Real Estate 2024

Overview: Despite Recent Turbulence, Real Estate’s Place as a Global Asset Class is Secure

Despite recent challenges, real estate remains an important asset class for global investment. With a global value estimated by real estate company Savills to be USD326.5 trillion, real estate is the world’s largest store of wealth, 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, just 4% of the value of global property, and less than half of just the agricultural portion of the real estate market. Despite recent market turbulence, the private real estate publication PERE recently reported that private equity fund allocations to real estate were on the upswing in the second half of 2023, and a January, 2024 survey of European fund managers and investment analysts by TIME Investments indicated that just over three quarters of investors planned to increase real estate allocations in the foreseeable future. A 2023 Investment Intentions Survey by the Pension Real Estate Association shows that institutional investor portfolios have an average 10.2% allocation to real estate. The asset class clearly remains an important investment target for global investors.

2023 global trends and results

Over the last several years, central bankers have raised interest rates aggressively in order to combat post-pandemic inflation. In the United States, the Federal Reserve raised interest rates 11 times between March 2022 and July 2023, with rates hitting a 23-year high in July of last year. At its March 2024 meeting, the Bank of England decided to maintain the Bank Rate at 5.25%, its highest level since 2008, as policymakers awaited clearer signals indicating that the country’s persistent inflationary pressures had subsided. And during its April 2024 meeting, the European Central Bank maintained interest rates at record-high levels for a fifth consecutive time. Because commercial real estate investors typically employ debt when acquiring real estate, this large increase in the cost of debt means that investors need lower prices in order to achieve their desired returns. Many owners, however, are not willing to sell at these lower values. The result has been a dramatic drop in transaction activity. MSCI Real Capital Analytics estimated that real estate sales decreased by 51% from 2022 to 2023, and the Urban Land Institute reported that global transaction activity within commercial real estate was lower in 2023 than in any year since 2012. Anyone working in this space (presumably anyone who may be reading this global guide) has seen more recent examples than they would care to of buyers and sellers starting down the road to transact but ultimately finding themselves unable to bridge the bid-ask gulf.

The results, at a macro level:

• Very few deals occurred. It qualifies as relatively good news that Asia-Pacific volume, after an uptick in the final quarter of the year, was down only 17%, with some markets such as Hong Kong and Australia actually expanding volume, according to real estate advisers JLL. On the other hand, property agents Colliers reported that direct investment in major European markets in commercial real estate was down 50% from 2022 – a ten-year low. In the US, according to Altus Group, only about USD190 billion was invested in traditional property classes for the year, down by almost half from 2022, with overall transaction volume down 55% from 2021, making 2023 the slowest year since 2013.
• Sticking close to home: the activity that was seen in 2023 was largely focused on investing domestically. A Real Capital Analytics study showed that global cross-border real estate activity in 2023 was down 40% from its five-year average. This was most pronounced in EMEA (down 59%) and the US (off 56%), in large part due to Asian funds staying home or at least in-region. Global funds transactions among Asian investors were down 64% year-on-year in the third quarter of 2023, according to professional services network PwC.
• Banks and owners spent more time fixing their debt portfolios, and for good reason: according to a recent Wall Street Journal article, close to USD550 billion in loans linked to commercial properties matured last year. Ratings agency Fitch anticipates that almost 5% of loans in commercial mortgage-backed security pools will be delinquent at the end of the year, with potentially 10% of those tied to office properties in default by some point in 2025. A significant number of owners will lose out before seeing a reset in debt costs, but in the meantime, there is sufficient appetite in both the investor and lender worlds to continue extending and restructuring loans. New loan issuances, by contrast, were down 43%, according to the Mortgage Bankers Association.
• Investors, seeing better returns in safer places, could not be bothered. As but one example, according to JLL, among US closed-end funds, fundraising was down nearly a third in 2023 from the year prior, to just USD142 billion. Investment data company Preqin reported that less than half as many funds closed in the first three quarters of 2023 as in the year before. Private funds in Asia-Pacific play a smaller role, but even there, new fund closings were off by more than 50% from 2022. Some of this unavailability of new funds is offset by the lack of transactions closing, although global commercial real estate company CBRE’s European Market Outlook for 2024 indicated that funds on the continent were sitting on USD66 billion in dry powder for European deployment alone.

