Real Estate 2023

Real Estate’s Place as a Global Asset Class

Real estate remains the world’s biggest store of wealth. Real estate services company Savills estimated that, at the end of 2020, the global value of real estate reached USD326.5 trillion, making it more valuable than all global equities and debt securities combined, and almost four times the size of global GDP. By comparison, the value of all gold ever mined is USD12.1 trillion, less than 4% of the value of global property, and less than half of just the agricultural portion of the real estate market. Although, like all other asset classes, real estate is impacted by local, regional and global economic and geopolitical conditions, it will no doubt remain an important investment around the world. 

Pandemic recovery, meet inflation!

Real estate was severely impacted by the COVID-19 pandemic. At the height of the pandemic, with travel restrictions and lockdowns in place across the globe, real estate transactions came to a virtual standstill. Some commentators were quick to predict the demise (or at least decline) of office buildings and a significant decline in the desire of people to live or work in high-density urban areas. However, the commercial real estate market came roaring back in 2021, and headlines like “2021 CRE Investments Hit Record USD746 billion”; “Global Commercial Property Sales Rocket to Record in 2021”; and “Covid-19 Fuels Best-Ever Commercial Real Estate Sales” captured the narrative. 

Inflation remained high throughout most of 2022 before cooling somewhat late in the year. From December 2021 to December 2022, US consumer prices rose by 6.5%, which was better than many predicted when US core inflation hit a peak of 9.1% in June. The situation in Europe was worse, exacerbated by fuel prices skyrocketing in the wake of the war in Ukraine.  There, the inflation rate hit 11.1% in November, and decreased a bit as the year ended, hitting 9.2% in January. One of the few major global economies not to experience a significant increase in inflation was Japan, where the economic recovery was markedly slower than in most of the world, with the silver lining of inflation hitting just 3.6% in October.

Aggressive moves from central banks globally have helped ease inflation, but at the cost of significant interest rate increases. Whether the global inflation we’ve seen over the last 16 months is transitory or persistent in nature is still uncertain, but as central banks have raised interest rates in their effort to get inflation under control, the increase in debt costs has had a significant impact on much of the real estate industry. As costs increased and became more difficult to forecast, real estate investment activity slowed. Real estate services and investment firm CBRE reported that Q4 US commercial real estate investment volume fell by 63% compared to 2021, with an annual volume drop of 17%, to a total of USD671 billion. Markets outside of the US also saw significant drops in real estate transaction volume, with Asia-Pacific faring best at a 29% decrease in transaction volume from Q4 2021 to Q4 2022. According to CBRE’s tally, global real estate transactional volume dropped 20% from 2021 to 2022. 

Let’s keep it in perspective

“It is a narrow mind that cannot look at subjects from various points of view,” as the author George Eliot once wrote.

Although real estate investment activity dropped significantly from 2021 to 2022, it’s important to put this drop in perspective. The year 2021 was a truly anomalous year with respect to global real estate investment activity. So while sales volume dropped precipitously from 2021 to 2022, it is worth noting that the sales volume in 2022 was still among the five highest global sales volumes in the last 22 years. 

Forecasts for 2023

At the start of this year, the consensus of market participants was significantly less optimistic than it was at the start of 2022. A Deloitte Center for Financial Services survey of real estate owners and investment companies found that almost half of respondents forecast that revenues at their firms would decrease this year. Most analysts predicted that we would see a slowdown for at least the first quarter of this year, and possibly the first half of the year, with an increase in transactions occurring later in the year.  The conventional wisdom seemed to be that, as interest rates stabilise, there will be more pricing clarity and the large amount of equity capital that has been on the sidelines will be deployed. According to JLL’s Global Research Group, as the calendar turned, some loosening of the debt markets had already begun, spurred by lower interest rate volatility and slowing core inflation. The conclusions of investors in Colliers’ Global Investor Outlook Report for 2023 is that a broad rebound in transactional activity is likely later this year, primarily as a result of a pricing imbalance resolving itself. 

This mixed outlook – short-term challenge, longer-term growth – is borne out in movement in the US Real Estate Roundtable’s quarterly economic sentiment index. A year ago, the Roundtable’s Overall Index registered seven points higher than the first quarter of 2021, and the index assessing current market conditions was up 27 points from the same time in 2021. Since then, both indices have dropped significantly, bottoming out with numbers close to early pandemic depths. However, early this year, both rebounded significantly. In Q1 2023, the Roundtable’s Overall Index (combining current sentiment and future outlook) registered at 44% positive (from 36% in Q4 of 2022), and the Current Index was at 58% positive (from just 48% a quarter earlier).   

This guarded optimism is tinged, however, by concerns about the debt market, the ongoing war in Ukraine, inflation, and pandemic-induced concerns about the long-term outlook of office properties. 

The above forecasts were prepared before the collapse of Silicon Valley Bank and Signature Bank in the US, the government-engineered acquisition of Credit Suisse by UBS, and the resulting uncertainty in the bank sector. Although it is too early to predict the impact of these developments, if there are additional bank failures, or if banks tighten their lending criteria and/or seek to reduce their real estate exposure, that will create additional headwinds for the real estate sector. 

