The economic outlook for real estate contains major areas of uncertainty driven by ongoing increases in interest rates and lack of debt and equity capital available, resulting in low liquidity, concerns about refinancing of existing loans and a ‘wait and see’ mode across the industry, according to the new Emerging Trends in Real Estate Global Outlook 2023 report from the Urban Land Institute (ULI) and PwC.
A key question according to the report is whether rental growth can be delivered against a background of stagnant economies, declining consumer sentiment, ongoing structural change and increasing capex requirements.
The full consequences of central banks’ monetary tightening and rising interest rates have still to play out, but the rush of withdrawals from private open-ended funds by institutional and retail investors has troubled real estate leaders. For institutional investors, the withdrawal is partly a response to the “denominator effect”, but these funds represent a relatively liquid investment, and the rush to the exit is evidence of investor concerns.
The biggest obstacle to getting deals done in 2023 is uncertainty over where and when interest rates will settle, following which more clarity will appear on real estate pricing. With the general expectation that interest rates will stay higher for longer, the current price discovery challenge – amounting for some to a “phoney war” between buyers and sellers – is exacerbated by low investment volumes and low liquidity. Logistics seems to have largely re-priced in major markets and hope that long-standing structural changes have now been priced in for retail is increasing, but huge uncertainty remains over office markets.
Debt finance is integral to a functioning investment market and increasing liquidity, but banks are in “wait and see” mode and it remains to be seen whether non-bank lenders will seize opportunities and plug the funding gap. Finance is scarce for new and re-development, where high construction costs, labour shortages and uncertain occupier demand add too much risk for most banks.
As existing loans are refinanced, distress on the scale of the global financial crisis is not expected, but many investors will feel the pain, the report predicted. At the same time, there is a huge need for repurposing and accelerating the ESG agenda, not the least to maintain buildings and earn rental income, and this puts the industry in a tough position, as it may no longer be possible to postpone upgrades and capex investments.
This challenge is especially prevalent for offices and there is a strong sense that the sector will experience similar disruption to retail. Most industry leaders are working on the assumption that office occupancy will trend downwards and they share a strong belief in “bifurcation” between prime and secondary, ESG compliant and non-compliant.
'Real estate leaders are adjusting to interest rates that are expected to stay higher for longer and getting to grips with a new normal of higher finance costs and minimal capital growth,' said ULI Europe CEO, Lisette van Doorn. 'The keys to success – operational management and rental growth – depend on making assets fit for purpose and ESG compliant. The industry can no longer ‘wait and see’, hoping that construction and financing costs will decrease, as occupiers will critically review their total occupancy costs at lease renewal and alignment with their space and ESG strategies is key. A failure to act may imply loss of rental income very soon.'
Gareth Lewis, ETRE Leader, Director at PwC, added: 'Redemption requests from open-ended funds point to doubts around current private property valuations, reflecting a disconnect between the public markets and private real estate. The slow speed with which real estate is revalued relative to equites and bonds is causing a problem for institutional investors, especially in the US, Europe and Australia. This denominator effect is taking some institutions very close to their cap on real estate holdings and could impact an important source of investment for the sector.'