ULI TRENDS REPORT Prepared by Robert Simons, Ph.D. Georgina Figueroa Levin College of Urban Affairs Cleveland State University r.simons@csuohio.edu Prepared for ULI Cleveland January 4, 2016 BACKGROUND This is the second edition of The ULI Cleveland District Council s Real Estate Trends in Northeastern Ohio. It takes the pulse of the region s real estate market, including capital markets, various sectors of property types, and geographic submarkets. This survey complements the national PWC/Urban Land Institute s Emerging Trends in Real Estate, adding an in- depth local perspective to the national survey s insights on the U.S. economy and real estate markets. In September, 2015, ULI Cleveland distributed a link to an online survey to its e- mail contact list. The survey was available on line between October 20 th to November 4 th and 67 non- random responses were collected, a response rate of about 6%. Additionally, 12 in- person interviews were conducted with key local experts from the private and public sectors across a range of professional disciplines, in particular real estate development, management, finance, and planning. The information presented in this report includes quantitative data and open- ended comments from the on line survey and quotes from the personal interviews. ULI Cleveland 2016 Emerging Trends 1
EXECUTIVE SUMMARY This survey provides a general overview of how the 67 respondents view various sectors of the real estate market. It should not be used as a basis for investment decisions. About a third of survey respondents are in a management position at their companies, and their companies are reported as active in markets both in and outside the State of Ohio. Main points drawn from the responses are: Generally, the Cleveland and Northeast Ohio real estate market is good, and consensus is that it should be better next year. Respondents expect to see a good profitability in real estate businesses in 2016, especially apartment/multi- family and office developers. The most important financial issues for real estate investment and development in 2016 are job, income and wage growth, followed by interest rates and inflation. The top potential needs for land development are better building and zoning regulations, better public transportation and more workforce for construction and skilled trades. Residential rental, retail and office sectors are still strong. Residential- for sale and institutional/public sectors rankings have nicely increased in percentage growth compared to last year. ACTIVE SECTORS. 2014-2015 CHANGES 80.0% 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% 2014 2015 Northeastern Ohio is also seen as more profitable for multifamily developers and private local real estate owners when compared to other markets. Though respondents feel the real estate capital markets through 2016 are undersupplied most respondents agree that some increase (58%) is expected in the availability of equity capital. ULI Cleveland 2016 Emerging Trends 2
The apartment and office markets are in a recovery/growth stage, while retail is viewed cautiously with a shift away from large regional centers to smaller community based retail centers. The hottest submarkets with good- excellent prospects continue to be University Circle, Downtown Cleveland and Lakewood. PROSPECTS FOR VARIOUS NORTHEASTERN OHIO SUBMARKETS IN 2016 University Circle Downtown Cleveland* Lakewood / Rocky River / Fairview Park Bay Village / Westlake Chagrin Falls / Hunting Valley Avon Lake Hudson / Streetsboro / Solon Maycield / Beachwood / Shaker Heights Cleveland- West Strongsville Aurora / Twinsburg 2016 Mentor / Willoughby 2015 Medina Richcield / Bath Cleveland- South Akron Brunswick / Hinkley Cleveland- East Olmsted Falls / Berea Columbia Station Newburgh Heights Parma / Middleburgh Heights Warrensville Heights 0 1 2 3 4 5 Abysmal Poor Fair Good Excellent All respondents regard the economic health of the region as vital to continued growth. ULI Cleveland 2016 Emerging Trends 3
SURVEY RESULTS METHODOLOGY A total of 67 respondents participated in the survey. Survey respondents chose and answered questions related to their professions, thus different sectors have a different number of responses. Not all respondents answered every question in their chosen sectors. Most questions before the property sector component of this report (apartment, retail, office) have sufficient sample to be instructive (typically 30-40 responses). Each of the sector responses have about a dozen responses, partially because housing people did not answer retail questions, and vice versa. This is at the lower end of the range of acceptable samples, and these results should be viewed with caution. When the number of responses falls below ten, these results should only be considered as anecdotal evidence of trends. The questions were asked in varying formats. To provide a better comparison, the CSU Levin College research team converted selected answers to standardized results on a 1-5 Likert scale. For example, abysmal prospects are assigned a score of 1, poor scores get a 2, fair scores a 3, good scores receive a 4 and excellent scores are 5. The same scale is used for comparison of prospects: running from much worse (scoring a 1) to much better (5). ULI Cleveland 2016 Emerging Trends 4
