerable number of doors. Taking on
development will open a few of these doors, allowing
for a greater number of deals to go through.
Regulation A+
One of the more colorful developments in the
investment capital stack is Regulation A+, which
was passed as part of the JOBS Act and went into
effect this past October. The new regulation allows
for the crowdfunding of a wide range of investments,
including real estate, up to a $50 million Tier 2 limit,
which would certainly go a long way on crowd
funding deals where the equity requirement could be
$2 to $5 million.
How, and how much, Regulation A+ will be used for
commercial real estate fundraising will be interesting
to watch in 2016. We are already seeing “blind
pool” funds being raised through the crowdfunding
platforms that enable individual investors to invest
in non-traded REITs or other fund vehicles. These
funds can deploy capital for real estate loans, equity
investments with local sponsors, or direct investments
in portfolios or even single asset properties.
How, and how
much, Regulation A+
will be used for
commercial real
estate fundraising will
be interesting to
watch in 2016.
7. A CohnReznick Report 3
Operations
In 2015, the major themes in operations centered
on the heightened compliance and transparency
expectations set into motion by 2014’s legislative
changes, which focused on controlling risk in the
financial system. As it turned out, the industry absorbed
those requirements fairly easily, often with the help of
third-party providers who had previously geared up to
meet the need. In 2016, the major operations themes
will revolve around information technology—how to
harness information for decision making and how to
protect information in an increasingly connected
(and thereby increasingly vulnerable) world.
Analytics
One measure of the extent of the digital
transformation that is taking place across
The
Relentless
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Opportunity
the economy is that it has now begun to impact
the commercial real estate sector. Historically,
the industry has viewed technology like it views
maintenance or employee benefits—an unavoidable
cost but hardly something that is likely to increase profits
or be a point of differentiation. And there were good
reasons for this skepticism. This view, however, is rapidly
changing for two reasons. First, there now exist analytic
tools that provide value to the investor, developer, or
property manager whose success depends on the quality
of his or her decision making. Secondly, the industry is
undergoing a generational shift in leadership as
millennials—for whom technology is as fundamental as
indoor plumbing—rise up in the ranks of commercial real
estate industry leadership and begin to exert influence.
8. Momentum 2016: Commercial Real Estate Outlook4
Firms that are beginning to see technology as an investment
rather than an expense are also discovering that the key to
success is in managing the integration—not just in terms of
the technology but more importantly, the culture of the firm.
At first, the new-fangled platform will seem a poor substitute
for Excel, but that is only because the learning curve has yet
to be scaled. But as the firm’s early adopters show what can
be done, others will follow their lead.
But this is just the start. Technology is not an end to itself.
As firms begin to broadly adopt analytical platforms, they
will begin to differentiate themselves based on how well
they leverage these new tools. Here’s what we expect to
see from the most forward-thinking firms:
• Creating a culture in which data analytics supports the
deal makers and property managers on the front lines
and gives them information in forms they can use to
make more informed decisions.
• Reaching outside the industry and hiring graduates
coming out of the growing number of data analytics
programs. Far from being a detriment, their lack of
real estate industry experience means they will bring
a fresh perspective to what can be done with the piles
of information at their disposal.
• Using data to look more broadly at the world and real
estate’s place in it. Real estate opportunities rise and
fall with changes in demographics, employment, health
care, and many other factors that can be quantified.
Data analytics gives a firm the ability to take that analysis
in-house and make it part of its strategic planning.
In the same vein, we expect firms to harness data to look
for new ways to add value to their tenants—and their
tenants’ customers—by enhancing the experience of the
end user whether that is the retail shopper or the millennial
apartment dweller.
In property management, the rise of the Internet of Things—
increased interconnectedness between different systems
such as HVAC, vertical transportation, and other systems—will
enable increasingly sophisticated management of facilities.
Algorithms analyze traffic patterns, temperature, and other
variables in real time to maximize comfort and reduce cost.
Like executives
in most industries,
decision makers in
commercial real estate
are concerned about
cybersecurity. However,
... relatively few firms
have been able to
translate that concern
into action.
9. A CohnReznick Report 5
Cybersecurity
Like executives in most industries, decision makers
in commercial real estate are concerned about
cybersecurity. However, our observation has been
that relatively few firms have been able to translate
that concern into action. There are two good reasons
for this. First, commercial real estate is a largely
unregulated industry. Unlike public companies,
healthcare firms, and financial services enterprises, for
example, there is no compliance regime equivalent
to Sarbanes-Oxley, HIPAA, or FINRA to guide the
industry’s cybersecurity efforts. Each firm is essentially
on its own in determining what constitutes substantive
risk and an adequate response.
