The commercial real estate (CRE) industry faces uncertainty in a post-pandemic landscape characterized by rising interest rates, slowing economic growth, and the widespread adoption of hybrid work arrangements transforming office spaces and urban centers. Against this backdrop of change, the Urban Land Institute (ULI) and PwC’s 2023 Emerging Trends in Real Estate report has dubbed the current environment “The Great Reset.”
This 45th edition of the influential annual CRE trends report, released in late October, synthesizes insights from over 2,000 industry experts. The report concludes that the CRE sector must look beyond pre-pandemic benchmarks to predict future market behavior and instead embrace new paradigms aligned with a new, post-COVID reality.
Key Findings
- The ULI and PwC report identified interest rates and cost of capital, capital availability, job and income growth, availability of qualified labor, and inflation as significant economic and financial issues.
- Construction labor costs topped the list of critical real estate and development issues, followed closely by construction material costs and labor availability.
- Housing costs and availability were among the top social and political issues, followed by immigration policy and political extremism.
Other takeaways from the emerging trends report included more than 50% of respondents believing inflation will continue falling in 2024, with about 33% expecting it to stabilize at current levels. Only 30% foresee declines in commercial mortgage rates. The report also sounded a caution, suggesting CRE investors are preparing for elevated risks to persist over the longer term.
While acknowledging the slowdown of transaction volumes — especially for offices — and a sizable gap remaining between bid and ask prices, the survey also found investors retaining substantial appetites for acquisitions, with the report’s Investment Sentiment Index seeing the highest “buy” rating in over 13 years, since the post-recession days of 2010. Keep reading for more key findings.
Retail Remains Popular
While the retail sector must navigate increased cybercrime, bankruptcies, and reduced foot traffic in cities whose workforces have remained virtual or hybrid, tenant demand has rebounded in some segments. Class A malls report strong occupancy, luxury retail is thriving, and hybrid employees spend more at local power, strip centers, and grocery-anchored shopping areas.
The Future of Work Remains Hybrid
2023 marked a turning point as the CRE industry acknowledged the permanent shift in the pre-pandemic office paradigm toward hybrid work arrangements. The trends report credits the rise of remote work as the single most disruptive trend in generations for property markets. This shift has had an incredible impact beyond where we work.
We’ve seen investors hit hard as office sales volumes plummeted more than twice as sharply as other CRE sectors. Core office markets face acute pain in fundamentals and deal flow. Paul Fiorilla, Yardi director and report contributor, said, “Demand is falling, vacancies are rising, and expenses are soaring. Meanwhile, property values are declining with loans coming down, sparking distress.”
Downtowns Must Evolve — Again
A trend has already begun to repurpose high-vacancy office buildings for other uses. Still, not all spaces can be converted economically or easily, with conversions presenting unique challenges. The potential remains, however, for some assets to be reinvented as mixed-use environments offering residential, healthcare, or retail spaces, adding vibrancy to live-work-play neighborhoods and driving demand.
These reinventions will take time, ingenuity, financial subsidies, and buy-in from the public and local governments, but the potential is exciting.
CRE Must Embrace AI
Artificial intelligence (AI) has already shown its potential to disrupt the CRE industry, from enhancing property searches to evaluating deals, analyzing and streamlining due diligence, and improving the customer experience.
AI companies continue expanding their footprints, and by the end of 2023, they’ll occupy over 17 million square feet of U.S. office space. It’s expected to show strong growth over the next 10 years and have a value of nearly $2 trillion by 2030.
CRE professionals should continue exploring the possibilities and opportunities AI offers to address industry pain points associated with analysis, building operations, transactions, and so much more to enhance productivity and performance.
CRE Cannot Ignore the Changing Climate
Extreme weather continues to intensify. In 2023 alone, the National Centers for Environmental Information has confirmed 25 weather/climate disaster events in the U.S., with losses exceeding $1 billion each. Since 1980, the U.S. has sustained 373 environmental disasters with damages and costs exceeding more than $2.5 trillion.
Greenhouse gasses and a naturally occurring El Niño weather pattern are predicted to push global temperatures even higher between 2023 and 2027, with a 98% likelihood that we’ll see this next five-year period the warmest on record. These extreme weather and climate events drive costs and risks for owners while complicating asset management. They’re pressuring the CRE insurance market with its escalating premiums but declining availability.
Warmer temperatures lead to more dangerous weather conditions. As climate change fuels more destructive — and frequent — weather events, building managers and owners creating resistance across exposed portfolios will face difficult decisions about coverage, risk mitigation, and underwriting.
Investors Hold Onto Debt
Multiple interest rate hikes since 2022 have tightened debt financing industry-wide. CRE professionals have partially attributed this year’s depressed sales volumes to reduced capital and availability.
Higher costs and more stringent underwriting have become the norm for CRE loans. In lieu of refinancing in this current market, many borrowers have opted to maintain their current positions. Next year brings looming liquidity risks as the debts on underperforming assets mature. 2024 could see an increase in defaults or distressed sales if owners cannot secure refinancing or the terms remain unfavorable.
Higher rates and scarce capital have stacked the odds against overleveraged owners, setting the stage for turbulence as projects fail to secure acceptable refinancing terms. With demand indicators flashing warnings in some sectors, the first few months of next year may bring trouble for properties that had boomed in the previously low-rate environment.
Portfolios Expand Assets
Evolving property and financial dynamics continue to define core assets and transform CRE portfolios. Fund managers seek more robust returns from alternatives and newer products rather than the once dependable office and regional mall sectors. Next year, we will continue to see a shift in the CRE portfolio, with core industrial expanding to include cold and self-storage and multifamily expanding to include single-family built-to-rent and student housing. Portfolios may expand to include niche investments like data centers, digital infrastructure, and life science properties.
Are you a commercial real estate investor or looking for a specific property to meet your company’s needs? We invite you to talk to the professionals at CREA United: an organization of CRE professionals from 92 firms representing all disciplines within the CRE industry, from brokers to subcontractors, financial services to security systems, interior designers to architects, movers to IT, and more.
