Investor’s Guide to the Current Market

Navigating the intricacies of today’s real estate market requires a comprehensive understanding of the forces shaping it. From the recent banking crises to the ripple effects of interest rate hikes and the transformative power of artificial intelligence (AI), investors are facing both challenges and opportunities. This guide aims to dissect the current landscape, offering insights into the performance of various commercial property types, key trends, and a glimpse into what the future holds for real estate investors.

 

Market Analysis

Capital Markets Trends

Throughout 2023, capital market activity was subdued due to the rapid increase in capital costs and the uncertainty surrounding where and when these costs will stabilize. A significant concern has revolved around refinancing maturing debt. An improved macroeconomic environment since 2022 has uplifted economists’ outlook for 2024, but investors must be wary of the tangible challenges that lie ahead.

 

It will remain to be seen how the CRE capital markets will evolve in 2024. As we look forward, the prevailing trends and challenges in the capital markets and CRE sectors lay the groundwork for the coming years.

 

Banking Crisis

Two bank failures occurred during Q1 2023, which stressed the financial sector and is of ongoing concern for businesses and investors nationwide. Silicon Valley Bank was closed by California regulators on March 10th, 2023, and the bank was then taken over by the Federal Deposit Insurance Corporation (FDIC) that same day. This event was the second-largest bank failure in U.S. history, with approximately $209 billion of asset deposits in limbo. In addition, Signature Bank, the third largest bank failure in U.S. banking history, was closed by New York regulators on Sunday, March 13th.

 

Interest Rate Hikes

On July 26, the Federal Reserve raised interest rates a quarter point to 5.25%-5.5%, the highest level in 22 years. The increase came after a long-awaited pause in June. Prior to June, the Fed issued 10 consecutive hikes aimed at slowing historically high inflation. Although the Fed’s actions have successfully lowered inflation to 3%, the lowest in two years, the government is still battling to reach its target rate of 2%.

 

Artificial Intelligence

AI is transforming the CRE financing industry by automating tasks, improving risk assessment, and reducing the time it takes to evaluate a loan application. Through AI-powered systems, lenders can analyze vast amounts of data to predict risk, estimate property values, and assess borrower creditworthiness. This enables lenders to make more informed decisions and reduces the risk of default.

 

Performance and Trends

Industrial

The industrial sector has (more or less) been immune to economic headwinds, but that changed in 2023 — investors saw decelerating sales velocity, plateauing growth, and cap rate expansion. New supply is expected to push vacancies up, which is currently at 5.1%. Supply is set to grow 3%, the highest percentage in 30 years, with 535 million square feet under construction, according to CoStar Group. There are a few trends industrial owners and tenants should keep an eye on entering 2024 that will likely have an impact on the sector’s future performance:

 

• Nearshoring 

COVID-19 spurred a need for closer-to-home manufacturing. Specifically for the U.S., the breakdown in the global supply chain encouraged companies to look at moving or expanding their manufacturing and distribution plants in North America instead of Asia. This move is referred to as nearshoring, and it may influence the industrial market, but most likely not for several years.

 

• Semiconductor & EV 

The industrial construction pipeline slowed dramatically at the start of 2023, but semiconductor and electric vehicle manufacturing continue to prop up the sector.
CommercialEdge reported that since the beginning of 2022, most of the 94 million square feet of industrial space under construction was devoted to semiconductors, batteries, and EV plants.

 

• Office-to-Industrial 

As developers face increased development regulations and markets lack land availability, investors are finding creative ways to repurpose current spaces to fit their industrial needs. The newest trend is converting old office buildings into industrial spaces. There are specific needs for this type of rehab, including proximity to major highways, expansive acreage, and single-tenant occupancy, but if the office fits the needs, it can present an excellent opportunity to bring new life to the property.

 

Multifamily

From suburban escapes to remote-work havens and booming senior living, 2023 witnessed a dramatic reshuffle in multifamily trends, reshaping the landscape of where and how Americans choose to live:

 

• The Suburban Migration 

As major markets’ cost of living indexes continue to rise, more Americans are opting to move to more affordable submarkets, usually in the suburbs. According to a recent survey by Homebay, the most prevalent 2023 moving trends included a quarter of Americans shifting from urban to suburban areas, while 31% of rural inhabitants relocated to suburban regions. Interestingly, if financial constraints were not a factor, 40% of Americans expressed a preference for living in a city. This has led to a substantial change within urban markets throughout the nation.

