On January 22, 2020, the ULI New York Real Estate Outlook 2020 event included a panel moderated by Sonny Kalsi titled “Capital Markets: The View from the Top.” Mr. Kalsi is President of BentallGreenOak, a real estate investments and asset management firm. He was joined on the panel by Chris Lee, Head of Real Estate Americas at KKR, Onay Payne, Managing Director at Clarion Partners, and Darcy Stacom, Chairman and Head of New York City Capital Markets for CBRE.

Darcy Stacom began the panel’s discussion with an overview of the New York City real estate market. Several facts serve as reminders of the important place New York City occupies as the financial and real estate center of the US. Greater New York City contributes 8.6% of US GDP and at $1.8T is the world’s 10^th largest producer, larger than Canada or Russia. In 2019, over 73,000 new office jobs were added to the market, and office employment peaked at 1.71M in May 2019, up 1.2% from 2018. New York continues to be a strong labor market. 953,000 residents have graduate or professional degrees and total technology, advertising, media and information (TAMI) employment is 366,400, second only to the San Francisco Bay Area.

Manhattan Office continues to perform well. Midtown transactions contributed the bulk of transaction volumes in 2019. Midtown South is challenging Midtown with average sales price per square foot of $947 for Midtown South and $1,040 in Midtown. User premiums for major transactions – such as Google’s purchase of Chelsea Market in 2018 and the Milk Studios building in 2019 – highlight the growing importance of Midtown South.

Two thirds of investment sales capital were domestic in 2019. German groups accounted for 21 percent of deal volume, Middle Eastern outfits for 11 percent, and 3 percent came from South Korean sources. The majority of core plus or value add transactions catered to domestic capital, and the median deal size was approximately $180M. Domestic pension funds increased their activity due to increases in yields early in the year. Value add funds were the most active segment of the market. Much foreign investment was subdued early in 2019 due to hedging costs and focus being turned to other markets.

Onay Payne of Clarion Partners reminded the panel that Darcy had described CORE as a 4-letter word in the 2018 ULI panel. Regarding a recent value-add investment near Grand Central, her firm had not found a good reason to sell, as investors were looking for more opportunity for growth, and so Clarion decided to hold. In New York City, Payne described three main drivers for investment decisions: 1. core vs. value-add 2) tax-burdened or tax-advantaged and 3) tech-economy adjacent.

Payne also noted that retail investors in the form of non-traded REITS are growing. Although the first iteration of the industry was a spectacular failure, version 2.0 has grown to $11.8B in 2019, up from $4.6B in 2018. Although still small compared to the total market of $600B in US transactions in 2019, it is important that the investment sector is growing. Adjacent markets are going to feel the spillover of this investment source.

Chris Lee from KKR posited that while real estate is valued dearly on an absolute basis, on a relative basis it is a good value. B-grade debt has dropped 80 basis points since Thanksgiving 2019. Spread product is continuing to compress. This compression makes real estate attractive to investors. They are all searching for yield. KKR is making an extra allocation of its balance sheet to real estate because it is so attractive right now. In deciding where to invest, Lee explained that 50 percent of GDP is in 15 US cities, although it is not evenly distributed. KKR looks to where white collar employment is going up, and the firm spends considerable time understanding consumers’ preferences. In general, KKR is investing in logistics, senior housing, multifamily workforce housing, student housing near Power Five and large state universities, and West Coast office. KKR is not buying hotels and or condos – their strategy is to buy cash flows and they prefer shorter business plans.

On the topic of retail pricing, Payne highlighted the mismatch in retail pricing versus the overall real estate industry. She noted that between 2008-2019, RCA average real estate prices increased by 42 percent across the US. Retail transaction pricing has remained virtually unchanged, so assets are undergoing a necessary repricing.  However, Stacom added that she is working on financing a retail deal in New York City for less than 4.5 cap, reflecting a “flight to quality.” Lee added that not only is it impossible to find CMBS lenders on bad retail loans, it is increasingly difficult to get any leverage for a retail deal. Stacom underlined that as the market moves to more practical retail, some space will be lost, and “big boxes that were badly built will go bye-bye.”

Finally, the panel discussed emerging environmental, social and governmental trends. Stacom noted that Local Law 97 – a green building code enacted in May 2019 in New York that limits building carbon emissions – will be an important factor in the real estate industry in and outside of New York. As she stated: “So goes New York, so goes the country.” Buyers will look at leases and tenants will decide if a pro-rata share of energy consumption is fair. Sonny Kalsi added his belief that regardless of one’s political leanings, it has been demonstrated that good social policy will become good business policy. Regardless of a company’s thought on climate change, every company, including in real estate, needs a strategy on how to deal with perceptions and regulations on the issue of climate change.