DLA Piper's Global Real Estate State of the Market Survey 2023: Economic headwinds bring bearishness, but respondents see areas of opportunity
Despite challenges caused by economic uncertainty, 10 interest rate increases by the Federal Reserve in just over a year, and what appear to many observers to be structural changes in the demand for office space, commercial real estate (CRE) leaders see opportunities across certain parts of the sector, according to DLA Piper's 2023 Annual State of the Market Survey. Conducted in February and March of 2023, the survey analyzes the views of CRE leaders on post-pandemic realities, the economic outlook, the attractiveness of various asset classes and investment markets, and overall expectations for the next 12 months.
In this year’s survey, 86 percent of survey respondents report a bearish outlook for the CRE sector over the next 12 months, with 46 percent of respondents citing interest rate hikes as the reason for their bearishness, followed by reduced debt availability (20 percent) and recession risk (15 percent). Despite these headwinds, which led to just the third projected bear market since DLA Piper’s inaugural State of the Market report in 2009, optimism remains for specific areas of the sector. As a whole, CRE leaders see value in asset classes that serve human necessities such as medical offices, grocery-anchored retail, and housing as the “new normal” of post-pandemic life begins to crystalize.
Interest Rate Increases Take a Toll
When identifying which factors will have the greatest impact on the global CRE market, interest rates topped the list, with 83 percent of respondents pointing to them as the factor that will have the biggest impact on the market. More than 92 percent of respondents believe that interest rate increases will have a negative impact on investments in CRE this year. Other major factors affecting the global CRE market are expected to be the US economic outlook (46 percent) and inflation (45 percent).
When thinking about the factors that will be most impactful on the CRE market in the next twelve months, 98 percent of survey respondents noted challenges in refinancing existing debt—though the true implications remain to be seen as roughly $270 billion of commercial real estate loans will reach maturity in 2023, according to Trepp.
“We are seeing that increasing interest rates are the primary concern for decisionmakers across the CRE industry," says John Sullivan, US Chair of DLA Piper's Real Estate practice and Global Co-Chair of its Real Estate sector. "An end to interest rate hikes, which a majority of CRE leaders believe is on the horizon (and which was hinted at in the May meeting of the Federal Reserve), would probably be the most impactful change that could take shape in the short term."
Reimagining Office Space as Work Changes
In just three years, the ways in which people work have undergone a dramatic paradigm shift. Many of these changes may be here to stay, which will have substantial implications for the office market. When looking at trends in office occupancy, 72 percent of respondents expect occupancy will not materially increase during 2023, and 82 percent believe there will continue to be a strong need to repurpose spaces and add amenities in office buildings. Additionally, 43 percent of 2023 respondents believe that US office building vacancies will never return to pre-pandemic levels, more than double the percentage reported in 2022 (20 percent).
"While changes in how today’s workforce uses traditional office space are creating challenges, they also provide opportunities for careful and creative investment," says Sullivan. "Fundamental shifts in the way spaces are used are rare, and the rapid transformation of how and where people work offers an opportunity for creative conversion and reimagination of some spaces. Nonetheless, it’s important to note that repurposing is not a one-size-fits-all solution for the office sector. In addition, there is continuing demand for new, amenity rich office buildings."
A Shift to Assets Serving Basic Needs and Away from Traditional Cores
Opportunities remain in certain asset classes. Respondents reported that logistics, warehousing, and cold storage spaces are the most attractive investments (53 percent, down from 66 percent in 2022), followed by multifamily housing (45 percent, down from 57 percent in 2022) and affordable and workforce housing (38 percent, up from 27 percent in 2022). Other asset classes identified by respondents as the most attractive this year in comparison to 2022 reflect spaces that serve basic necessities: Medical offices rose from 28 percent in 2022 to 37 percent, grocery-anchored retail rose from 22 percent to 27 percent, and senior housing rose significantly from 13 percent to 25 percent.
The accelerated migration of Americans from traditional urban cores into the suburbs and Southeast and Sunbelt cities may be influencing the areas of perceived opportunity. Developers are increasingly building projects like grocery-anchored retail outside of downtowns. And while Austin was identified as the top city for investment in 2023 at 39 percent, that was a significant drop from last year’s 60 percent. Miami (39 percent), Nashville (39 percent), and Raleigh-Durham (37 percent) made up the remaining top four cities, highlighting that the opportunities are expected to be best in the areas that have been on the receiving end of the population shift.
"Pent up demand following the global pandemic, coupled with historically low interest rates, lead to record levels of CRE investment activity over the past two years,” says Sullivan. “Now, with interest rates rising significantly and slowing economic growth, it’s not surprising that we are seeing a pullback in investment activity. However, our survey indicates that CRE leaders continue to see opportunities in asset classes that have solid fundamentals and secular tailwinds."