Changing consumer habits and the rise of e-commerce continue to accelerate the transformation of commercial real estate. While outdated second-tier malls were a drag on the sector – Green Street’s Commercial Property Price Index declined 1 percent, to 125.5, in October, its largest monthly decline since the recession – other major asset classes remained stable, with industrial values climbing 10 percent over the past 12 months.

Year-over-year transaction volume, another barometer for the market’s health, was down 9.6 percent in the third quarter, yet remained above the $100-billion threshold at $109.6 billion, an increase of 3.2 percent from second-quarter 2017, according to Real Capital Analytics. During the first 10 months of the year, commercial property sales totaled $368.9 billion, down 7.4 percent from the same period last year, RCA data show.

“The rapid expansion of commercial real estate over the last several years has been a force to reckon with,” said Richard Matricaria, senior vice president and Midwest division manager at Marcus & Millichap. “Most of our clients are taking a closer look at their equity position and overall strategy right now given what is happening with both tax reform and monetary policy. While it’s true retail is very dynamic and suburban office operations are challenging, the overall outlook is positive for investment sales given the equity chasing return in the marketplace.”

Heading into 2018, here are seven trends that will impact commercial real estate in the new year, according to some of the industry’s leading Midwest experts.

1) Shakin’ Up The Core: Millennials, who are now the largest generational employee group, continue to have a dramatic impact on the office sector. The generation that helped revitalize urban cores and blurred the lines between living, working and playing are now approaching their child-rearing years and could shake things up again with demand for alternative-urban, or even suburban, office locations.

In Chicago, demand is spreading from the CBD into areas like the recently rezoned North Branch Industrial Corridor, a 760-acre stretch of land where high-rises are expected to replace smokestacks thanks to newly adopted land-use guidelines that allow for a mix of residential and commercial uses. In anticipation of the change, Chicago-based Baker Development Corporation is converting a former industrial building at 2017 N. Mendell St. into a 62,000-square-foot Class A office building, complete with a rooftop deck. Scheduled to deliver in early 2018, the riverfront development will help users establish a presence near the emerging Lincoln Yards mixed-use district, one of the proposed sites for Amazon’s HQ2.

“This location provides tenants with an attractive value proposition, allowing them to enjoy state-of-the-art office space on par with submarkets like the West Loop and River North, but at a 25 to 30 percent savings due in large part to our lower tax basis,” said Dan Slack, principal at Baker.

Another emerging office submarket is Chicago’s Pilsen neighborhood, where the Chicago office of Transwestern is leasing Mural Park, a mixed-use redevelopment comprising a pair of 100,000-square-foot brick-and-timber loft buildings. When completed in fall 2018, the project will offer a mix of office, light manufacturing and retail space.

“Although quality office product has been limited in these submarkets, firms are more than willing to make the move — especially if it means saving as much as $7 a square foot without giving up the creative office environment that has become a valuable recruiting tool,” said Jeff Dowdell, senior vice president of agency leasing in Transwestern’s Chicago office.

In Denver, KTGY Architecture + Planning is designing Central Park Station ONE, a 190,000-square-foot office building in the Stapleton neighborhood, just south of the Regional Transportation District’s Central Park commuter rail station and midway between downtown and Denver International Airport. Part of a larger 35-acre mixed-use development, Central Park Station ONE offers walkability and the same amenities found in downtown towers, including a lobby with cafés and restaurants, a rooftop terrace, and private balconies on each floor that serve as extensions of individual offices.

“Tenants want to feel like they’re in a contemporary downtown office, and when space is easily accessible via rail or road, it becomes less about the location and more about the design,” said Terry Willis, principal of KTGY.

2) Silver Tsunami Raises All Boats: The senior population is growing and, increasingly, gravitating to the rental lifestyle. The number of Americans age 65 and older increased from 35 million in 2000 to 49.2 million in 2016, and baby boomers are expected to live longer than previous generations, fueling an unprecedented boom in housing that is setting up to bolster tangential property types like medical office centers.

“Baby boomers are doing what millennials are doing in terms of locating themselves in proximity to urban conveniences,” said Jeff Berta, senior director of real estate development at Chicago-based Structured Development. “With that comes the need for medical office space that is modern and accessible to a growing segment of the population.”

In 2015, Structured Development completed NEWCITY, a 565,000-square-foot mixed-use center that includes 30,000 square feet of medical office space, along with a grocery store, numerous shops and restaurants, a movie theater, bowling alley and adjacent residential tower. “If they don’t live at NEWCITY, guests who come to the center for medical appointments typically visit several establishments while they’re there – it’s an intentional mix of uses that spans multiple sectors,” said Berta.

The design of medical centers themselves also continues to evolve, with many placing a greater emphasis on wellness through both design and programming, according to HSA PrimeCare, the national health care real estate division of Chicago-based HSA Commercial Real Estate.

