Brian Olasov has been involved in commercial real estate for many years. Through his role at a large regional bank issuing commercial real estate loans, to his research of the collapse of the S&L industry, to his role at Carlton Fields as well as speaking engagements and guest lectures at graduate schools around the country, to his expert witness work in mortgage-backed securities and mortgage finance, Olasov continues to study why commercial real estate properties default, ways to better predict that, and what the commercial real estate market looks like now and over the next 18-24 months.

DesignIntelligence: Because the term can be used in different ways by different people, what is your definition of commercial real estate?

Brian Olasov: It is anything that is income-producing. The core property types are retail, office, industrial, lodging—which includes hotels—and multifamily residential.

Brian Olasov at the Design Futures Council Leadership Summit on Collaboration Across the Design Continuum

DI: How would you describe the current commercial real estate market?

BO: I would describe it as “surprising equanimity.” There are so many pressures, tensions and risks that we’ve been identifying for several years, and yet we actually have quite a benign market this year. The consensus view is that 2017 will continue to be benign, and 2018 is probably also going to be favorable. But there are some “black swans” that can’t be predicted, like macroeconomic factors, geopolitical factors or acts of terrorism.

Supply and demand is the basic dynamic that drives commercial real estate stability and instability. We’re actually at a very comfortable spot in terms of supply and demand. If we look at new product— which is new construction coming online—and we measure it against the existing stock of commercial properties, the long-term relationship between those is about 1.7–1.8 percent. So for every million square feet of the existing stock of commercial real estate property, under normal times there would be something like 17,000–18,000 net new square footage coming into the market each year. Right now, we’re actually at about 1 percent replacement to existing stock. This helps to keep the lid on competitive pressures for the existing stock of commercial properties. Looking out across the country, the new supply is quite muted.

DI: Is there variation between the different sectors (i.e., retail, office, industrial, lodging and multifamily)?

BO: Absolutely. Retail has had a wave of negative press recently. There’s a lot of attention on the fact that the United States has much more retail square footage per capita than any other industrialized country. I don’t think it’s as unhealthy as the headlines would indicate, but that’s not to say that everything is rosy for bricks and mortar retail. Obsolete malls are a problem with limited repurposing. As a result of online shopping, there’s a corresponding need to construct technologically up-to-date fulfillment centers and warehouses.

DI: How about the other sectors?

BO: Offices have held up fairly well. It seems that the absorption rates in suburban office have actually improved a little bit relative to central business district office (CBD). It still has a higher vacancy rate than CBD but some of that pressure seems to be abating.

Multifamily has experienced a bit of a renaissance due to a couple of dynamics. First, at no point during the financial downturn was multifamily starved of credit availability. The second dynamic is that there’s a long-term demographic move away from homeownership, which has been dropping since 2004. Some people have chosen to be renters versus owners. The results of those two dynamics have supported multifamily in a healthy way.

Lodging has done fairly well. The “revenues per available room”—which is the product of occupancy times the average daily rate—is still growing but the growth rate has slowed considerably.

Industrial has actually been the best performing sector even though it’s a relatively small sector compared to the other major property groups.

DI: What factors do you watch when you’re trying to get a picture of the economic future?

BO: At a very macro level, commercial real estate—both formations and property values—is derived from general economic robustness. To the extent that we have a growing economy, chances are that will continue to support commercial real estate performance.

The fly in the ointment can be interest rates, which have stayed very low for a long time. Since 2008, the Federal Reserve has kept in place a zero or low-interest rate policy, notwithstanding their recent movements that have moved the interest rate to about 1.25 percent on Fed funds. We’re still at an absolutely low cost to borrowing in terms of financing available to commercial real estate.

DI: When you look out at the horizon, what storm clouds of risk do you see?

BO: One of the top imponderables right now is political risk. When you’re talking about political risk, particularly in the realm of commercial real estate lending or real estate lending more generally, you’re talking about regulations and legislation. There has been a major shift in how this administration looks at risk and regulating real estate lenders compared to the prior administration. Coming out of the Great Recession, that was all predictable. How that ultimately shakes out may have a dramatic impact on commercial real estate lending.

DI: What are some of the barriers to and potential engines of growth in the next 18-24 months?

BO: Let’s go back to the topic of political risk. We’ve been in a state of flux since the election in November about what’s going to happen with tax policy, regulatory policy with respect to real estate lenders, and infrastructure investment. We’re seeing that even immigration policy is having an effect on construction labor and household formation. There are so many open-ended questions right now, and I think that’s one of the reasons that transaction volume for the first quarter came in weaker than expected. There seem to be a lot of decision makers who were sitting on their hands waiting for some clarity. This isn’t necessarily harming the economy but it’s definitely putting a cap on growth and real estate transactional volume.

For potential engines of growth, there are technology disruptions. Either positively or negatively, one topic is, for example, the rise of autonomous driving. This could have dramatic consequences for commercial property and parking, and will impact the number one employment source for males in this country. Also, as we discussed, online shopping is growing by double digits each year. With the purchase of Whole Foods, it seems that Amazon’s intention is to dual purpose some of these retail locations into local distribution centers as well.

DI: What do A/E/C firm leaders need to know about the future of commercial real estate?

BO: Based on the meetings I attended with the Design Futures Council in March, it appears that there are a number of technological innovations that are getting ready to burst through in a way that makes construction and development of new properties much more cost effective and efficient in terms of construction timeline management. All of that will have an effect on supply and demand.

DI: What do commercial real estate investors want to know from design and delivery professionals?

BO: They want to know how to derive better values from their properties. There are a number of ways to do that: reduced construction costs for new construction and more efficient redevelopment budgets when repurposing a property. They want to know about energy efficiency and the ability to implement new technology that’s being required by all tenants. And there are vanity attributes—developers want beautiful buildings but it always has to make economic sense.

DI: Are you optimistic about the future for commercial real estate?

BO: Absolutely. In terms of what I can see on the horizon for the next 18 months, I think conditions look quite favorable. It’s a good time to be a borrower.

Brian Olasov is executive director—financial services consulting of Carlton Fields.

Photo by EJ Yao on Unsplash.

Excerpted from DesignIntelligence Quarterly.