CRE Fundamentals Remain Strong: a Q&A on the DLA Piper Global Real Estate Summit

Sullivan_John_webCommercial real estate transaction volume has fallen from its peaks in 2015 and 2016. But the market remains fundamentally sound and quite active, especially when viewed on an historical basis.

So says John Sullivan, chair of DLA Piper's US Real Estate practice, in a discussion of the state of the market and what lies ahead leading up to DLA Piper's Global Real Estate Summit in September. Sullivan predicts steady activity through the end of 2017.

Q: Given the robust deal making we've seen for the past several years, some experts are wondering whether we're in the bottom of the ninth or the beginning of a doubleheader. What is your take and why?

JS: I think the fundamentals – employment, consumer spending, household formation – are still healthy and I'm seeing a fair amount of optimism about the possibility of tax and regulatory reform in Washington. Foreign investors still have a strong appetite for stable assets here in the United States, so I think we're in reasonably good shape barring some type of black swan event.

At the same time, the Federal Reserve has done a good job of communicating and managing interest-rate expectations, allowing them to be priced in gradually. If we want to stick with the baseball analogy, I'd actually say we're in the sixth or seventh inning. And we could go into extra innings.

Q: Deal volume has been lower this year – which has been attributed to higher capital costs and questions about future cap rates on exits. At the same time, the public markets continue to set new records. What do you think is causing the disconnect?

JS: If you look at US commercial real estate over a 10-year period, it's clear that deal volume is still quite healthy. Lower volume now looks bad because we were coming off such a big spike in 2015 and 2016. In some ways, a reversion to the mean is not a terrible thing. But, clearly, there is a concern, particularly in gateway cities, that things have gotten pricey. And it's true that some investors were likely inclined to take a "wait and see" approach with respect to the surprising results in the US presidential election.

Many people just didn't know what to expect from a Trump administration. Some policy goals we've heard about would be good for real estate – tax reform, infrastructure improvements, the repatriation of money held outside the US, Dodd-Frank reform. All of that – and less of a protectionist bent – gives the business community reason to be optimistic. However, there's an open question as to how much of that can get done in the current political climate.

Q: What are the most disruptive forces impacting commercial real estate? How can savvy investors circumvent or leverage those forces?

JS: It all starts with technology and innovation. The way people use office space, whether it's taking up less space or the shared office space model, can be disruptive. The Internet of Things is also going to have a big impact on real estate regarding the kind of information we can gather. The data has the potential to be powerful, but we haven't really begun to figure out how to use it. It's a different way of thinking about real estate.

Demographics, of course, are important. Our aging population will present challenges with respect to pensions and health and social services, but it could also add additional boost to urbanization, transit-oriented development and senior services, but it could also add additional boost to urbanization, transit-oriented development and senior living and medical office development. Millennials have proven to be much more willing to rent, but it's unclear whether that's just a passing phase. Certainly, a lot of people between 30 and 40 are continuing to rent in urban areas, and many observers predict that this is more than just a passing phase.

Lastly, the inflow of foreign capital – which has been such a game changer in the past few years – will likely continue. Even though investment opportunities in gateway cities have gotten pricey, the relative stability and transparency of the US real estate market should continue to make US real estate an attractive long-term investment for many non-US institutional investors.

Q: What differentiates successful investors in today's commercial real estate market?

JS: It's never been more important to stay informed – and to have a global perspective. You need to know what's happening in your city, your region and your country while also keeping an eye on what's happening in China, in the Middle East, in the United Kingdom and everywhere else. Even if you're not invested in those areas, events there can have ripples across the planet. If you can understand these global economic events, you can draw informed conclusions about the impact on real estate, and that will point you toward where there's opportunity and where there's risk.

You also need to be very focused on technology and innovation. The pace of change is faster than it's ever been before. I just finished Thomas Friedman's latest book, and he says we're living in "the age of accelerations." Considering the changes we've seen in some industries – transportation, hospitality and retail, to just name a few – you have to constantly ask yourself, what's next, and how will it impact real estate?

Q: Let's talk about the Summit for a moment. What makes it a unique and special event? What do you think attendees will take away from it this year?

JS: This isn't a conference where you can come if you just write a check. It's by invitation only. And that's important because you get a lot of very high-level people – from the C-level on up. Year after year, we've had an atmosphere where the attendees are open and honest about what they're seeing and feeling.

I hope – and I think – they'll come away this year with valuable insights on the challenges and opportunities in the real estate markets in the next 12-18 months.

Q: And what do you think that might be?

The two "i's" – innovation and international. Innovation and technology will continue to drive and reshape much of commercial real estate as we know it today. And international capital flows, and globalization generally, will continue to have an increasingly significant impact on US real estate markets. As an asset class, real estate was rather late to the game on globalization, but it is now clearly there.