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Profimex Outlook for Real Estate in 5779- תשע"ט

As we enter the Jewish New Year, 5779- תשע"ט, we would like to wish you a happy and peaceful new year.

The New Year is an excellent opportunity to present our forecast for the coming year, which is characterized by the moderation of the high yields experienced in the post-financial-crisis real estate market, as well as a greater need for experience and professionalism in locating and managing investments.

Backdrop of Real Estate Investments

Although the US is competing against China for the title of the world’s largest economy, it maintains its first place standing with an impressive 60% GDP gap and continues to grow. As evidence, the second quarter of 2018 saw an annualized 4.1% growth rate of the Gross Domestic Product (GDP) throughout the US —the strongest gains experienced within the industry since 2014. Growth was driven by broad gains in consumption, exports, investment and government spending. This trend indicates that favorable fiscal policies at federal and state levels may continue to drive the unemployment rate lower, leading to further job creation and wage growth.

In Europe, we witnessed an intense election year, which marked the end of a period of significant political uncertainty, enabling the economy to grow and shift towards center stage. It is estimated that in 2017, Eurozone growth increased to 2.4%, the highest in a decade. A slight dip to 2.2% was originally predicted for 2018, but this forecast was recently revised in light of German transactions. A year-end upside remains a veritable possibility. In the UK, by contrast, another year of BREXIT negotiation is expected to limit activity to a slightly disappointing 1.5% growth, similar to the rate experienced in 2017.

US NATIONAL REAL ESTATE MARKET

Real estate investment will maintain momentum in the near future. Commercial real estate investment volume totaled $118.8 billion in the second quarter of 2018, a 1.7% increase from the equivalent period in 2017, and is expected to continue increasing throughout the remainder of 2018 and 2019. Pricing for all property types (except for retail) is at or near all-time highs, with a mild deceleration in recent months. Increases in multifamily and industrial pricing will continue to lead the national index. In addition, we have noticed the use of conservative lending practices, as reflected in existing loan to value (LTV) ratios, reasonable mortgage costs, and moderate lending covenants. Thus, it can be concluded that engaging in responsible borrowing practices, increasing demand for income-producing properties and ensuring a well-functioning economy will continue to push commercial real estate prices forward. Nevertheless, investors will encounter hurdles in retaining the same return on investment (ROI) they have grown accustomed, as the post-global financial crisis (GFC) high returns era has ended. When selecting a property, upholding conservative assumptions and projections and maintaining a diversified portfolio will not only protect any equity invested, it will also support the application of sound investing strategies within the unceasingly strong real estate market.

RETAIL

On a national level, retail is currently being fueled by consumption growth and a strong labor market. As such, retail sales continue to show steady growth. However, in times when many traditional REITs holding regional malls and shopping centers are trading well below their net asset values (NAVs), a new trend has begun to emerge; forward-thinking, proactive investment managers are identifying key opportunities and are taking advantage of the several existing decaying malls and shopping centers still operational within the market. They are buying them for a pittance and converting them into pleasant working spaces and sophisticated logistics and distribution centers. This trend is expected to grow and scale in the coming years. Regional brick-and-mortar malls will shift focus to providing personalized customer experience and rebranding their malls as a family-friendly hotspot for recreational experiences, if their owners are astute and have the capital necessary to invest.

As online shopping continues to reshape the retail industry, its effects are being felt in the real-estate market as well. For instance, selling merchandise on floors above street level once made sense for retailers, such as department stores and, in some cases, was preferred by landlords over using the space for less glamorous office space. Today, many larger-format retailers are reworking their concepts to maximize their retail footprint. They still want to showcase their goods, but due to the changing retail environment and high occupancy costs, many no longer need as much physical store space. Consequently, more and more retailers are opting to end their leases on any floor above the ground and vacate the spaces that, hopefully, will be taken over by traditional and coworking office spaces.

OFFICE

In the office market, a source of great attention is the economy’s operating at or near capacity. While an increase in labor force participation could provide some relief, growth will still be limited by an aging population and other demographic factors. Likewise, fiscal policy may continue strengthening the job market, but gains will likely be modest given that the timing coincides with the economy operating almost at full capacity.

