We’re halfway through 2023, so we thought we’d take a step back to review the latest CRE trends. It’s been an interesting six months so far. Initially, we saw record investment volume and funding levels early in the post-pandemic recovery period. But since Q3 and Q4 2022, CRE has continued to slow, thanks to continued inflation and high capital costs. Eventually, the turbulence will subside, but many investors are riding out the waves.
After multiple rate hikes, the Fed unanimously approved its 10th interest rate increase in May to 5-5.25%. According to the Bureau of Economic Analysis’ latest estimate, the U.S. GDP increased by 1.3% in Q1 2023. Multiple estimates indicate U.S. CRE investment volume has fallen between 55% and 57% year-over-year (YoY). The weaker market continues to challenge the CRE sector, indeed. Here are some of the other ongoing and developing trends for CRE.
- Commercial prices declined 15% YOY in May after peaking in Q1 2022. Sales in financial markets and rising interest rates have slowed the price growth. The steepest decrease? Apartment prices, at just over 10% YoY. Retail and suburban offices fell nearly 6%, but the central district office pricing only dropped 2.9%, according to MSCI’s RCA Commercial Property Price Indexes. Some CRE professionals believe we’ll see a significant cap rate expansion across most sectors.
- Multifamily and single-family rentals continue to benefit from a tight housing market. And investors continue vying for Class A properties as building quality, amenities, and proximity to public transportation (in bigger cities) are top priorities for tenants.
The National Association of Realtors (NAR) found multifamily rent increasing by 2.5%, with office rent growth slowing to just 0.9%. Industrial rents have topped 10%, warehouse rents have neared 12%, and retail rents are seeing just under 4% growth.
- According to Deloitte, CRE firms continue trimming budgets and reducing costs as they focus on efficiency. Rising interest rates, increased borrowing costs, and ongoing economic turmoil are motivating CRE leaders to implement technology that centralizes information, streamlines processes, and positions firms to find and take advantage of emerging opportunities quickly.
- CRE lending has also dropped, with the Lending Momentum Index declining 33% QoQ and 53% You. While private credit players are capturing a more significant market share, banks remain the most active segment of players.
- According to the Financial Times, demand for specific industry types and rising office vacancies have contributed to declines in some CRE valuations. Financial institutions suggest building owners prepare for debt loss and declining portfolio values. Many experts are optimistic that a rebound will happen, but this downward trend could have far-reaching implications and dictate market activity in the near future.
- Environmental, social and governance (ESG) remains a priority for many CRE investors. More than 65% of investment firms have adopted or plan to adopt ESG standards as part of their investment criteria, with an emphasis on environmental factors. CRE professionals anticipate more ESG growth since ESG-friendly investments help the environment by boosting energy efficiency and lowering operational costs. ESG certifications offer more opportunities to attract profitable tenants and obtain new funds or exclusive lending deals.
- Financial turmoil stemming from the Silicon Valley Bank and other bank failures also had investors rocking back on their heels in recognition of the critical need to manage risk efficiently and transparently. A trend emerging from these bank runs is a rapid increase in auditing exposure to partners, capital sources, and other criteria. Investors are implementing purpose-built technology to gain greater visibility and help manage and react to risk in real-time.
Asset Class Trends
- Even before the pandemic forced everyone to shop online, e-commerce had been growing. 2020 accelerated its growth. It’s expected that e-commerce will account for 25% of global retail sales by the end of 2026. What does that growth mean for brick-and-mortar stores? They’ll need to change their approach — an evolution that has already begun. Retailers have pivoted to an omnichannel strategy, with many brands turning their physical stores into distribution centers, buy-online-pickup-in-store (BOPS) locations, and showrooms. Augmented reality (AR) and virtual reality (VR) technologies are helping increase the sophistication of the complete customer experience.
- The traditional malls as we know them are also changing. They, too, saw foot traffic decline precipitously in 2020 and 2021. But the sector still has opportunities, especially within strip malls in more densely populated areas. And mixed-use strip malls are increasing in popularity as they attract diverse tenants from salons and restaurants to professional services, healthcare clinics, and grocery stores. In fact, according to the April 2023 Commercial Insights Report from NAR, strip center rents rose 4.5%, the second highest pace within the retail sector — second only to neighborhood centers.
- The popularity of industrial properties — warehouses, last-mile or final-mile fulfillment centers — also remains strong as distribution centers remain a vital component of the supply chain. Demand has slowed since its mid-2020 peak, but the vertical outperforms others. Industrial’s vacancy rate was slightly behind retail in Q1 2023, but its rentals show 10% growth YoY — including nearly 12% in the logistics niche.
- Another booming CRE sector? The life sciences industry. Its inventory jumped nearly 50% as of Q4 2022, and experts predict its space will top 220 million square feet by 2025. The busiest hubs include Boston and Cambridge, with Chicago and the San Francisco Bay area not far behind.
- Operational real estate — like senior living, student housing, and storage — is another niche market experiencing growth. Total CRE investment in operational spaces doubled to over 12% in 2021, and the National Investment Center for Seniors Housing & Care (NIC) found that occupied units remain at an all-time high with record demand. Meanwhile, the self-storage industry remains robust, with a 926% increase in construction since 2013 and over 52 million square feet of new space delivered in 2023 — a 38% increase compared to last year.
Technology (Proptech) Trends
- CRE has lagged behind other capital markets when adopting the latest technology. But the past few years have increased the adoption of property technology (proptech), as firm leadership saw its value in helping streamline and simplify processes. The quick pivot to remote work in 2020 accelerated the process, prompting more CRE firms to embrace the cloud. A Deloitte survey found:
- 56% of respondents agreeing the pandemic exposed digital capability shortcomings
- 53% of respondents indicated they have a roadmap of their future technology plans
- 32% of respondents actively restructuring (or planning to restructure) internal processes based on tools and technology
- 58% of REITs and 45% of developers plan to partner with technology companies to help the transition
- Cybersecurity is a priority as CRE firms focus on data security. The cost of a data breach averaged $4.35 million globally in 2022 — and in the U.S., it costs more than twice that amount, at $9.44 million. Nearly half of data breaches (45%) happen in the cloud, underscoring the need for CRE organizations to improve their cybersecurity protocols. Firms should leverage a more advanced approach to tracking user activity on software platforms and implement more sophisticated network controls. Technology professionals recommend implementing SOC 2 Type 2 compliance, the industry standard for data security.
- 92% of the 100 largest publicly traded REITS name cybersecurity as a significant threat
- 96% of office-focused REITs consider cybersecurity a serious threat
- 93% of hospitality-focused REITs consider cybersecurity a serious threat
- 92% of multifamily-focused REITs consider cybersecurity a serious threat
- Proptech gives investors the visibility and clarity to make more precise decisions quickly. Faster, more streamlined access to standardized data enables investors to gather insights more efficiently than via the traditional spreadsheet approach. Tech-enabled firms using centralized systems position themselves ahead of their competitors.