After two years of historic rent growth and record investment returns, a recession would bring a “cleansing” and a “healthy down cycle” for real estate rather than a crash. That sums up the overall outlook of the more than 2,000 experts that were interviewed and surveyed for Emerging Trends in Real Estate 2023 being released today at the ULI fall conference.
It doesn’t mean there won’t be challenges as well as opportunities in the months ahead. The report, which is issued annually by PwC and the Urban Land Institute, identifies 10 currents that will shape the industry in 2023 and beyond. Here they are:
“Normalizing”
Rent increases, values and tenant demand are all expected to “normalize.” Transactions volumes will fall, cap rates will rise, even for multifamily and industrial, and new construction will slow. Hotel and retail, meanwhile, are likely to normalize upward. Economists and analysts surveyed in April 2022 estimate the NCREIF Property index will be 8 percent in 2023 and 7 percent in 2024 vs. 20-plus percent in the four quarters through mid-2022—almost three times the 20-year average.
“…Still, We’ve Changed Some”
COVID initiated “structural shifts” in how various property types are used, and that is expected to continue. People are more focused “on lifestyle choices than on their employer,” said one interviewee, and that has changed how they see apartments, single-family rentals, and their offices. Video meetings will replace some business travel, impacting hotels and further reducing office space needs. As online shopping grows, fewer shopping centers will be needed.
“Capital Moving to the Sidelines—or to Other Assets”
Interviewees expect capital availability to decline for every one of the 13 equity and debt capital sources (see chart below). The higher cost of acquisition and construction debt, weakening cap rates, and lower antipated returns will cause many investors to pause until values settle, while some will redirect capital to equities and bonds. Lenders will tighten underwriting and raise their risk threshold. “Equity” will be king, but there will not be a lot of distress to take advantage of.
READ ALSO: The Benefits of Interest Rate Caps at a Time Like This
“Too Much for Too Many”
Rising interest rates will worsen the housing crisis. Single-family home prices are near record levels, and higher mortgage rates make ownership less attainable. That means increased demand for rental housing, but demand is outstripping supply. Mass migration to cheaper markets is making them less affordable. Some experts see single-family rentals exacerbating the affordability crisis because investors drive up prices in the resale market, their capital is cheaper and they have tax advantages.
“Give Me Quality, Give Me Niche”
Real estate investors will become more selective as they gravitate toward the strongest demand fundamentals, most likely industrial and multifamily; best quality assets in disrupted sectors, especially retail and office; and narrowly targeted subsectors, like student housing, and niches, like single-family rentals.
“Finding a Higher Purpose”
There will be more repurposing of redundant assets. Office buildings will be turned into residential or retail, and retail buildings will become office or industrial or residential. Other properties will be “scraped” to free up developable land. The report recognizes the challenges of these projects—there are no “cookie-cutter” conversions–and value losses have to be considered. Owners of older properties will also need to upgrade properties to make them more sustainable.
“Rewards—and Growing Pains—in the Sun Belt”
Investors will still gravitate to the Sun Belt, but the report acknowledges that growth has brought “big-city problems,” like congestion and housing affordability, to these formerly “18-hour cities.” Infrastructure growth has not kept up with population growth. The report also notes that inflation rates in Phoenix, Atlanta and Tampa, Fla., are among the highest in the country.
“Smarter, Fairer Cities Through Infrastructure Spending”
Two years ago, one of the report’s emerging trends was “Washington Fumbles; States and Cities Pick Up the Ball.” So, interviewees are encouraged by the passage of the Bipartisan Infrastructure Law of 2021 and the Inflation Reduction Act of 2022. These bills will help improve transportation infrastructure, expand broadband access, and make real estate more resilient.
“Growing Impact of Climate Change”
The report highlights the growing impacts of climate change on commercial real estate. Climate will determine where people want to live. Areas with extreme heat and droughts are expected to have declining demand, for example. It also acknowledges that making buildings sustainable is costly but notes that resilient real estate will be an absolute must for institutional investors.
READ ALSO: Net Zero Is Easier Said Than Done
“Smarter, Fairer Cities through Infrastructure Spending”
Expect more regulation as governments grow “impatient” about the private sector’s lagging efforts to fix issues like affordable housing and carbon emissions, the report states. At the city level, in particular, emissions standards, rent regulation and vacancy taxes are becoming more common. The report also points to the Security & Exchange Commission’s proposed climate risk disclosure rules, though the agency recently backed off the Scope 3 emissions in its third draft of the new rules.
Emerging Cities
The report also identifies the top 10 “U.S. Markets to Watch” for overall real estate prospects. Nashville was No. 1, but Miami bumped Seattle off the top 10 list and Phoenix fell from 3rd place to 9th.
- Nashville, Tenn.,
- Dallas/Fort Worth
- Atlanta
- Austin, Texas
- Tampa/St. Petersburg
- Raleigh/Durham
- Miami
- Boston
- Phoenix
- Charlotte, N.C.