Second, in the deal-focused world of commercial real
estate, IT, like many other back-office functions, has
been historically considered a cost center, tangential
to the firm’s core mission, and thus kept on a tight
budgetary leash. This means that taking a more
proactive stance on cybersecurity requires a change
in the way IT has been regarded. But so far, when real
estate firms have been victims of cyberattacks—such as
“spoofing” emails that appear to be from a legitimate
source requesting a transfer of funds—those issues are
usually dealt with quietly. There has yet to be a Sony,
Home Depot, or Target-caliber wake-up call that would
spur the real estate firms and the funds (including high
net worth individuals that invest in them) to take a
more aggressive stance toward cybersecurity.
In our view, 2016 needs to be the year that the
commercial real estate industry compels itself to
make cybersecurity a strategic priority—before
disaster strikes. The reason has to do with the
changing IT profile of the industry. As the Internet
of Things continues to move from whiteboard to
reality, the vulnerable “attack space” of the industry
becomes both larger and more tempting to the cyber
underworld. Consider, for example, the economic
consequences of having the “smart” elevators in a
class A office building shut down as part of an extortion
attempt. This is the not-so-distant future for which
commercial real estate IT departments must prepare.
There is a tendency in most organizations, regardless
of sector, to think of cybersecurity as an IT issue. But
true cybersecurity involves the enterprise at multiple
levels, and attention must be paid to each. This is one
reason that implementing an effective cybersecurity
program requires a visible commitment from the head
of the firm.
The commercial real estate industry is centered
on the savvy evaluation of risk. In other words, the
necessary perspective for best practice cybersecurity
is already baked into the industry. Firms need
merely to understand that IT is no longer ancillary to
their business, but central to it, and then apply the
corresponding level of care.
True cybersecurity
reaches from the
boardroom to
the back office.
10. Momentum 2016: Commercial Real Estate Outlook6
Market Sectors
As in 2015, the overarching dynamic for 2016
continues to be a great deal of capital chasing
too few deals. Developers and fund managers
are reacting in a number of ways. Managing the
expectations of investors eager to put capital to work
is key. Some funds are asking investors to rethink the
limitations they put on the types of deals they will
invest in. But counseling patience merely buys time.
Funds and developers are also having to become
more entrepreneurial, mining opportunity in markets
that would have been passed over only a couple of
years ago.
Consider, for example, the plight of the suburb. Only a
few years ago, the suburbs were largely regarded as
a forlorn collection of 1980s office parks without much
future at a time when the Central Business District
(CBD) has taken center stage. The allure of the CBD
has indeed continued—so much so that millennials
are being priced out of the trend they helped to
bring about. Developers quickly realized that those
old office parks offered the basic footprint that could
readily be converted into 18-hour live/work/play hubs
that could offer an affordable alternative, especially
if it were connected to the city by mass transit.
Other developers and funds are going so far as to
redefine what is meant by “real estate investment,”
buying portfolios of cell phone towers or outdoor
advertising space. While it’s too early to say how those
“markets” will fare, the larger point as we head into
2016 is clear. Real estate investors and developers
would be well-served to look at the larger set of skills
and resources that they have at their disposal. Their
access to capital. The ability to analyze deals. Their
knowledge of local markets. Of course, the caveat to
stick to what you know still applies. But seen from this
larger perspective, a portfolio of cell phone towers
doesn’t seem so far-fetched.
The
Relentless
Search for
Opportunity
11. A CohnReznick Report 7
Multifamily
2015 was the year in which people got tired of talking
about the imminent collapse of the multifamily
bubble and started to accept the fact that the
sector continues to benefit from fundamental shifts
in demographics, home ownership, economic
improvement, and a seemingly endless supply of
capital. Millennials are putting off starting families,
and when they do, are choosing to sacrifice space
for location. They are willing to live in smaller quarters
in urban areas rather than move to the suburbs. (As
noted elsewhere, suburbs are making a comeback—
but largely to the extent to which they can mimic on
a smaller scale the pulse of an urban center.) Younger
millennials are foregoing space from the start, fueling
a trend in micro apartments of 350 square feet or less.
It is tempting to attribute these developments to
the fact that millennials came of age against the
backdrop of the housing bubble. While that has
certainly been a factor, we are also seeing two
deeper forces at work. Embracing smaller living
spaces allows millennials to live where they want to
live—a strong manifestation of the growing inclination
to value experience more than material objects.
Second, millennials are “digital natives,” and the fact
is that a digital life—one in which all photos, music,
and books are online, for example—simply requires
less space. We don’t expect either of these trends
to reverse themselves any time soon. So it is that the
Harvard University study “State of the Nation’s Housing
2015” predicts a future in which 60% of adults are
renters, turning the traditional post-World War II home
owning metric on its head.
In other words, the 5.4% increase in renewal rates and
5.9% increase in effective rents witnessed in the third
quarter of 2015 are the numbers we would expect
from an asset class in transition. While some absorption
in some markets is leveling off, nationally we are far
from capacity despite record completions. As a result,
multifamily is not only the most successful asset class
among commercial real estate sectors, it has arguably
become the single most significant driver in the growth
and improved success of other sectors such as retail
and self-storage.
