Last year was filled with considerable change regarding politics and economic policies. Specifically, the new tax laws, the consequences of Brexit, low inflation and shifts in the retail industry all make up the new commercial real estate trends to look for in 2018.
Jerome Powell will soon step in as a new Federal Reserve chairman. With new leadership, will the Federal Reserve continue as planned to amplify interest rates? And what are the plans to improve the stiff low inflation? The benchmark interest rate increased from 1.25% to 1.5% in December, and as of right now the Federal Reserve has not touched the schedule that will bring three 2018 rate increases.
While the plan to increase the rates remains unchanged, the 10-year Treasury rate has been rather consistent. This may be caused by the market not believing that the Federal Reserve will increase the interest rates substantially. The Federal Open Market Committee hinted to a slight halt in job market growth when it replaced the previous comments about expecting strength to simply stating monetary policy will assist the job market’s strong stability.
Rate hikes are more likely expected if inflation begins to speed up. However, if inflation follows the pattern of last year’s slow pace, it should be difficult for the Federal Reserve to reasonably raise the interest rates. This may be one of the main reasons two policymakers voted to cancel the new rate increase.
The important question is now how will this dilemma affect the commercial real estate industry? If the Federal Reserve chooses not to raise the interest rates substantially, the borrowing and property value will likely continue to be secure.
The negative effect would be creating a bubble that takes away the lender motivation to improve and raise lending standards. This could become a sign of a weakening economy, which would directly affect the value of the commercial real estate industry.
The recent changes to U.S. tax laws are seen as assisting business due to a lower company tax rate, but they may negatively influence big U.S. and foreign banks, including any association with commercial real estate lending. Citigroup and Bank of America are two of several large international companies that have stated they predict the new tax laws will cost them billions in 2017 profits.
The base erosion and anti-abuse tax, or BEAT could have another profound impact on multinational corporations. BEAT requires a tax on transactions between the U.S. and foreign associates of the same company. The new tax was created to motivate U.S. corporations to deal at home rather than move profits abroad to countries with lower taxes. European banks like Barclays and Credit Suisse both deal with U.S. commercial real estate financing, and could be negatively affected due to funds they commonly transfer among separate branches of the company. The overall outcome is still undecided, but if the government does choose to impose BEAT’s policy, many corporations will be forced to pay large sums of fees or create new ways to adapt in order to maximize their financial situations.
Though U.S. taxes potentially pose a considerable change in international lending, Europe and Britain have another issue at hand. Unless the U.K and EU can come to a trade agreement by October, the U.K. will become a “third country” on March 30, 2019, and will officially be out of the European Union.
The EU has warned that they will no longer be able to operate across Europe.
U.K. Chancellor of the Exchequer Philip Hammond and David Davis, the U.K.’s Brexit secretary, explained that the EU’s decision to decline inclusion of financial services in a trade deal threatens the stability of Europe’s banking sector. The refusal is understood to be the EU’s way to prevent banks and other financial companies from transferring to Germany. If no trade deal can be agreed to by the time Brexit officially takes place, the EU has warned that they will no longer be able to operate across Europe.
Lenders such as U.K. banks HSBC and Barclays, London-based hedge fund Child Investment Fund and Germany’s Deutsche Bank are all directly involved with Brexit and aiding to finance U.S. commercial real estate. Deutsche Bank specifically has a large office in London that is considered the foundation for its largest investment banking activity.
Deutsche Bank has over 8,000 U.K. employees, but once Brexit goes into effect, there is speculation that half those jobs could relocate out of the country. In regards to this concern, CEO John Cryan stated that Brexit will cause the movement of jobs, but only hundreds not thousands. Cryan alluded that the majority will remain in London, yet there were reports that Deutsche Bank was looking into large corporate buildings in the Frankfurt area.
The larger issue for commercial real estate is the actions that Brexit will cause by banks slowing down their business endeavors. The concern for probable losses will only increase as Britain and the rest of Europe continue to grow apart.
Retail and industrial sectors
Retail corporations were hit hard by a record-breaking year. 2017 held new records with store closings tripling the previous year after reaching nearly 7,000, and an increase in retail bankruptcy rose to over 600. Large companies who chose to close stores included Sears, Kmart, J.C. Penney and Macy’s, while other larger companies such as Toys R Us, Payless, The Limited and Hhgregg were compelled to file for bankruptcy.
2017 may have been a record year for retail, but 2018 is expected to hit even harder. The commercial real estate firm stated that the total number of U.S. store closings is predicted to increase by 33%, to be more than 12,000. The expectations also include that an additional 25 large retailers will file for bankruptcy. Already, Gap, Banana Republic, J. Crew and Teavana have announced they will be shutting down stores throughout 2018. Even Walmart has had to close 63 Sam’s Clubs, including locations in Arizona, California and Florida.
Some of the Sam’s Clubs will be converted into e-commerce distribution centers which will play a helpful role against Amazon, a major competitor. The world is adapting rapidly and commercial real estate is no different. E-commerce continues to expand and while the retail industry is closing stores, commercial real estate is merely transitioning into distribution centers like the Sam’s Clubs. Warehouses and storage centers alike will start to provide the largest value to commercial real estate and serve a crucial part in the modern retail industry.
Commercial real estate analysts like PricewaterhouseCoopers and Urban Land Institute focus on real estate progression and have both reported the industrial division as the highest valued property type for 2018.
2018 is predicted to see major impacts from increases in interest rates, the effects of new taxes and Brexit on international banking, and the retail adaptation to the commercial real estate industry. We hope these changes can provide for a beneficial and profitable new year.