 

• Remote Work 

The increasing prevalence of remote work has significantly contributed to the Sunbelt migration trend. As major markets witness a surge in the cost of living, a substantial number of Americans are embracing the trend of relocating to more affordable submarkets characterized by favorable business environments and lower taxes. The evolving landscape of remote work has spurred a demand for more spacious living arrangements suitable for home offices. This shift has made Build-to-Rent (BTR) and Single-Family Rentals (SFR) increasingly attractive solutions, providing individuals with affordable alternatives that offer the necessary space for remote work.

 

• Rise in Popularity of Senior Housing

The senior housing sector experienced an unprecedented boom this year. The average occupancy rate rose to 83.7% in Q2 2023, reaching an all-time high of 900,000, according to a report by the National Investment Center for Senior Housing & Care and NIC MAP. This surge represents a 0.6% increase over the year’s first quarter and marks the eighth consecutive quarter of positive growth – the longest trend ever observed in this industry

 

• Evolving Tenant Preferences 

Today’s tenants seek more than just a place to live; they are looking for a comprehensive living experience. Amenities such as fitness centers, co-working spaces, pet-friendly facilities, and smart home technology are becoming increasingly important. Property owners who can offer these amenities and cater to the evolving needs of tenants are likely to attract and retain high-quality residents.

 

Office

From repurposed spaces fostering connection to remote work reshaping layouts, 2023’s office trends redefined the very purpose and design of the workplace:

 

• Remote Work 

The rise of remote work has changed not only how businesses approach work arrangements and where individuals want to live but also the entirety of the office sector. Companies have been forced to reevaluate their office space needs, with several opting for smaller offices. However, the need for in-person collaboration and connection still remains. Several office layouts are undergoing significant transformations, emphasizing collaborative zones, conference rooms, and designated environments for employee interaction and creativity.

 

• Adaptive Reuse

There has been a notable increase in adaptive reuse throughout the real estate industry. Investors and buyers now see that adaptive reuse comes in several forms, and the possibilities of projects are endless. According to projections, 90 percent of real estate growth within the next 10 years will entail the adaptive reuse of existing buildings rather than new construction.

 

Retail

• Artificial Intelligence 

As retailers adopt AI technologies to optimize their daily operations and improve customer experiences, the demand for AI-enabled retail spaces is increasing. Brokers can leverage AI for enhanced market analysis, lead generation, and personalized client services. Owners can create smart buildings, implement predictive maintenance, and improve tenant retention. Tenants can enjoy personalized shopping experiences, data-backed marketing strategies, and efficient inventory management.

 

• E-Commerce Effect on Casual Dining 

The casual dining industry, otherwise known as full-service restaurants, has felt the same adverse effects of e-commerce as traditional brick-and-mortar retail, department stores, and suburban mall centers. According to Bloomberg, consumer tastes have strayed from the sit-down experience model, evidenced by the rise and relative out-performance of local restaurants, fast food chains, delivery-focused companies, and fast-casual concepts. Full-service restaurants are desperately rethinking their business models to pivot and adapt.

 

• Grocery-Anchored Retail 

In the early days of the pandemic, grocery-anchored retail was dismissed because of the assumption that e-commerce would vastly expand and reduce the need for the mass amount of square footage a grocery store requires. However, consumer preferences and shopping habits, plus the additional challenges of running a profitable delivery service, have solidified the strategy of investing in grocery-anchored retail as a specific asset class.

 

• Sustainability and Green Initiatives

Sustainability has been a prominent concern throughout businesses, including the multifamily market. Tenants are actively seeking eco-friendly living options as they become more aware of the environmental consequences. Property owners might incorporate energy-efficient appliances, green building materials, and recycling initiatives to address these expectations. This not only benefits the environment, but it may also attract environmentally conscious tenants.