EMERGING TRENDS

Emerging trends are creating noise within the real estate industry, as experts predict disruptions and significant impact on how and why the number of real estate investments made. Other than with respect to online shopping, industries involving autonomous vehicles, coworking spaces, sustainable production, green construction, and shared housing are expected to influence the way we think about real estate. According to leading tech experts, autonomous vehicles will be available and operational in early 2020, making a huge impact on the automotive industry, as we know it. The demand for parking spaces will decline and suburban markets will become more attractive both for office and residential use. Green construction and sustainable production will emphasize the benefits of occupying new and “green office buildings”. “Green building premium” is reflected by higher net asset value assigned to properties built according to a green standard. Recent studies have shown that “green buildings” tend to achieve better rental and occupancy rates, as well as higher sales prices than non-green assets.

For US coworking space, companies such as MindSpace, WeWork, Impact Hub, and MakeOffices, 2019 may be a challenging year. There is no doubt that the sector is currently flourishing, with WeWork reaching a milestone of 200,000 users, and becoming New York City’s largest commercial real estate tenant. In addition, CBRE surveyed over 200 major commercial real estate organizations and found that 40% of them are currently using or considering using coworking spaces for their operations. Despite this boom, most co-working companies continue to burn cash, with WeWork suffering a net loss of $933 million. WeWork’s $35 billion valuation comes courtesy of the deep pockets of Japan’s SoftBank and the Saudi-backed $100B Vision Fund, which led a $3B investment last year. Luckily for WeWork, coworking space companies’ valuations are based on their growth potential. Soaring valuation premiums will only be justified if they can prove that they are far more than just providers of flexible office space.

EUROPE

CBRE forecasts a positive economic environment for most of Europe through 2018 and 2019 and believes that continued strong growth of managed assets will put pressure on investors to deploy capital. Most European economies will end 2018 on a strong note, with economic confidence at a 30-year high. As such, there is no reason to think that this positive economic environment will halt or stagnate during the remainder of 2018 and 2019. Very strong demand growth has cut the availability of large-scale modern space, producing capacity constraints in some of the main European logistics hubs. Robust e-commerce related growth will support a further rental increase. Also, growth in appetite for flexible offices will permeate across European markets. On the pricing front, increased long-term interest rates in the US will begin to lead to higher rates spiking in Europe, which will start to pose a pricing challenge in many property markets. It is excepted that prime property yields will remain largely flat during 2018, but in 2019, rising interest rates will put upward pressure on property yields. Prices for residential units are currently rising across continental Europe, and the service and amenities offered to the private rental sector will only improve.

FINAL THOUGHTS

Real estate prices, in many areas, have already exceeded those from the pre-crisis period of 2008.

Driving these record-high prices is the demand for quality real estate and the pressure to invest in larger transaction sizes, particularly as a result of commitments, dry powder and mega-funds pertaining to some of the world’s largest institutional investors. Their focus has and will continue to be on large-cap investments and portfolios.

We at Profimex, contrary to the above, together with our partners, are seeking to source investment opportunities in properties at reasonable prices, that have yet to be affected by the demand driven high pricing. This will be done by focusing on the size of the investment, secondary markets or the location of investments, utilizing our partners’ experience and knowledge of the market. We believe that investors, similar to us, who are not pressured to invest large amounts per transaction, will continue to benefit from a healthy real estate market, that is backed by a steady growing economy and strong economic fundamentals. We plan to continue to focus on investments that have been scrutinized and where the rate of return matches the level of risk.

In 2017, we invested in a total of only 13 investments, after thousands of potential investments were evaluated by a careful screening process unique to Profimex and its strategic partners.

This fact, along with our rich experience, will protect our investors’ interests by providing downside protection and maximizing their returns.

We will keep on serving you with integrity, respectability and transparency; always striving to achieve the best results for our investors, who have entrusted us throughout the past 20 years.

Happy New Year,
Profimex Team