Value reductions in 2023 were much smaller in Asia, which may indicate an earlier bottoming out and start of the recovery cycle in Western markets, while investors in APAC wait out repricing exercises. That said, PwC reported that commercial volume was down 25% in the first three quarters of 2023 in China, with many funds and other players stepping out of the market indefinitely. The collapse of Evergrande and Country Garden, in part due to changes in central government policy, may hamper inbound as well as domestic investment in the market for the foreseeable future. Australia may also be an outlier, as its upward interest rate swing was steeper than in other markets in the region.   

Not all was grim, however. There was investment activity in certain asset classes, including data centres, housing, cold storage, medical office and life science assets.

The data centre space was the best performing asset class in 2023. The rise of artificial intelligence, along with cryptocurrencies, streaming services and other heavy computing power usages, are combining to fuel the need for ever more data centre space. According to CBRE, North American deliveries increased 26% from 2022 to 2023, and current construction projects were up almost 50% from the previous year. A Cushman & Wakefield study predicts a 2.5 times increase in data centre capacity in the Americas, a two times increase in EMEA and a 2.2 times increase in APAC. Research firm Renub predicts that, within four years, the Asia-Pacific data centre market alone will be worth USD54 billion. US investment management firm PIMCO recently announced the launch of its first European data centre fund, targeting a EUR750 million fundraise. Although the demand is strong and predicted to grow, one challenge faced by this sector is the availability/sufficiency of power and, in some markets, the availability of land.

Longer term, analysts are nearly unanimous in seeing increased activity in the housing markets. Ageing populations, especially in East Asia and Europe, lack of affordable housing in Western urban centres, and the demand for education are starting to strain current inventory, so construction growth in senior, student and affordable multi-family housing, in particular, is anticipated.

2024 Outlook: Have We Reached the Bottom of the Market?

There are some signs of light at the end of the tunnel. In a recent consensus forecast from the Pension Real Estate Association (PREA), investors predict a gradual improvement in 2024 and beyond, and a recent CBRE survey reveals higher purchasing and selling expectations for 2024 compared with 2023, amid growing optimism that the real estate investment market will return to normalised levels of activity in the short to medium term. A number of the largest commercial real estate investors have indicated that they believe that the market is close to, or already at, the point where significant investment opportunities will arise. For example, with Blackstone recently announcing its USD10 billion acquisition of AIR Communities and its USD3.5 billion agreement to take single-family landlord Tricon private, President Jonathan Gray told investors that the firm believes that real estate values are bottoming and he expects deal activity to pick up. More generally, US transaction volume started to rebound in the last quarter of 2023, rising by more than a third from the prior quarter’s doldrums, according to Altus Group. European investment volumes started to pick up slightly in the fourth quarter, too, according to CBRE, with large upticks in the Nordic markets, Spain and Italy.

A year ago, one of the topics of the day was distressed debt, and how resolving the difficulties in lending books was the biggest hurdle to the resumption of business as usual. How much property would banks be taking back? How much debt could be restructured? How long would it take to redeploy?

As the year wore on, the markets started to address this issue. While many owners entered 2023 in “wait and see” mode, hoping that interest rates would come down and drive cap rates down with them, or attempted to restructure their debt and hang on a bit longer, eventually time ran out for some as lenders started to move on collateral. According to real estate data source ATTOM, commercial foreclosures began climbing in the US market in the second quarter of 2023, and by January of this year reached 635 new filings, the highest level since 2015.

For many who avoided turning their properties over to their lender, 2023 saw more owners coming to grips with writing down the value of their investments. JLL reported second quarter year-to-year value drops in 2023 of 19% in the US and 21% in Europe (29% and 31%, respectively, in the office sector).