SURVEY RESPONDENT CHARACTERISTICS Professional service firms represent the largest share of survey respondents at 30%, followed by private developers (15%) and Non- profit organizations (12%). See Chart 1. CHART 1: RESPONDENTS BY FIELD University Institutional Investor Builder 1% 2% 2% Lender 4% REIT 3% Property Management 6% Non- Procit 12% Brokerage 7% Government 9% Professional Service Firm 30% All others 9% Private Developer 15% About a third of survey respondents were Vice Director/manager (27%), and general employees (24%). Others were President or Vice- President (15%) and owner (17%) of their firms. CHART 2: RESPONDENTS BY POSITION Others 12% Owner 17% Associate 24% President/CEO 9% EVP/COO/CFO 5% Director/Manager 27% Vice President 6% With respect to markets in which respondents are active, nearly half of the respondents organizations (40%) are active in markets both in and outside Ohio. 34% of respondents are focus on Northeastern Ohio real estate market only. ULI Cleveland 2016 Emerging Trends 5
Another question posed to respondents was which real estate trends they were following the closest. This as an open answer question that got several different responses. The most popular answer was downtown development and walkability (16%). Another common response was new development and rehab (14%). Affordable housing (10%), capital availability (10%), mix- used development (10%), and millennial trends (10%) were all popular responses as well. Other responses less popular were senior housing, job growth, industrial, hospitality sector, etc. CHART 3: MOST FOLLOWED REAL ESTATE TRENDS Multi- family development 10% GENERAL BUSINESS PROSPECTS Affordable Housing. 10% Dowtown development and walkability 16% Millennial trends 10% Capital availability 10% Mix- used development 10% Overview Survey respondents affirm their real estate businesses (all sectors combined) are performing well in 2015 and expect them to get slightly better in 2016. 70% of survey respondents claim their profitability to be good or excellent in 2015, and 78% expect things to be good or excellent in 2016. A total of 57 respondents answered this question, and Chart 4 shows their expectations. CHART 4: EXPECTED PROFITABILITY OF REAL ESTATE BUSINESS IN 2015 VS. 2016 45 40 35 30 25 20 15 10 5 0 Residential 8% Rent rates 6% New development and rehab 14% Retail 6% Abysmal Poor Fair Good Excellent 2015 2016 ULI Cleveland 2016 Emerging Trends 6
Business expectations Chart 5: BUSINESS PROSPECTS FOR NORTHEASTERN OHIO IN 2015 COMPARED TO OTHER MARKETS Multifamily developers Private local real estate owners Commercial developers Real estate brokers Homebuilders/residential land developers Real estate investment management REITs Real estate consultants Commercial bank real estate lenders Architects, designers Insurance company real estate lenders CMBS lenders/issuers 0 1 2 3 4 5 Much worse About the same Much better According to the 43 respondents, new multifamily development has the highest profitability expectation in Northeastern Ohio in 2016, followed by private local real estate owners. Overall, the rest of the respondents don t expect big changes in other sectors compared to markets outside Cleveland in 2016. See chart 5. CAPITAL MARKETS Inflation, Interest rates and Borrowing Costs Inflation and interest rates are expected to increase moderately in 2016 as well as over the following three years. See chart 6. CHART 6: EXPECTED CHANGE IN INFLATION AND INTEREST RATES IN 2015 AND BEYOND 50 40 30 20 10 0 Fall Remain Stable Increase Moderately Increase Substantially ULI Cleveland 2016 Emerging Trends 7
When asked how they are planning to respond to potential interest rate increases, the most popular answer, drawn from 37 responses among the 26 participants, was to obtain financing or refinancing now (38%), followed by scaling back risk (30%). One participant mentioned the option of doing nothing because interest rates are at all time lows and will continue that way. CHART 7: HOW ARE YOU PLANNING TO RESPOND TO ANTICIPATED INTEREST RATE INCREASES Do nothing 3% Other 13% Scale back risk 28% Obtain cinancing or recinancing now 38% Reduce development activity 8% Capital availability Adjust portfolio 10% The 60 survey respondents generally felt that real estate capital 2016 is undersupplied. Chart 8 shows that a large portion that adds up to 50% of the respondents agrees that the capital markets are either undersupplied or substantially undersupplied, with undersupplied (48%) being the most popular opinion. Since availability of capital is a key component to real estate development and ownership, there is some concern about tight markets in 2016. The good news is that respondents expect capital to loosen up over the near term: whether this expansion is sufficient to propel growth remains to be seen. Good news is that most of the 60 respondents agree that some increase (58%) is expected in the availability of equity capital for real estate and lending. An increase overall is the most popular answer, reflecting 60% of the responses. Chart 9 shows that only 40% of the respondents agreed that either no change, or some decline is likely. ULI Cleveland 2016 Emerging Trends 8