Not surprisingly, this asset class has increasingly
become a favorite of institutional investors, private
equity funds, and REITs.
Office
Last year was a strong one for the office sector, and
2016 should bring more of the same. This asset class
continues to be a favorite of institutional investors
who continue to expand their sights into secondary
markets. In our view, there are two main reasons
why office fundamentals continue to be strong.
First, despite the rise of freelance workers and the
“gig economy,” office-based jobs are still accounting
for 39 percent of total job growth—as long as the
economy continues to expand, and the employment
picture improves, the need for office space will
increase as well.
The second reason why the sector will continue to
be attractive is far less cyclical. How people work,
and the spaces they need to work most effectively,
continues to fundamentally change. This has brought
about both the need and the opportunity for
significant amounts of adaptive reuse. Consider the
following trends:
• Cubicle-intensive tenants like law firms and
accounting firms are giving way to software
companies and app-based services that favor
open areas, ergonomic lighting, and tech-intensive
infrastructure. The trend toward “densification” is
another trend making old floor plans obsolete.
• Employee expectations regarding amenities have
carried over from multifamily living. Along with the
usual operations contingent, companies looking to
rent space now bring along the human resources
director to see if the new office has sufficient
common areas, recreational facilities, green design,
and other details.
• With the rise of ride sharing, better public
transportation, and the inclination of people to live
where they work, parking lots no longer require the
space they once did, presenting developers with an
interesting reuse challenge and opportunity.
12. Momentum 2016: Commercial Real Estate Outlook8
As we look to 2016 and beyond, there are two
specialty trends we will be keeping our eye on. One
is the rise of co-working spaces, perhaps the ultimate
“densification” reuse strategy. Does the rapid growth
of this subsector signal a real, permanent shift in
how we work, or will it fade over time? The second is
the suburban medical campus, which represents a
confluence of changes in healthcare, demographics,
and market opportunity. As healthcare delivery shifts
from independent physicians to hospital systems, and
as baby boomers continue to age and live longer,
hospital systems are setting up satellite facilities in
office parks—another factor contributing to the
rebound of the suburbs noted above.
Retail
As the multifamily sector responds to changes in how
people live while office properties are reconfiguring to
match developments in the workplace, activity in the
retail sector is being driven by the ongoing evolution
from shopping to “the shopping experience.” Online
shopping, it turns out, did not kill bricks and mortar
retail, but rather reoriented it. Yes, people can buy
whatever they want online, but it turns out—as retailers
themselves have long known—that mere purchasing is
not enough. For most of history, after all, shopping has
been a physical, tactile and, ultimately, social activity.
In 2016 and beyond, retail will continue to reclaim
this heritage in the form of exciting, vibrant six or eight
block unified environments of pedestrian friendly
storefront retail mixed with restaurants, cafes, theaters,
and hotels. These environments will include upscale
apartments centered around fountains, public
squares, and other areas for public interaction. The
hunger for this type of retail complex is particularly
acute in fast-growing, car-centric cities such as Los Angeles,
Houston, and Atlanta—cities with high population
density that lack the public spaces that older cities do.
Savvy developers will see this need as an opportunity
to not just build properties but to create deeper
partnerships with their retail tenants. Indeed, developers
looking to harness data to improve operations will find
that much can be learned from the retail sector—a
relatively early adopter of data analysis to manage
inventory and spot consumer trends. Working together,
developers and retailers have the opportunity to
make the retail experience even more responsive and
innovative. In fact, this unified concept of multifamily
and retail will also prove to be a strong driver for shifts
in investment strategies toward suburban markets.
Industrial
The industrial sector, which had experienced a long
period of relative dormancy, has in the last few years
gained considerable traction largely powered by the
need for reconfigured distribution infrastructure to
meet the exploding demands of e-commerce. While
this trend continues—and should through 2016—one
additional development we have seen in our clients
is notable activity in self-storage. Some investors have
long been attracted to this specialty asset class,
which tends to produce attractive revenue streams—
and without tenants. But activity has experienced
a notable uptick since the Great Recession of 2007-
2009, as people downsized their living spaces and
needed storage space for excess belongings. Indeed,
the activity in this sector has fueled consolidation as
investors seek market dominance through acquisition
of less-deep-pocketed rivals.
It will be interesting to see the long-term trajectory of
the self-storage category. If we are truly entering a
digital era centered on experience and information
rather than objects, self-storage centers may become
even more important as a way station for an increasing
number of things we no longer need but are not yet
ready to live without.
Online shopping,
it turns out, did not kill
bricks and mortar retail,
but rather reoriented it. Yes,
people can buy whatever
they want online, but it
turns out ... that mere
purchasing is
not enough.
