From left to right: Andrew Alperstein, partner,PwC; Sara Queen, head of RE equity, MetLife Investment Management; Andrew Yoon, chief operating officer/ partner, BentallGreenOak; Mary Ludgin, head of global investment research, Heitman; Spencer Levy, global chief client officer and senior economic advisor, CBRE, discussing the latest Emerging Trends report at the 2024 ULI Fall Meeting in Los Angeles.
If you were comparing the year ahead in commercial real estate to an amusement park attraction, it might look more like a carousel than a rollercoaster. There are definitely hurdles and market disruption ahead that could make your head spin. But the pace of change for the latest emerging trends shaping the industry is going to be a slow ride.
“Higher and slower for longer” is one of the major trends highlighted in the newly released Emerging Trends in Real Estate® 2024 report. Now in its 45th edition, this report published by ULI and PwC US identifies top investment markets and industry trends to watch in the coming year across the U.S. and Canada. A key takeaway: commercial real estate market participants will need to adapt expectations and investment strategies to an era of higher interest rates. At the same time, slower economic growth will force commercial real estate owners and investors to get back to the basics of income and cash flow versus relying on cap rate compression for returns.
“We’re going into a tough market. It’s going to be tricky, and I do agree that [there’ll] be winners and losers,” says Andrew Yoon, chief operating officer and at BGO (BentallGreenOak). Along with the challenges will come opportunities to invest in all parts of the capital stack. “If people have the right capital structure, I think that this could be an interesting year,” he adds. Yoon was one of five panelists discussing the Emerging Trends report at ULI’s Fall Meeting in Los Angeles.
The overarching theme of the report is “The Great Reset.” That need to reset is a nod to various dynamics now in play. They include repricing of assets to reflect the higher interest rate environment and major secular shifts that are affecting the demand for space across property sectors. Market participants will need to recalibrate their expectations to reflect diminished drivers in the coming years to the detriment of rent growth, property values, and returns. The report also digs deeper into numerous top trends, such as AI, housing affordability, the impacts of climate risk, the future of office, and problems brewing in America’s downtowns.
Despite market challenges, the Emerging Trends Barometer for 2024 registered its highest “buy” rating since 2010, which could reflect the buying opportunities investors see ahead with recent and expected price declines. “There seems to be a lot of guarded optimism that we heard from our interviewees and from the survey results as a whole,” says Chuck DiRocco, director of real estate research at PwC. “I think investors are waiting for an entry point and watching these variables,” he says.
Sunbelt markets continue to shine
The list of top 10 markets to watch reflects another key trend highlighted in the report: the outlook remains bright across the Sun Belt. Southern markets continue to attract growth due to such factors as quality of life, lower costs, strong demographics, and labor. Of the top 20 markets for “overall prospects,” 15 of them are located within the Sun Belt . Nashville nabbed a three-peat as the number one market to watch, followed by Phoenix, Dallas/Fort Worth, Atlanta, and Austin in the top five.
“The names on the list are not surprising. There has been a lot of excitement about those. But it really depends on what you’re buying in each of those markets,” says Sara Queen, head of equity strategies for MetLife Investment Management’s real estate group. “It’s not a blanket statement that you can buy anything in Nashville or San Antonio and it’s going to be fantastic. You really have to peel back the onion and understand what it is you’re looking at, and what are the demographics there,” she adds.
Other panelists were more cautious on the investment opportunities within those markets. A lot of capital is targeting those Sun Belt markets, and we no longer have a high tide raising all boats. “Especially in this market, you have to be very detail oriented. You need people on the ground in those cities to dissect why one corner is better than the next, and why one asset class is better than the next,” says Yoon.
In some cases, that list could be a sell signal, notes Mary Ludgin, head of global investment research at Heitman. Many of the top 10 markets have more new supply than they’ve ever experienced before, particularly in multifamily. Some people are going to be disappointed that their pro formas are not going to work out, despite the really strong demographic profile that exists in those cities, she says. “Always be careful when you’re talking about the U.S., because we know how to overbuild good demand.”
Investors also are more attuned to the fact that many of the growth cities and areas where people are choosing to live are often the more fragile locations from a climate perspective. Escalating risks from climate change could affect the trend of positive investment in this region. Investors are paying more attention to exposure to such things as hurricane risk and portfolio diversification, as well as the significant impact on soaring insurance costs. “Insurance is the new variable that can blow apart your cash flows,” says Ludgin. In some cases, insurance costs have quadrupled in the past year. “Insurance will be the vector that changes people’s minds about where they should invest,” she says.
The future of office
After three years of remote and hybrid working, there is no longer any reasonable expectation of a full office market recovery to pre-pandemic levels. People are settling into the realization that a significant share of the existing inventory is functionally obsolete and will need to be repurposed or demolished to make way for higher uses.
“Office Armageddon has come. The question is, what are you going to do now?” says Queen. Like retail, office has become a bifurcated market, split by haves and have-nots. Companies do need office space, but investors are spending more time thinking about the amenities they are offering in a building and how they are partnering with tenants to create an environment where people want to come back to the office.
The decline in office use is less about the physical office and more a dispute between labor and management, which affects how occupiers and investors need to think about office, notes Spencer Levy, global client strategist and senior economic advisor at CBRE. “I don’t think there’s any [operational expenditure] solution, where you give people experiences and other reasons to go to the office,” he says. In addition, solutions need to involve partnering with state and local authorities on things including removal of obstacles for permitting to help jumpstart projects and help communities preserve their tax base, he adds.
The decline in office vacancies and daytime populations in central business districts also is linked to another key trend highlighted in the report: the need for downtowns to reinvent themselves—again. A flight to the suburbs has occurred while downtowns battle crime and safety issues. “It’s not localized just to larger cities. It’s everywhere, and I think we’re going to need some serious leadership to make a difference,” says Yoon. He also has a contrarian stance on office with his view that people, especially millennials, will want to return to the office.
Digging for opportunities
Looking ahead to 2024, multiple risks loom that could affect the outlook for the economy and commercial real estate, including geopolitical issues Israel, Russia, and China, as well as a divided U.S. Congress and an upcoming presidential election. Debt will continue to be top of mind in 2024 and beyond, with roughly $2.8 billion in commercial real estate loans maturing over the next five years that could strain capital available for refinancing, acquisitions, and development.
Despite such challenges, market participants continue to evaluate investment opportunities across the spectrum of short, intermediate, and longer-term assets, from bonds to new development. Great opportunities exist across the board, notes Levy: “The one … I think is the most interesting right now is that you can buy the best real estate in the best submarkets at thirty to fifty percent below replacement costs, and that is an intergenerational opportunity.”
Survey results that show a healthy appetite to buy assets also suggest some underlying optimism on buying opportunities ahead. “We’re real estate people. We like to do deals,” says Queen. There is some optimism because values have gone down. However, investors are trying to figure out where the puck is going and how to get there, while also understanding how difficult things are in the market right now, she adds.
Another factor fueling optimism is that many firms have strong asset management teams that can roll up their sleeves and solve the problems of the assets. There will be winners and losers in this current cycle. Having experienced teams that understand how to manage risks and create value will be a key differentiator in the coming year.
More Resources: 2024 Emerging Trends Report US & Canada (PDF)