CHART 8: OVERALL STATE OF THE REAL ESTATE CAPITAL MARKETS THROUGH 2016 Oversupplied 17% Substantially Oversupplied 1% Undersupplied 48% In Balance 32% Substantially Undersupplied 2% CHART 9: EXPECTED CHANGE IN EQUITY CAPITAL FOR REAL ESTATE AND LENDING Some Increase 58% No Change 27% Some Decline 13% Large Increase 2% NORTHEASTERN OHIO MARKET OVERVIEW According to the 65 survey respondents, job, income and wage growth are the top most important economic and financial issues for real estate investment and development in 2016, rated 3.9, followed by interest rates and inflation, state and local budgets problems and energy prices rated between 3.2 and 3.3. The rest of the issues were not rated or of no relevance for the respondents. CHART 10: IMPORTANCE OF ECONOMIC AND FINANCIAL ISSUES FOR REAL ESTATE INVESTMENT AND DEVELOPMENT IN 2016. ULI Cleveland 2016 Emerging Trends 9
Job, Income and wage growth Interest rates and inclation State and local budget problems Energy prices Overall the survey reports that the most active sectors in Northeastern Ohio are: residential rental (71%), retail (53.2%) and office (51.6%). As it can be seen from Chart 11, the order represents no change from last year s report, but the percentages of these three sectors have substantially increased. Hospitality (21%) has increased slightly. Another remarkable change is that the residential- for sale (22.6%), and institutional (17.7%) sectors showed the largest percentage increases. Industrial (14.5%) and niche sectors (14.5%) have decreased activity slightly. See charts 11 and 12. Chart 11: ACTIVE SECTORS 0.0 1.0 2.0 3.0 4.0 5.0 No importance Moderate Great Importance Sector 201400.0% 201500.0% % Change Residential - rental 52.9% 71.0% 34.2% Retail 41.2% 53.2% 29.1% Office 32.4% 51.6% 59.3% Residential - for sale 8.8% 22.6% 156.8% Hospitality 17.7% 21.0% 18.6% Institutional/public 8.8% 17.7% 101.1% Industrial/distribution 20.6% 14.5% - 29.6% Niche/alternative 20.6% 14.5% - 29.6% ULI Cleveland 2016 Emerging Trends 10
CHART 12: ACTIVE SECTORS. 2014-2015 CHANGES 80% 70% 60% 50% 40% 30% 20% 10% 0% 2014 2015 NORTHEASTERN OHIO GEOGRAPHIC SUBMARKETS Submarket prospects Based on 67 responses, University Circle is still viewed as having the best prospects in the region for real estate activity in the year ahead, with a rating of 4.5. Downtown Cleveland also achieves good- to- excellent ratings and this year, and Lakewood/Rocky River/Fairview Park passes Bay Village/Westlake and moved from the 5 th to the 3 rd position. For this question, respondents were allowed to select the submarkets they wanted to rate. On the other hand, Olmsted Falls/Berea, Columbia Station, Parma/Middleburgh Heights, Brunswick/Hinkley, Newburgh Heights and Warrensville Heights rated poor- to- fair, showing no change from last year s prospects. Downtown Cleveland (Urban Core) has the highest development expectations in our region. According to our interviewees, City and inner- ring neighborhoods continue to be well- positioned to take advantage of demographic trends as larger percentages of millennials gravitate to urban work- live neighborhoods and delay until later in life household formation decisions that may led previous generations to relocate to exurban areas. Beachwood is feeling multifamily occupancy pressure from Downtown. ULI Cleveland 2016 Emerging Trends 11
CHART 13: PROSPECTS FOR VARIOUS NORTHEASTERN OHIO SUBMARKETS IN 2015 University Circle Downtown Cleveland* Lakewood / Rocky River / Fairview Park Bay Village / Westlake Chagrin Falls / Hunting Valley Avon Lake Hudson / Streetsboro / Solon Maycield / Beachwood / Shaker Heights Cleveland- West Strongsville Aurora / Twinsburg Mentor / Willoughby 2016 Medina 2015 Richcield / Bath Cleveland- South Akron Brunswick / Hinkley Cleveland- East Olmsted Falls / Berea Columbia Station Newburgh Heights Parma / Middleburgh Heights Warrensville Heights 0 1 2 3 4 5 Abysmal Poor Fair Good Excelent Land use and development needs All of the 64 survey respondents believe that more economic growth is the dominant force in driving land use and continued development in Northeastern Ohio. Better building and zoning regulations is also seen as a major need (92%), followed by better public transportation (89%), and a better- trained workforce for skilled construction trades (82%). Greater availability of development sites (78%) and better parking in downtown/ohio city (57%) are seen as lower priorities. Chart 14 provides this information. ULI Cleveland 2016 Emerging Trends 12