13. A CohnReznick Report 9
For our owner/
operator clients,
optimizing operations
is the focus. Data analytics
has become even more
central to the process
than it has been
in the past.
Hotels
The hotel sector continues to expand to meet the demand for increased capacity.
This expansion comes in the wake of the tremendous contraction the sector underwent
during 2007-2009. In fact, we don’t expect supply to catch up to demand until 2019 or 2020.
In pragmatic terms, this means that those looking toward a deal should do so now, while
there is still a considerable tailwind to harness.
For our owner/operator clients, optimizing operations is the focus. Data analytics has become
even more central to the process than it has been in the past. The hotel asset class, because
it is built on selling property with a one-day term, has always been more data-centric than
most of the other real estate sectors. But even so, managers are working double time
to absorb and synthesize the amount of data that is now available.
Online reputation management is another critical area. Even with supply
behind demand and steady increases in Average Daily Rates, travelers
are ruthless in summarily rejecting properties with even one or two bad
reviews. It is essential for operators to invest in the resources to monitor
and respond to social media and travel sites in real time.
As with office and multifamily, there is a greater sensitivity to amenities
in the hotel sector than there has been in the past. But here we
caution restraint. Investing in elective amenities (that is, those not
dictated by the franchisor) should be done in the context of a
larger business strategy—to attract a certain type of traveler or
to differentiate yourself in the market in some way. It is too easy
to get caught in an endless cycle of “keeping up with the
Joneses” that brings no significant return on investment.
The flip side of this is to fully leverage an amenity
that can truly differentiate the property. This
strategy can be particularly powerful for
properties located in historic districts. One
client bought a hotel property that had a
reputation for being haunted. The new
owner promptly set up “haunted tours”
that have become both a source of
distinction and a continual revenue stream.
14. Momentum 2016: Commercial Real Estate Outlook10
In our view, the “rational optimism” that defined the commercial real estate market in 2015 has every reason to
continue through 2016. The breadth and extent of the industry’s trajectory reinforces the conclusion that much
of the industry’s activity is driven by the race to meet a wide range of societal needs: Millennials need smaller,
more ergonomically designed and more affordable apartments in vibrant areas. Companies need office space
attuned to an increasingly wired, mobile, and autonomous workforce. E-commerce giants need the warehousing
and distribution capabilities that can continue to scale to their growth.
These needs are much stronger now than they were before the recession—if they even existed then at all. It
falls to the commercial real estate industry to effect these changes for a vast country. As long as the industry
continues to exercise discipline and judgment, it will continue to benefit from these opportunities.
Conclusion
15. A CohnReznick Report 11
About CohnReznick’s
Commercial Real Estate Practice
About CohnReznick
CohnReznick LLP is one of the top accounting, tax, and advisory firms in the United States, combining the
resources and technical expertise of a national firm with the hands-on, entrepreneurial approach that
today’s dynamic business environment demands. Headquartered in New York, NY, and with offices nationwide,
CohnReznick serves a large number of diverse industries and offers specialized services for middle market and
Fortune 1000 companies, private equity and financial services firms, government contractors, government
agencies, and not-for-profit organizations. The Firm, with origins dating back to 1919, has more than 2,700
employees including nearly 300 partners and is a member of Nexia International, a global network of
independent accountancy, tax, and business advisors.
The CohnReznick Advantage for Commercial Real Estate
CohnReznick’s Commercial Real Estate Industry Practice provides a broad array of accounting, audit,
tax consulting, tax compliance, and business advisory services across all sectors, operating platforms, and
geographic regions. Our pledge to provide commercial real estate clients with senior-level engagement teams
and forward thinking, success-oriented strategies is what we call The CohnReznick Advantage.
The CohnReznick Advantage is based on delivering the following benefits to our clients:
• Industry Insights, Optimized Solutions – We proactively advise investors and owners on the current market by
anticipating challenges and developing strategies based on a client’s portfolio, investment objectives, and
risk profile.
• Transformative Advice – We provide commentary on a broad array of international, federal, state, and local
tax issues to help clients navigate complex tax laws and capitalize on relevant tax benefits.
• Responsive Culture – Our streamlined organizational structure enables key engagement team members to
provide faster, smarter, more efficient services by empowering them to make decisions and provide hands-on
advice.
• Capital Markets Dexterity – Working with CohnReznick Capital Markets Securities, we help our developer
clients forge strategic alliances with critical capital sources.
• Proactive, Resourceful Service – We consult regularly with client management to develop effective resolutions
to critical issues and ensure expectations are met and documented.
• National with Global Reach – Having worked with commercial real estate clients in all 50 states and
internationally, we understand the regulatory requirements and other issues pertinent to specific geographic
areas and countries.
For more information, visit www.cohnreznick.com.