Given the higher cost of debt, in most cases, prices will have to come down in order for transaction volume to increase. In this regard, the so-called “wall of maturities” is a double-edged sword. In the US alone, there is an estimated USD1 trillion of commercial real estate debt coming due before the end of 2025, according to data and analytics provider Trepp. The combination of declining values and higher interest rates will mean that many owners will not be able to – or will elect not to – refinance their existing debt. Although this is bad news for owners who cannot refinance their loans, many lenders prefer not to own these assets, and so they will price them to sell, which should result in buying opportunities and increased transaction volume.

The dynamic of markets establishing new pricing in order to move forward can be seen in some recent transactions featuring prominent properties in Western markets. Just a few examples:

• Two towers at Detroit’s Renaissance Center, totalling close to 700,000 square feet of office space, traded earlier this year for a measly USD15 million. That is a per-square-foot price closer to the average yearly rental rate in the Detroit market.
• The Aon Center in downtown Los Angeles was sold at the end of 2023 for a little over half what it previously traded for, in 2014.
• 5 Churchill Place in London’s Canary Wharf moved into receivership last year and has now sold at a 60% discount.

There are other signs of life emerging, as well. Along with uncertainty in the debt markets, the long-term effects of the COVID-inspired “work from home” movement have been hampering rental markets, as corporate tenants struggle to determine how much space they really need going forward. Some normalisation has started to occur, however: return-to-office mandates have taken hold at an 85% clip in Asia and 75% in Europe, according to JLL’s 2024 Global Real Estate Outlook. The US is lagging here, with just 55% of employers having taken affirmative steps to bring people back to the office, but this is widely expected to increase throughout 2024.

The result is some hopeful signs starting to appear in the office leasing submarket. In the final quarter of 2023, global office leasing volume was up 13%, as strong as it had been in almost two years. Logistics leasing was another bright spot towards the end of 2023. US volume, after a year-and-a-half of consistent falloff, was up 17%. Meanwhile, the Asia-Pacific logistics market had a record-setting year in uptake.

With more and more people returning to daily routines that include spending time in central business districts, knock-on effects in retail, hospitality and tourism could begin to appear in the medium term.

Inflation and interest rates

As noted above, the efforts of central bankers to combat inflation by raising interest rates took a significant toll on the real estate sector. With inflation starting to get closer to central bank targets, there has been a growing expectation for interest rate cuts in 2024. However, the US Bureau of Labor Statistics (BLS) March report indicated that the US economy added 303,000 jobs in March, an acceleration in the pace of hiring, and other important labour market indicators in the BLS report, including a 3.8% unemployment rate and a 0.3% month-on-month rise in average hourly earnings, were also strong. In the UK, although the annual inflation rate fell in March for the second consecutive month, the fall was less than expected. These reports have generated some uncertainty about the timing and amount of rate cuts in the US and the UK. Rate cuts may come sooner in the European Union. The EU ended 2023 with a 3.2% inflation rate across its markets, and the rate has since gone down to around 2.6%. As a result, the European Central Bank has signalled that it could start cutting rates as soon as June.

While Asian markets tended to see far less drastic rises in their inflation rates – with China moving from around 5% before the pandemic all the way into a deflationary environment throughout 2023 – those markets have settled, as well. CBRE’s 2024 outlook for Asia anticipates entering an “interest rate cut cycle” by midyear.

Conclusion

The global commercial real estate market has been on a roller coaster ride in recent years, with 2021–2022 representing the climb to the top, and 2023 reflecting the swift (and sometimes scary) descent. However, certain asset classes, such as data centres, continue to attract significant investor interest. More broadly, there are indications that the market may be at or near the bottom and poised for a recovery. The amount and timing of interest rate reductions will be a major factor in the market’s performance over the next 12 months, with a reduction in rates being a welcome tailwind, but any increase (or even the absence of a decrease) in rates being a significant headwind. In addition, the huge amount of low-interest-rate debt coming due over the next few years should force a repricing of many assets and thus spur investment activity.