CHART 14: IMPORTANCE OF POTENTIAL NEEDS FOR LAND USE AND DEVELOPMENT IN NORTHEASTERN OHIO More economic growth Better building and zoning regulations Better public transportation More workforce for construction and skilled Greater availability of sites for development Better parking in downtown/ohio City When asked which demographic factors they deemed more important for real estate development, participants agreed that wage growth (51%) is most important, followed by household formation (30%). The nation has recently experienced an uptick in real wage growth, but the sustained future of wage growth in Ohio is partly dependent on Fracking and the shale sector. In regards to which finance factors are the most important for real estate development, survey respondents believe creative financing (67%) is most important and the least important is tighter financing regulations (13%). As to which public leadership factor is most influential for real estate development, participants opinions ranked zoning reform (40%) and tax credits (47%) about the same. There are two design factors that survey participants think are important for economic development: both space efficiency (45%) and healthy/green design (48%) were popular responses. NORTHEAST OHIO APARTMENT SECTOR 0 1 2 3 4 5 Low Moderate High Overall, the apartment sector in Northeastern Ohio is perceived as good. According to the 42 survey respondents, the apartment industry is recovering and growing. However, over 30% of the respondents think the general apartment sector is peaking, an increase from last year, when only 20% of the respondents believed it was at the peak. Survey respondents shared their belief that the apartment sector will continue to grow: The shift toward long- term renting among millennial professionals shows no signs of abating. Continued wage stagnation and income inequality also fuel demand for rental housing. One survey respondent thinks more growth is coming but shows concern for the development of luxury apartments: ULI Cleveland 2016 Emerging Trends 13
I think the rental market in general is going to continue to grow. This is driven by a delay in family formation by millennials and also the re- urbanization of downtown areas. My concern with luxury apartments is while the job market has improved some, wage growth and student loan debt payments weigh heavy. So I think millennials will try and seek more affordable housing options. Luxury apartments simply serve a smaller portion of the rental market and I feel that is going to peak first. Apartment Cycle Chart 15 below shows respondents perception of the current market cycle for luxury apartments, moderate apartments, tax credit apartments and student housing. The vertical axis shows the number of responses out of the 42 people that answered these questions. Overall, perceptions of the apartment sector in Northeastern Ohio are good. Most survey respondents believe the apartment sector is recovering, growing, and some believe at the peak. Moderate apartments (78%), student housing (68%) and tax credit apartments (68%) are considered to be the market segments best positioned at this time. CHART 15: CURRENT STAGE OF REAL ESTATE CYCLE: APARTMENT 20 18 16 14 12 10 8 6 4 2 0 All apartments Luxury apartments Moderate apartments Tax credit apartments Student housing Peak Early decline Advanced decline Bottomed out Recovery/growth Growth Apartment Recommendations This question asked respondents to recommend their conclusions on whether to buy, hold or sell. Based on 41 responses, about 75% of investment recommendations for the apartment sector in 2015 are hold or buy, especially for moderate apartments. Luxury apartments have gained the least support for buying. NORTHEAST OHIO RETAIL SECTOR ULI Cleveland 2016 Emerging Trends 14
Overall, retail in Northeastern Ohio is mixed. According to 33 survey respondents, some, but not all sectors of the retail industry are recovering. However, about half of the respondents consider the Northeastern Ohio market to be somewhat declining, especially in the case of regional malls. Most investment recommendations for retail business were to hold in 2015. Respondents agree that regional malls are in decline. One respondent commented: Companies have shifted focus from retail to entertainment- anchored centers. As technology improves, people won't need to go to the mall. Developers need to build centers that cannot be replaced by new tech(nology). Shoppers will not want to order toilet paper online, so grocery- anchored shopping centers will do fine. At the other end of the spectrum, shoppers will not be able to get real- life entertainment and super high- end goods online. Someone needs to create a