Commercial real estate players are predicting a recession to hit the U.S. economy in the coming months — but they think it will be “short and shallow," according to the Urban Land Institute and PwC’s 2023 Emerging Trends in Real Estate report, released Thursday.
ULI and PwC’s annual report interviewed 617 individuals working in CRE and analyzed survey responses from more than 1,450 people in the sector.
Interest rates remaining higher for longer will add to uncertainty and slow economic growth, but the pandemic fading into the background will help the economy normalize, the survey found. But people are still adapting to the changes that the pandemic introduced into their lives, leaving asset classes in flux as owners and investors figure out how to move forward, ULI Senior Vice President Anita Kramer told Bisnow in an interview.
“Life as we know it didn’t change, but certainly there are some structural changes in how we go about our lives,” she said. “The dust hasn't settled yet.”
Here are the 10 trends that experts believe will heavily affect the industry in the coming year.
The Economy Will Normalize — And So Will CRE
The CRE sector saw some of the strongest rent growth, price appreciation and returns in recorded history in 2021 and the beginning of this year, which are now gradually coming down from their pandemic-era highs. With rising cap rates and falling transaction volumes, asset prices are declining and rent gains are moderating, the report found.
Home sales will decline as a result, the report predicts, and more expensive debt will hinder property investments. Multifamily and industrial — the darlings of the pandemic — will likely be among the most affected asset classes, while some of the asset classes that suffered most during the pandemic — hotel and retail, in particular — will likely see increases in activity and a slight recovery.
Rent Control, ESG Rules To Expand Their Influence
Institutional investors and real estate owners will face mounting pressure to disclose more information regarding their environmental, social and governance policies and targets as the SEC’s draft regulations take shape and emission reduction deadlines in local regulations — like New York City’s Local Law 97 — start taking effect.
Regulation may also target housing affordability as renters and buyers across the country reel at eye-watering prices. At least 17 states were considering rent control legislation in some form, with multiple cities also considering their own measures, the report said. Vacancy taxes may also see some changes as regulators try to incentivize property owners to put buildings to productive use.
Online Retail And Remote Work Will Continue To Dominate
People are still spending online for the sake of convenience, but online shopping has declined slightly as customers have returned to stores. That leaves physical stores that survived the pandemic with an opportunity to absorb some of the market share, according to the report.
But remote work will affect asset classes linked to in-person work and business travel.
Demand for remote work will remain strong and will lead office tenants with expiring leases to make hard choices about how long they are willing to continue holding onto empty space. A record level of office space is already available for sublease, brokers said. While 2023 is unlikely to see a mass exodus from offices, tenants are more likely to downsize their physical spaces and owners will be asked to consider redesigning spaces to fit tenant desires.
Business travel is also unlikely to return to pre-pandemic levels during 2023, with the options of hybrid meetings and conferences putting downward pressure on business hotels, conference centers and fine dining restaurants, the report predicts.
Hesitancy Will Dampen Investor Demand
Investors are moving away from real estate assets in favor of equities and bonds, the report found, with uncertainty over where prices will settle creating hesitancy among investors seeking to avoid overpaying.
Rising interest rates have already made acquisition and construction debt more expensive, while debt overall has become more difficult to obtain. With buyers expecting lower income and higher costs from deals, they will pull out or seek price breaks, the report predicts.
But even with a slower flow of deals, few experts predicted a crash or liquidity crunch: overall, strong balance sheets, low leverage and only small value declines are quashing fears of widespread distress. However, deal volumes aren't expected to creep back up again until the market understands the Fed’s strategy, the report predicts.
Buyers Pushed Out Of Homebuying
The Fed’s rate increases have already pushed some would-be homebuyers out of the market. Buyers who are able to will move to more affordable markets, but more will continue to pull out over the coming year, the report predicts. Cost of debt, increased construction costs, the shortage of available properties, labor shortages and existing tax codes favoring investors over individual homebuyers are among the factors that will continue to affect the market in 2023.
Investor Interest In Flight To Quality And Niche Asset Classes Continues
Demand for top-tier space will continue to dictate activity in the office market over the next year, with high ceilings, floor-to-ceiling windows, sustainable design and the latest HVAC systems remaining key attractions, investors told ULI and PwC. But also catching investor interest is rising demand for niche asset subclasses, including medical office, student housing, self-storage, senior housing, single-family rentals and life sciences.
Building Conversions On The Horizon
The nationwide housing crisis, coupled with a surplus of aging buildings with the potential to be repurposed, could see more discussion of conversions next year, the report predicts. Older offices may be considered for conversion to modern offices or residential buildings, while excess retail space could turn into fulfillment centers or mixed-use properties. In cases where buildings aren’t good options for conversion, some may be torn down and replaced with high-density housing.
Sun Belt Growth To Slow But Not Stop
Most of the markets to watch for the next year will be cities in the Sun Belt, the report found. There is a risk of oversupply in cities like Atlanta; Austin, Texas; and Tampa, Florida, where developers have moved fast to keep up with demand over the past two years. But while the level of inbound migration to Sun Belt markets may ease slightly over the coming year as residents offset lower taxes against cost of living and quality of life, overall market growth is likely to stay strong, experts said.
Infrastructure Spending Will Supercharge Cities
Spending linked to the Bipartisan Infrastructure Law, enacted in November 2021, will spur new initiatives to expand broadband access and changes to transportation infrastructure. The country’s highway systems will get the biggest cash injection in their history, while at least $1B in federal funds will go into community-led efforts to rebuild neighborhoods of color bulldozed in favor of highways during the 1950s and 1960s.
Resilient Development To Take Center Stage
Climate change will continue to push up heating, cooling, water and electricity costs in the U.S., affecting decisions about where to live and where it is possible to build. Drought in the Southwest and heat domes in the Pacific Northwest will bring the areas’ feasibility into question — and while CRE players are typically slow to react, changes to insurance costs and policies may hasten how they approach building upgrades and decisions around assets.