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Renewed activity in a period of adjustment
Real estate professionals are increasingly selective in their investment strategy, asset class allocation and selection, and value driver focus because of higher capital costs and a higher-for-longer interest rate mindset.
- The investible asset class is widening into what we believe will eventually be more often referred to as “real assets”. While location, condition and quality still drive investment decisions, real estate market participants are expanding their investment lens to pursue opportunities in adjacent subsectors that have scale. For example, data centers and other digital-economy properties continue to benefit from strong demand. Other alternatives also are experiencing an increase in desirability, notably experiential and wellness real assets, mixed-use assets surrounding sports and live entertainment venues, and variants of residential real estate tied to the longevity economy, such as senior housing. Further, market participants are studying and preparing plans to capitalize on the significant activity occurring in the development of semiconductor manufacturing facilities, renewable energy components and the production of critical minerals. What is clear on the ground, but not often discussed, is that the amount of market activity is astounding.
- Regulatory and economic pressures have led many banks to reduce lending. Resultant decreases in loan-to-value (LTV) ratios, and more conservative lending standards, particularly for commercial mortgage-backed securities (CMBS), have created opportunities for private credit lenders. As one of the fastest-growing segments in the lending landscape, private credit is further increasing its relevance by offering flexible, tailored financing solutions. The activity in private credit is multidimensional, as insurance company capital is also focused on the ability to deploy significant amounts of capital for acceptable durations and earn accretive returns.
- The anticipated wall of maturities indicating that $400 billion to $450 billion of commercial real estate (CRE) loans will mature annually for the next few years, while slower to materialize than initially anticipated, is providing opportunities for prepared investors. While the capital markets are well positioned to facilitate workouts and resolutions where necessary, distressed assets are providing buying opportunities for investors who are increasingly focused on prime assets rather than on seeking bargains, with an emphasis on quality over price. Of note, however, is that many market participants are frustrated by the amount of distressed activity and the pace with which it is coming to market. As we have noted in prior editions of our outlook, we have been of the opinion that this was going to be the case as market participants do not want to relive past experiences, particularly those from the financial crisis. This is not to say that distressed activity will not move higher, but that we see market participants collaborating to find long-term solutions to the challenges rather than taking short-term decisions.
These factors, together with emerging investment opportunities associated with a continuously evolving economy, which are driving change across the industry, continue to keep us optimistic as we see significant opportunities for patient and creative market participants who are willing to take the long view across the investment landscape.
Investors search for returns in new asset classes
Demographic, climate, geopolitical environmental and digital changes have prompted real estate professionals to broaden their focus beyond traditional asset classes. This portfolio pivot is upending long-established norms of CRE portfolio construction beyond the typical mix of office, retail, industrial and multifamily assets, notably with a blurring of lines between real estate and infrastructure. One example is the surging demand for data centers, which are part infrastructure, part real estate and part technology, but the changes in activity are much broader.
As the industry continues to embrace sustainability, these assets present significant challenges from a climate perspective, given massive power demands and heat generation, which will require solutions to ensure sustainability and tie in to existing and new energy infrastructure development to sustain growth. Coupled with a broader transition to decarbonize existing energy sources, this increased demand presents significant growth opportunities between real estate and infrastructure.
Real estate investors have also been monitoring niche sectors such as cold storage, and wellness real assets, mixed-use developments surrounding sports and live entertainment venues, which are increasingly becoming more institutionalized. In addition, variants of industrial real estate are presenting new and interesting opportunities as companies increasingly look to reduce exposure to potential supply chain disruptions by locating manufacturing in the US and nearby markets, such as Mexico, and embracing the automation and electrification of fleets.
“Despite negative headlines, the amount of activity occurring in today’s market is substantial, and accelerating, as market participants collaborate to find solutions to our challenges and focus on what they can control.”
The bottom line
Despite the challenges of economic uncertainty and relatively higher interest rates, there are opportunities for real estate investors and leaders. Investors should be encouraged by the slowdown in distress signals in addition to the current availability of capital, which indicates that the financial markets are poised to support a recovery in deal volumes. Emerging investment opportunities will be key to driving change and fostering optimism across the industry. For the remainder of the calendar year and beyond, we believe there is a significant potential for market participants who are patient and creative, and who take a long-term perspective across the investment landscape.
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