product that meets that demand. Retail Cycle Chart 16 shows respondents perception of the current retail cycle for regional malls, power centers and neighborhood/community centers. The vertical axis shows the number of responses out of the 33 people that answered these questions. Overall, perceptions of retail in Northeastern Ohio are mixed. About 60% of survey respondents believe neighborhood and community shopping centers are in the recovery phase, versus 73% last year. Almost the same percentage of respondents (70%) believe regional malls are in advanced decline compared to last year. Most feel power centers are either in growth or in a recovery/growth stage. See chart 16. CHART 16: CURRENT STAGE OF REAL ESTATE CYCLE: RETAIL 16 14 12 10 8 6 4 2 All retail Regional malls Power centers Neighborhood/community shopping centers 0 Peak Early decline Advanced decline Bottomed out Recovery/growth Growth ULI Cleveland 2016 Emerging Trends 15
Retail Recommendations: Respondents were asked to recommend whether to buy, hold or sell retail real estate. Based on 31 responses, over 90% of investment recommendations for retail in 2016 are hold or sell. The only exception is neighborhood/community shopping centers. In this case, over 40% of the respondents think it is time to buy. NORTHEAST OHIO OFFICE SECTOR Overall, the office market in Northeastern Ohio is mostly growing or recovering. According to 30 survey respondents, most sectors of the office industry are recovering. Most investment recommendations for the office sector are to hold in 2015. Many respondents are concerned about the overlap between office development and apartment development: It will be interesting to see what happens when Downtown class B and C products get used up by apartment/hotel redevelopments. Companies still need that kind of office space. Office Cycle Chart 17 shows respondents perception of the current cycle for the office sector for central city offices, suburban offices and medical offices. The vertical axis shows the number of responses out of the 30 people that answered these questions. Overall, perceptions for the office sector in Northeastern Ohio indicate a recovery. Half of the survey responses believe central city offices have made a large shift toward to recovery while medical offices are either growing or recovering. CHART 17: CURRENT STAGE OF REAL ESTATE CYCLE: OFFICE 20 18 16 14 12 10 8 6 4 2 0 All ofcice Central city ofcice Suburban ofcice Medical ofcice Peak Early decline Advanced decline Bottomed out Recovery/growth Growth ULI Cleveland 2016 Emerging Trends 16
Office recommendations This question asks respondents to recommend their conclusions of buy, hold or sell. Based on 30 responses, 90% of investment recommendations for general office in 2015 are to hold or sell. However, some respondents think it may be a good time to buy central city offices (31%) and medical offices (33%). NORTHEAST OHIO: OTHER SECTORS There were a small number of respondents to provide definitive results, so these following sections should be considered anecdotal. Industrial sector 9 people participated in the survey for this sector. According to this limited sample, the industrial market in Northeastern Ohio is good. According to survey respondents, most sectors of industrial are recovering. Based on 9 responses, most of the investment recommendations for industrial in 2015 are to hold or buy. This is an interesting shift from last year, when the recommendation was to sell or hold. Hotel sector 13 people participated in this part of survey. Overall, the hotel sector in Northeast Ohio is good. According to survey respondents, the hotel sector is either peaking or recovering/growing. Based on the responses, investment recommendations for all hotels in 2016 are to hold (60%) or sell (31%). Other real estate sectors 10 people participated in the survey on the education sector. They believe the education sector in Northeastern Ohio is mixed. According to survey respondents, though real estate needs for higher education might be peaking, and hospitals needs are growing. General investment advice for education in 2016 is to hold. 9 people participated in the survey on niche/alternative sectors. According to survey respondents, the land business in Northeastern Ohio is recovering, contrary to last year when the general opinion was that it had bottomed out, consistent with pick- up in the residential for sale sector. Urban mixed- use properties are seeing growth: 55% of respondents believe 2016 will be a good time to buy into niche/alternative sectors, especially urban mixed- use properties (78%) and infrastructure (89%). The biggest shift from last year comes from the residential- for sale sector. This year respondents believe that the residential- for sale market is in a recovery stage. Investment recommendations for residential for sale investors in 2016 is to hold or sell. ULI Cleveland 2016 Emerging Trends 17