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Five Questions about 2019 with Bob Brown, Division Executive, Commercial Real Estate Banking

1.) When you look at the skyline of Boston with all those cranes across the city, it’s clear that real estate development has been strong. Will we see more of the same in 2019 in Boston and the suburbs?Bob Brown CRE Division Executive

It doesn’t take a real estate expert to see that development has been going strong throughout Greater Boston. Should the strength of the labor market continue, the cranes will remain active in the city as well as the suburbs.    

Boston area employment continues to grow above the long-term trend.  Boston’s unemployment rate of 2.9% is slightly better than the 3.5% unemployment for the state.  Since the pre-recession peak Massachusetts has added more than 350,000 jobs.  Primary growth areas continue to be professional and business services as well as manufacturing and construction. 

With downtown office vacancy rates at less than 6% and just over 10% for suburban office with ongoing strengthening rents of $50 psf in Boston and $30 psf in the suburbs and more than 50,000 households earning over $100,000 since 2009, office and residential construction is anticipated to continue in 2019. 

The strength of our local economy and the related new construction that results from it, will continue to drive demand for more apartments and office space.  That said, external forces can have dramatic impacts on the continued growth.  However, we continue to be skeptically optimistic in 2019.

 2.) The current environment of rising interest rates is having a big impact on global equity markets, with most having nothing to show for 2018, how does this slowing global growth impact the CRE market?

There are many parts to this question.  First, Brookline Bank is fortunate to be lending in an area with a diverse economy in life sciences, higher education, healthcare as well as a diverse service sector.  Unemployment is very low and household formation remains very strong which continues to push apartment and office rents upward.   Given the limited supply and strong demand, rents are expected to continue to grow albeit at a slower pace than in the past several years as there are limited sites that can be developed and construction prices continue to escalate.   At the same time, significant demand by CRE investors compresses yields which pushes prices higher and higher.

 

While real estate asset prices are typically more sticky than equity market valuations, CRE valuations are based on some margin in excess of the 10-year Treasury.  Volatility in the equity markets are impacting the treasury yields which in turn impacting the CRE market over the long-term.  Over the past 12 months, there appears to be very little impact on CRE prices.  The bigger issue appears to be the volatility of interest rates across the yield curve for both shorter and longer durations which seems to slow transaction volume.  For example, short term yields rose steadily over 100 bps higher in 2018, while the long term yields ranged from a low of 2.5% to a high of just over 3.25% with only a 20 bp increase.  


3.) Online retail was supposed to end brick and mortar retail, but that’s not exactly the case. What do you see the future holding for the retail sector?

Retail continues to evolve with technology and consumers’ interest.  Some retail centers have and will experience some pain as “big box” tenants like Sears, Toys ‘R’ Us, Kmart, JC Penny and others face pressure from online retailers and newer retail concepts.  Larger blocks of contiguous space will require more creativity to reposition for alternative uses or will incur additional costs to be repositioned.  Some of these spaces are reinventing themselves with alternative uses as fitness centers, medical or general office uses, or some are subdividing into smaller retail stores. 

 

Retail concepts that provide flexibility to innovate and adapt will be able to meet changing needs of the consumer in the future.   While some tenants come and go, retail properties that provide experiential opportunities and convenience will position themselves to withstand online competition while maintaining customer demand.


4.) What part of CRE do you see being the biggest area of growth in 2019?

Growth is relative given where we are in the cycle and the compression in returns seen over the prior several years. CRE returns are likely to continue compressing in 2019. With ground up construction returns between 5.5% to 6.0% and escalating construction costs, the similarly yielding repositioning of existing assets that offer shorter lead times and prices below replacement cost as an opportunity.  However, finding well-located assets that meet the criteria are becoming more difficult to acquire at reasonable prices.

5.) What trend surprised you the most in the CRE market in 2018?

The strength of the residential market and the vastness of the many different neighborhoods, cities and towns it is affecting.  Neighborhoods and towns that have seen very little redevelopment or new construction in past cycles continued to see activity in 2018.  Whether it is ground up construction or redevelopment of existing supply, the widespread development activity does not seem to show any signs of weakening into 2019.  With the advent of the Opportunity Zones, continued development is expected in the coming years.

Many of Bob's perspectives on 2019 were featured in the January 21, 2019 issue of Banker and Tradesman (subscription required).