“As health care continues the shift to a patient-centered model, facility design has become much more thoughtful – a trend that manifests itself in a variety of ways, including the use of warmer colors, abundant natural lighting and amenities like on-site pharmacies and imaging services,” said John Wilson, president of HSA PrimeCare. “Some outpatient facilities have also added fitness centers that can be used for physical therapy and preventative care. And because patients want to be no more than 10 minutes away from their doctor, healthcare providers are bringing outpatient facilities closer to the patients they serve.”

3) Bad Bits For Builders: In the coming year, developers will likely face higher construction costs caused by a number of factors – from hurricanes to the White House’s tariffs on Canadian lumber. But many agree it’s the debilitating labor shortage that poses the greatest challenge to growth in 2018.

William Di Santo, president of national commercial contractor Englewood Construction, notes many subcontractors still have not returned to pre-recession staffing levels.

“The workforce was badly depleted in the mid-2000s, and it never picked up to match the current high level of activity in commercial construction,” Di Santo said. “Another challenge for builders is that clients are asking to have projects completed on shorter timelines, which further strains the capacity of the subs and workforce.”

With a network of subcontractors across the country, Englewood has been able to mitigate the labor shortage by bringing in trade workers from other cities – sometimes hundreds of miles away – when needed, but not all firms have that ability, noted Di Santo.

Steve Rappin, president of Chicago-based Evergreen Real Estate Group, is also seeing a shortage of skilled workers available for projects.

“Subcontractors are extremely busy right now,” he said. “In turn, they’re more selective with their bidding because the volume of opportunity is so high. We’re also keeping our eye on an aging workforce. As baby boomers retire, not as many younger workers are filling their roles as field supervisors, which is critical to our work.”

Due to the impact of Hurricanes Harvey and Irma this fall, Rappin expects to see volatility in the market as demand for supplies shifts to the South as those areas rebuild. Specifically, in 2018, he anticipates an increase in the cost and lead time for certain construction materials.

4) Retail Resuscitation: E-commerce continues to reshape the way people shop. Over the past decade, U.S. government data has shown a steady rise of e-commerce as a percentage of total retail sales. At the end of the third quarter, the Commerce Department reported estimated online sales were up 15.5 percent over the year-earlier period, vs. a 4.3 percent increase for total retail sales. Traditional retailers haven’t given up yet, however, and are still seeking creative ways to lure customers into their brick-and-mortar locations.

One bright spot within the retail sector continues to be grocery, according to William Di Santo, president of Englewood Construction. “Cost- and quality-conscious consumers no longer do all their grocery shopping at a single store – instead, they make the rounds to retailers they prefer for specific items,” said Di Santo, whose firm bid and built multiple grocery projects in 2017 for brands including Aldi and Trader Joe’s. “Because of that, our grocery clients are working with us to define their unique in-store experience by renovating, expanding or adding features like food service counters and dining spaces – similar to a traditional food court.”

The so-called “Amazon effect” is felt in grocery, too, particularly after the e-commerce giant’s purchase of Whole Foods. “More grocers are offering curbside pickup to compete with online options, and we’re being tapped to incorporate the infrastructure and parking accommodations these services require,” said Di Santo.

Despite the growth of e-commerce, brick-and-mortar is here to stay, according to Chicago-based Structured Development. The firm developed 360,000 square feet of retail space at NEWCITY, a mixed-use complex in Chicago’s Lincoln Park neighborhood. In 2018, the firm expects to break ground on another 200,000-square-foot project nearby that will also include a retail component.

“While almost anything can be purchased online from the comfort of your home, there will always be shoppers drawn to the in-person experience and customer service that cannot be duplicated by scrolling and clicking,” said Jeff Berta, senior director of real estate development at Structured. “After all, you can’t test out a new sofa, get personalized home design advice or feel the quality of hand-crafted leather accessories though a computer screen.”

5) Goodbye, Garages: One trend just beginning to take hold may prove to have a profound impact on commercial real estate beyond 2018: the rise of autonomous vehicles (AVs).

National real estate firm Transwestern is predicting self-driving cars will reduce the need for parking, even if the majority of consumers aren’t able to afford the technology when it’s officially rolled out. Instead, self-driving fleets capable of shuttling multiple passengers in one trip will reshape how office buildings are designed by giving rise to curbside pickup stations and dedicated waiting lobbies, according to Transwestern’s recent “The New Industry Driver” report.

The report also predicts industrial real estate could see the most disruption of any commercial sector due to the widespread adoption of AVs, with self-driving trucks working in tandem with automated warehouses, where most parking would become obsolete.

“Although commercial real estate was once considered a late adopter, it’s actually among the industries that will be most affected by this technology, which is why we continue to monitor its development and implementation,” said Transwestern Midwest President Mike Watts. “It’s a shift that will forever alter not only where commercial buildings are built, but also how they’re designed and used.”

