US real estate deals insights: Q3 2019

Real estate deal activity fell slightly during the quarter, but fundamentals and outlook remain strong

Deal volume and value declined slightly during the third quarter of 2019 compared with the same period in 2018. Yet pricing stayed firm, and the number of transactions in the industrial sub-sector is among the highest we’ve ever seen.

Public market indices tied to US real estate have outpaced gains in the Standard & Poor’s 500 Index by more than 6% during 2019, underscoring robust investor interest in the sector. We expect deal activity to finish the year at a steady pace, spurred on by the healthy labor market, sustained consumer spending, and a decline in interest rates.

Trends and highlights

• This quarter, total real estate deal value contracted by 10.2%, compared with the same period in 2018. But the current dip overstates the slowdown, and we believe that the current market is still quite attractive for real estate industry transactions. While announced value for RE deals in the first nine months of this year did dip 3.8% from the comparable period in 2018, it’s slightly above the five year average of 2.1% for that seasonal period.

• Similarly, deal volumes are off slightly from 2018. Third quarter volumes are off 6.9% from 3Q18. The Jan-Sept 2019 numbers have also been drifting downward; they are now down 1.8% over the five year average for the same seasonal period.

• Unlike the other measures, average deal size is up 3% in the first nine months of this year vs Q1-Q3 2018.

• Cap rate compression has leveled off, indicating that pricing is now holding steady after a period of growth, but we still see a great deal of interest in the real estate market relative to other asset classes.

Analysis by real estate sub-sector

The industrial and apartment sub-sectors contributed most to the industry’s deal value during the third quarter, with transactions totalling $40.1 billion and $32.9 billion respectively. The industrial sub-sector continued to gain investor interest, with deal value rising 62.5% compared with the third quarter of 2018 and more than doubling compared with the second quarter of 2019. Overall, industrial real estate transactions accounted for 31.6% of the industry’s total deal value during the third quarter. That compares with a 15.1% share during the second quarter of 2019 and a 16.7% share during the third quarter of 2018.  

The hotel sub-sector continued to grow while remaining a small portion of overall deal activity. Its deal value increased 22.3% compared with the third quarter of 2018 and surged 53% compared with the second quarter of 2019. The real estate industry’s greater attention to customer experience has fueled interest in the hotel sub-sector.

Real estate deals outlook

As highlighted in Emerging Trends in Real Estate® ‒ US and Canada: 2020, we expect investors will continue to seek opportunities that capitalize on technological innovations and shifting customer preferences. They will also probably focus on achieving differentiation in an increasingly competitive operating and investing environment. Differentiation will grow more important in a market crowded by investors with record levels of ready capital.

The coworking model is gaining appeal as technological change prompts a sense of isolation among some workers. Coworking offers the community environment sought by many consumers. Despite some recent market noise, we see strength in this area, and several signs of its appeal have emerged: coworking office space continues to expand, commercial property owners are increasingly offering alternatives to traditional office space, and an investor group during the third quarter backed Industrious, a shared workspace company.

In the same vein, consumer demand for community space continues to drive new development and redevelopment across many real estate sub-sectors. Also, investors are seeking properties and partnerships that cultivate closer tenant-customer interaction. 

The hotel industry appears to be approaching an inflection point amid slowing economic growth and flat operational performance. Deal activity in the sub-sector has quickened, with several big transactions announced in 2019.

Changes in hospitality trends and guest preferences have prompted differentiation in hoteling. For example, professionals are increasingly using hotel lobbies and other common areas for conducting business. Some hotels are profiting by embracing the coworking model and adapting to demand for nontraditional workspace. Accor Hotels launched its Wojo coworking concept in 80 locations, while Hoxton Hotel plans to introduce its “Working From” space in Chicago and London.

Investors will probably remain cautious in coming months in the face of economic and political uncertainties. Still, the shift in trends and preferences in many sub-sectors opens the way for differentiation backed by many types of investors seeking higher yields. We expect to see the introduction of unique offerings in real estate that capitalize on emerging social, demographic, and economic trends. 

Amid strong demand for fresh real estate opportunities, the sector continues to be the focus of regulatory scrutiny in the US and other countries. Rent control in the apartment sub-sector has tightened in many states, prompting investors in multifamily properties to review their strategies and business models. We believe regulatory change will influence real estate investment beyond 2019. 

With interest rates near record lows in many countries, the US remains an attractive option for both foreign and domestic investors. US properties currently can add value to an investment portfolio and often generate higher returns than many other asset classes. US properties are especially appealing to institutional investors and family offices. Competition will probably intensify as family offices shift more resources to direct investments in real estate. We believe that, as uncertainty persists in global markets, disciplined capital seeking an alternative investment will probably flow to non-core real estate.