As 2023 comes to a close, now is a good time to start looking forward to what 2024 may have in store for the various real estate markets.
With that in mind, we have outlined and summarized the key emerging trends (based on a recent study published by PWC) that we believe will have the most significant impacts for real estate investors in 2024.
Trend #1 - Higher and Slower for Longer
In 2023, the looming threat of recession was a primary concern for CRE professionals. Despite prolonged anticipation, the U.S. economy resisted a downturn, leading to expectations of a "soft landing" or a "growth recession." A senior executive from a CRE advisory firm highlighted the paradox of a robust labor market and job growth coexisting with interest rates causing a slowdown.
The report emphasized the need to differentiate between the broader economy and real estate. While optimism prevailed about averting a recession, the downside for the real estate industry was the prolonged period of elevated interest rates, surpassing earlier projections.
Looking ahead to 2024, the report highlighted factors influencing consumer and business spending, such as below-normal household savings rates, the resumption of student loan payments, and tightening lending standards. Potential contributors to economic distress included oil price hikes leading to inflation and unforeseen events like recent terrorist attacks in Israel.
Trend #2 - The Great Reset
After the Great Financial Crisis, commercial real estate enjoyed a 15-year period of robust returns driven by rent growth, declining cap rates, and rising property values. However, the Federal Reserve disrupted this trend with the first of 11 rate hikes in March 2022, signaling that markets won't return to their former strength soon.
In 2023, as the reality of sustained higher rates set in, market participants prepared for the future by recalibrating their expectations, anticipating diminished drivers affecting rent growth, property values, and returns.
Quoted in the study, the head of an asset management firm noted that investors are anchored to the past era of zero interest rates, hindering transactions between buyers and sellers until they adjust to the new rates.
On a positive note, the study highlighted that, despite the significant impact of the office sector on perceived risks and opportunities in commercial real estate, fundamentals in most other sectors remain strong, with low distress.
Trend #3 - A Painful but Needed Capitulation
After three years of anticipating a rebound, survey participants have accepted that the demand for office space has undergone a permanent shift. The study emphasizes that a full recovery to pre-pandemic levels is no longer a reasonable expectation.
The office sector is currently undergoing a comprehensive reassessment of its purpose and role. Despite considerable talk about office-to-residential conversions, the study cautions against drawing sweeping conclusions.
Interestingly, the study suggests that the retail sector's transformation over the past decade, influenced by e-commerce and the pandemic, could offer valuable insights. Office investors are now turning to retail properties to understand how owners successfully navigated the evolution of that sector.
Trend #4 - It’s All About the Debt
Interest rate increases, impacting the CRE industry, are also affecting various sectors of the economy, including governments, businesses, and consumers. The study notes that despite record levels of debt, both household and corporate debt burdens appear manageable compared to historical benchmarks, and delinquency rates remain low.
However, the study warns that CRE capital has become scarce and expensive, creating a potential liquidity crisis. Owners of underperforming buildings may face debt deadlines, leading to defaults or distressed asset sales, even though current distress levels remain low.
The study anticipates an increase in delinquency and default rates, especially in the office and multifamily sectors, as major leases expire and mortgages come due. Capital availability ranks as the second most crucial issue for real estate in 2024, following only "interest rates and cost of capital," according to the survey.
Trend #5 - Eco-Anxiety Comes Home
This year, the study emphasizes the central role of insurance in the climate discussion, noting that historically, it has been a minor concern for commercial property owners, constituting approximately 3% of rent. However, a recent surge in insurance costs is capturing owners' attention, prompting concerns about potential resistance from tenants or the erosion of returns.
Compounding the issue is the diminishing availability of insurance. While major institutional investors typically secure insurance across their portfolios, smaller buyers, especially in high-risk areas like Houston or South Florida, may face challenges obtaining insurance, impacting their ability to secure loans. According to a property investor, the ultimate consequence of higher insurance costs is likely to be a reduction in new housing or industrial space supply and an increase in rents, particularly for properties in high-risk locations such as coastal or forested areas.
Trend #6 - Even Further Out of Reach
"Housing affordability is the critical issue in real estate," stated a prominent real estate academic, specifically highlighting the issue in for-sale housing. Survey respondents overwhelmingly identify "housing costs and availability" as the most critical social/political concern this year.
The United States witnessed the fastest-ever decline in housing affordability over the past three years, marked by a 30% surge in the median price of existing homes sold from 2020 to 2022, as per NAR data cited in the study. The study notes a subsequent "historic mortgage rate shock" driven by the Fed, resulting in a 150% increase in mortgage interest rates (from 3.0% to 7.7%) and a median home price in August 2023 that exceeds what a typical household can afford by more than a third.