The reduced need for parking raises the question of how existing garages will be repurposed for other uses. KTGY Architecture + Planning‘s R+D Studio has created a new model for converting underutilized parking structures into residential buildings. Called Park House, the concept calls for a “donut” configuration in which the middle of a garage would be carved out to create a central courtyard. Shipping containers would then be inserted into the existing parking levels to create individual residences.

“Municipalities are gradually changing their parking requirements, so the traditional parking garage will soon be a thing of the past,” said David Senden, principal of KTGY. “This will create opportunities for developers to replace or retrofit existing structures in a way that enhances the urban environment while generating additional revenue through rents – whether they be residential, commercial or a combination of the two.”

6) Robot Revolution?: As consumers do more shopping online, retailers are racing against the clock – and each other – to fulfill orders. Leading the pack is Amazon, which has established a vast network of fulfillment centers to facilitate same-day and even next-hour delivery. To compete, Walmart and other retailers are increasingly relying on automation to gain an edge in terms of cost and efficiency.

According to Tom Boyle, a principal at commercial real estate firm Transwestern, the robot revolution is well underway in the Chicago area, where high-tech machines power nondescript warehouses, stacking and sorting the products they store.

“Metal fabricators are among those taking full advantage of this technology, using large metal arms to move materials in specialized facilities,” Boyle said. “Across all industries, clear heights will be impacted as warehouses will need more room to accommodate the growing number of robotics. Eventually, we’ll see taller distribution centers – as high as three stories – in Chicago just as they’ve appeared on the coasts as owners and occupiers look to maximize efficiency on the limited quality land sites that remain.”

While robots boost productivity and reduce overhead, proximity to skilled labor remains important to many industrial users, according to Bob Smietana, vice chairman and CEO of Chicago-based developer HSA Commercial Real Estate. Tenants of HSA’s industrial development in suburban Nashville have found its location advantageous as employees can take advantage of the area’s affordable housing stock while benefitting from a shorter commute.

“There’s a lot of discussion about robots replacing labor – while the jobs may be different and there will likely be fewer of them, the reality is labor will always be critical to the industrial sector,” said Smietana. “On average, warehouse employees will change jobs for as little as a 75-cent hourly wage increase or slight cost savings on housing and transportation. This means location still matters, even as some warehouse operations become all or partially automated.”

On the whole, user demand for industrial warehouses will continue to grow in 2018, regardless of whether humans or robots are doing the majority of the work inside the facilities, said Kenneth J. Szady, national director of North America and Canada for Marcus & Millichap’s Institutional Property Advisors.

“We are seeing more space being used to store merchandise, which is a driving factor of why industrial vacancy rates continue to decline and remain at record-low levels,” said Szady. “Companies are looking hard at their logistic and supply chain models to optimize last-mile deliveries and service their end customer more efficiently. With such strong user demand for e-commerce-designed buildings, newly constructed buildings along the major industrial interstates and arteries continue to be priced aggressively at cap rates below 5 percent for properties with credit tenants.”

7) Sweet Nectar In Switching Sectors: High property values, low interest rates and concern over softening in the multifamily, office and retail sectors is leading some investors to cash out of existing investments and redeploy that capital into new, less saturated asset classes. Higher returns may be waiting in industrial – the current darling of commercial real estate. The burgeoning sector has seen demand outpace new supply and is expected to grow along with its lifeblood: e-commerce and its rapidly expanding logistics networks.

“While some capital sources have become more selective on which multifamily assets they will finance, we actually have seen increased demand for industrial exposure from both construction and permanent lenders,” said Matt Wurtzebach, vice president with Draper and Kramer’s commercial finance group. “Several life insurance companies have started to consider industrial assets for construction-to-permanent programs and are more aggressively pursuing industrial exposure for their equity platforms.”

Wurtzebach noted Draper and Kramer is also seeing increased interest in senior housing from institutional investors. “In previous business cycles, many investors viewed senior housing as a niche sector or as a non-real estate asset due to the operational nature of the properties,” said Wurtzebach. “As the U.S. population continues to age and demand for assisted living and memory care centers increases, more of our capital sources and institutional investors see a need for exposure to the asset class.”

Not only will traditional real estate investors be looking at new property types in 2018, but money will be flowing in from new sources as well, according to Steven “Sonny” F. Ginsberg, co-founder of Chicago-based law firm Ginsberg Jacobs LLC.

“The private equity market used to be primarily coastal firms, but we have seen a growing number of smaller Chicago firms make equity available for real estate projects,” said Ginsberg. “Much of this is due to thinking that the stock market is at an all-time high, leaving little runway, while investments that are deemed safer, such as treasuries, bonds and CDs, show anemic returns.”

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