Distressed debt

A plurality of investors in the Colliers Global Investor Outlook Report for 2023 predicted core asset prices would decrease by somewhere between 1% and 20% in the US this year, and the outlook among them was not much better in EMEA or Asia-Pacific. The combination of increased debt costs and decreasing values will make it difficult to refinance many commercial real estate loans, and depending on the magnitude of the value decrease, some borrowers may not be able to sell their properties for an amount sufficient to repay their loans. Bloomberg Business estimates that, at the start of this year, USD175 billion of real estate credit was already distressed. In many markets, we expect to see an increase in foreclosures and voluntary transfers of properties to lenders, especially in the office sector. 

Even some assets without current debt service problems that could lead to them being considered distressed, may need restructuring. As owners of even well-performing assets find themselves approaching maturity on loans, they’re finding a need to extend maturity dates in the face of a thin disposition market. This instability may have a knock-on effect in reluctance on the part of some financing sources to expand their lending books until problem loans are worked out.

Conclusion

After the initial shock to real estate markets in all global regions from the COVID-19 pandemic, 2021 and 2022 saw an equally rapid rebound. The market slowed significantly in the second half of 2022, however, and commercial real estate remains in a somewhat uncertain state heading into Q2 of 2023. Quickly rising interest rates have left a gap between seller and buyer price expectations, especially in the office market, where post-COVID tenant usage patterns are starting to come into focus and indicate an oversupply. As capital starts to settle on new return expectations with interest rates stabilising, and sellers adjust to the new normal or are forced to dispose of assets with maturing debt, most analysts see a general uptick during the remainder of this year. At the same time, the debt markets have a large volume of loans that will need to be restructured or written down in the coming months, which might add to instability and discomfort for some time.

Asset Class Notes

US/Americas

• According to CBRE, overall investment in multi-family, industrial, office and retail in the Western Hemisphere fell somewhere between 58% and 70% in Q4 of 2022, compared to a year earlier.
• Retail saw a rise in the overall increase in investment fund flow in 2022. Pandemic shopping habits are to some degree reverting to pre-pandemic norms, and the fact that there has been virtually no development of new retail space in the past decade is leading to some demand for new supply. This is particularly true in suburban markets – with more people spending more time working from or near their homes, local shops and restaurants are seeing increased demand. 
• In the US, consumer interest rates and other factors have marked the residential market as a place of instability for the foreseeable future.  According to the National Association of Realtors, net absorption in the multi-family market was 75% lower in 2022 than the prior year.  However, rising interest rates eventually caused single-home residential sales to begin slowing during the second half of last year, and in February 2023, for the first time in over 11 years, the average US home price declined. These developments may lead to a stronger rental market going forward. 
• The office market remains uncertain. As mentioned above, bid-ask prices are still working their way to a new normal, with cap rates expected by most observers to start settling in when there is more certainty on interest rates and borrowing costs.
• In hotel and hospitality, the revenue generated per available room (RevPAR) in the US was 10% higher in 2022 than pre-COVID numbers. This remains the sector most off-phase with the rest of commercial real estate in the Americas generally, and JLL reports that hotels in the Americas outperformed competitors globally and surpassed 2019 RevPAR in each subregion.

Asia-Pacific

• Overall, investment in APAC fell 19% in the last quarter of 2022, although the office market was off by just 4% from a year prior. The region has not, to date, experienced the same mid to long-term adjustments in where people are working as the rest of the world, making its commercial office market more stable. One sign for concern, however, is that year-over-year leasing activity was off over 30% during Q4 of 2022. Whether this is due to oversupply or catching up to the rest of the world in changing space-use appetite remains to be seen.
• Hospitality did not see quite the reverses during COVID-19 in APAC as it did elsewhere, although recovery has lagged, in large part due to restrictive domestic regulations in China. CBRE anticipates that RevPAR should be back at pre-COVID levels some time in 2024. 
• Industrial and logistics have remained the darlings of developers in the region, although it is possible that supply has started to catch up.  From late 2020, returns on capital in APAC logistics assets skyrocketed to over 10% in 12-month returns, and stayed there for almost two years. Gains are still two to three times as great as those in the residential and office sectors, according to a study by financial services company, JPMorgan.
• Japan is widely seen as the safe harbour for investors in the region for the time being. Lower interest rate movement has led to a smaller gap in pricing and fairly stable cap rates across sectors.
• Life sciences is also seeing increased investor attention in the region, with Singaporean group CBC and Australian-Dutch partnership Lendlease/PGGM alone committing in excess of USD2 billion last year.
• The end of China’s zero-COVID policy and the resultant effects lower the confidence level of any predictions for that particular submarket over the next year.

Europe

• Energy and inflation (even higher than in the rest of the world) fuelled by the war in Ukraine were the primary factors coming into the year, and most analysis indicates that interest-rate hikes and quicker-than-anticipated adjustments away from Russian energy should have impacts soon.
• In the hospitality sector, consumer stresses from rising living costs are anticipated to be offset by the return of Chinese tourism later in the year. Overall, hotel performance is currently off just 3% from pre-pandemic levels, although development may lag due to energy and supply costs.
• The impact of remote working has been lower in the European markets than in the US in particular, with some forecasts estimating that just over a third of employees will be working outside traditional office space by the end of 2025 (up from 27.5% pre-COVID, versus less than 10% in the US). As a result, while pricing gaps remain throughout Eurozone markets in office space, this is mostly seen as a function of financing costs rather than long-term oversupply.
• The European logistics market has remained strong, with prime logistics asset rents increasing an average of almost 14% from Q3 of 2021 to the same time last year. Vacancy rates of 2% seem to point to continued investment pouring in despite macroeconomic headwinds and development costs.