 

2024 Outlook

The commercial real estate landscape in 2024 is varied, with unexpected resilience in retail, a hybrid work reality reshaping offices, and the Sunbelt remaining popular despite climate concerns. Rising federal debt casts a shadow, but investors see opportunity in undervalued assets. AI promises to transform the industry while climate challenges demand sustainable solutions and downtown reinvention. The housing affordability issue remains a pressing concern, but a focus on construction offers hope for a brighter future.

 

Adaptive Reuse

The real estate industry has observed a significant rise in adaptive reuse projects. Investors and buyers recognize that adaptive reuse can take various forms and present endless possibilities. It is anticipated that 90 percent of real estate growth in the next decade will involve the adaptive reuse of existing buildings instead of new construction.

 

Impact of Technology on CRE Financing

Traditionally, underwriting a commercial loan has been a manual process, requiring extensive documentation and analysis. However, with automated underwriting, technology can expedite this process, evaluating loan applications based on pre-set criteria and deciding in a matter of hours rather than days or weeks. By lightening the strain on underwriters, automated underwriting can give them more time to concentrate on complicated deals.

 

Blockchain technology is another exciting development in the CRE financing industry. Using blockchain, lenders can create smart contracts that automate the loan origination and servicing process. Smart contracts can reduce the need for intermediaries, making the process more cost-effective and transparent. Additionally, blockchain technology can reduce the risk of fraud and improve the security of sensitive data.

 

Retail Takes Center Stage

Despite challenges in the retail industry, such as concerns about crime, certain retail bankruptcies, and downtown retail being affected by a decrease in office workers, there has been a significant rise in demand from retail tenants. Class A and trophy malls are experiencing high occupancy rates, luxury retail is seeing increased demand, and the prevalence of hybrid working has led to more people spending time at home and visiting strip centers, power centers, and grocery-anchored shopping centers more frequently.

 

Popularity on Sunbelt Markets

The Sunbelt remains an attractive destination for residents, businesses, and investors due to lower regulations and taxes, improved quality of life, and a growing workforce. This trend has persisted for years and is expected to continue throughout 2024. The Urban Land Institute and PWC’s Emerging Trends in Real Estate 2024 report revealed that out of the top 20 markets to watch in 2024, 15 are situated in the Sunbelt region. These are attractive due to “the warmer weather, more affordable housing, and strong job growth.”

 

Key Investment Strategies to Navigate the Evolving Market Landscape

Smart investing begins with a deep understanding of the market. Market research is not a one-time affair; it’s an ongoing process. Start by analyzing the market where you plan to invest. Look for trends, evaluate demand, and understand your competition. This knowledge will help you make informed decisions about when and where to invest.

Due diligence is non-negotiable. This means investigating every aspect of a property before you invest. Scrutinize financial health, including rent outlook, expenses, and maintenance history. If you’re uncomfortable completing this process, consider working with a qualified real estate professional who can guide you.

 

Diversification is also a classic risk mitigation strategy. It applies to both asset types and geographic locations. Spreading your investments across various asset types like office spaces, retail centers, and multifamily properties reduces the impact of a downturn in a single sector. Similarly, investing in properties across different geographic locations can help spread risk. Some regions may be more resilient during economic downturns. Additionally, embracing technology isn’t just an option; it’s a necessity for risk mitigation in today’s competitive commercial real estate market. With the advent of predictive analytics, you can foresee market trends and future risks, allowing you to make proactive decisions. Blockchain technology, known for its security features, ensures that transactions are tamper-proof. Leveraging big data and artificial intelligence will enable you to scrutinize vast amounts of information quickly, revealing hidden opportunities and potential risks.

 

Takeaways

In summary, the commercial real estate market stands at a critical juncture, influenced by a confluence of factors. The banking crises have underscored the fragility of financial sectors, while interest rate hikes have reshaped borrowing dynamics. The performance of different property types, from industrial spaces adapting to global shifts to the evolving preferences in multifamily and the resilience of certain retail segments, paints a dynamic picture. Looking ahead, embracing technology, diversification, and unwavering due diligence emerge as key strategies for investors to thrive in this ever-evolving landscape.

 

The 2024 outlook highlights the significance of adaptive reuse, the impact of technology on financing, the resurgence of retail, and the enduring appeal of Sunbelt markets. In the face of uncertainty, smart investing, continuous market analysis, and a tech-savvy approach will be the pillars of success for investors navigating this complex terrain.