While renters currently experience flat or minimal rent growth nationally, a relief after a peak of over 15% year-over-year in early 2022, this trend is causing concern for some multifamily investors. An additional million multifamily units scheduled for completion through 2025 are expected to exert downward pressure on rents in specific markets. Survey respondents indicate that in 2024, multifamily and single-family housing will be the top prospects for investment in the United States.
Trend #7 - Portfolio Pivot
“Recent shifts in both property and financial markets are upending long-established norms about how CRE portfolios should be constructed, including the definition of ‘core’ assets,” noted the study, adding that “with downtown offices and regional malls — the traditional pillars of CRE portfolios — both suffering existential declines in tenant demand and property values, fund managers must find replacement investments.”
Many are exploring "newer product types" for commercial real estate portfolios, previously considered niche but now offering more compelling returns, according to the study. The definition of core industrial is expanding to include cold storage and self-storage, while core multifamily now encompasses student housing and single-family rentals, as mentioned by a leader from an asset management firm.
The Emerging Trends 2024 survey identifies the top five sectors as specialized sub sector segments, such as data centers and moderate-income/workforce apartments. Core investors are also open to considering conventional office buildings, but with a different approach, focusing less on geography like urban or central business districts and more on factors such as age, stage, or capital intensity, according to an asset manager.
Trend #8 - Not Remotely the Same
“The shift to remote work might be the single most important trend for property market dynamics in generations, as impactful for the office sector as e-commerce has been for the retail and industrial sectors, but with other far-reaching impacts on our lives and property markets,” said the study.
Remote work in the United States has nearly tripled compared to pre-pandemic levels, increasing from 5.7% of all workers in 2019 to 15.2% in 2022, as reported by the U.S. Census Bureau's 2022 American Community Survey. This shift has had a more significant impact on large cities and office-centric professions, negatively affecting the nation's office sector and downtown areas.
“Remote and hybrid workers are more willing to relocate than other workers, typically moving to less-dense suburbs and smaller cities, often in search of more affordable housing. This trend is especially strong among younger households under age 35, normally the likely urban dwellers,” noted the study.
Trend #9 - Downtowns Need To Reinvent Themselves — Again
Urban economists and city leaders are currently deliberating the future of downtowns, anticipating a potential decrease in occupied office buildings, the study highlights. It introduces the concept of an "urban doom loop," where the decline in foot traffic due to empty offices sets off a downward spiral. This scenario involves the closure of nearby stores and services, diminishing the area's allure for residents, leading to reduced property values.
The study emphasizes that tax revenues decline, compelling cities to cut critical services, further diminishing the appeal for both commercial and residential users. Additionally, transit systems suffer as ridership declines, necessitating service cutbacks and further discouraging commuters from using buses and trains.
A more positive perspective focuses on the traditional strengths of cities to attract young, highly adaptable people. “The dynamics that made urban centers attractive to a huge percentage of the population exist today and will persist into the future,” said a leading housing sector consultant. “I don't want to live in the woods, even if I’m not going to the office.”
Trend #10 - An Artificial Boom
“Despite the hype and popular attention on artificial intelligence, actual CRE uses appear to be limited and most are mundane to date,” noted the study, with a developer that leases to many tech firms adding, “there are ways we can’t even fathom that will be helpful in all businesses. But the one I’ve heard of more recently is administrative tasks. It basically serves as your superpower assistant.”
Despite this, the study highlights the rapid potential expansion of industry uses due to the promising technology and substantial venture capital investment. Potential applications include the use of probabilistic models to predict property climate risks, identify investment opportunities, and construct higher-performing portfolios.
Commenting on potential jobs losses, the study said, “AI adoption could replace many types of routine white-collar work, but jobs losses could be offset by greater overall economic growth as well as space demand from AI firms."
Emerging Cities
The study also identifies the top 10 “U.S. Markets to Watch” for overall real estate prospects:
Nashville
Phoenix
Dallas/Fort Worth
Atlanta
Austin
San Diego
Boston
San Antonio
Raleigh/Durham
Seattle
Conclusion
The most interesting result from the survey is that “investors are eager to acquire new assets,” the study said, adding that “the Emerging Trends Barometer for 2024 registered its highest 'buy' rating since 2010, likely reflecting recent and expected price declines, making this a more favorable entry point for acquisitions after a decade of relentless appreciation.”
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