Exclusive ULI Fall Conference Release: The Investors’ Guide to 2024 Real Estate [Part 2]
Having explored the first five trends in our previous blog, you’ve gained insights into some of the key forces currently reshaping the real estate landscape. Now, we continue our learning about the ‘Emerging Trends in Real Estate Report from ULI.
Let’s delve into the next set of trends, which further define the contours of the ‘Great Reset’ in the industry.
6. Even Further Out of Reach: Rising Rates Challenge Home Buyers
The United States has rapidly declined housing affordability over the past three years, largely influenced by the Federal Reserve’s policies. During the pandemic, the Fed’s near-zero interest rates led to historically low mortgage rates, spurring a surge in housing demand amid a dwindling supply. This imbalance, worsened by investors buying existing homes for rentals and a slowdown in new home construction, resulted in a 30% increase in median home prices from 2020 to 2022.
Additionally, mortgage rates have skyrocketed by 150%, rising from 3.0% to 7.7%, which has drastically reduced housing affordability. For example, in 2023, a homebuyer with a median income could afford a home worth $300,000 at a 7.7% mortgage rate, whereas two years prior, the same buyer could have afforded a $500,000 home at a lower rate.
This affordability crisis is compounded by the Fed’s rate hikes, making home financing and development more challenging, ironically stalling the construction needed to address affordability issues.
Despite a brief dip in home prices due to these high rates, prices have begun to rise again due to the severe scarcity of homes for sale. Current homeowners, largely insulated from these high rates due to existing low-rate mortgages or outright ownership, are reluctant to move, further constricting the market supply and driving up prices for the few available homes.
Recently, renters in the U.S. have experienced a more favorable market, with rent growth either flat or minimal after a peak of over 15% year-over-year increase in early 2022. This change is attributed to a significant increase in apartment supply, with over 460,000 units added in 2023 and a total of 1.2 million since the pandemic began. However, this relief might be short-lived.
The same interest rate hikes that impacted homebuyers have also increased borrowing costs for multifamily developers, slowing the addition of new rental units. Additionally, rising household formation rates, particularly among remote workers seeking more space, have maintained high occupancy and rent levels despite the increase in supply.
Economic analyses indicate that the growth in household formation, especially in less dense markets, has offset the potential decrease in occupancy and rent due to out-migration from high-rent areas. Consequently, the recent surge in apartment supply has barely made a dent in the national housing supply gap, which has expanded to 4.3 million units. As a result, multifamily developers and investors remain optimistic about the potential for rent growth, particularly as new multifamily deliveries are expected to decrease after 2023, indicating a potential return to rising rents for renters in the near future.
Addressing the affordable housing crisis is complex, but a key solution lies in building more housing across all price points. Recent market trends have clearly shown that supply significantly impacts housing affordability. Home prices surged with increased demand and limited supply, while rent growth stabilized when a substantial new apartment supply entered the market. However, much of the new housing is not affordable for lower-income individuals; only about 60% of units built from 2020 to 2022 are accessible to 41% of America’s renters. The hope that more expensive units vacated by wealthier tenants will “filter down” to less affluent families is uncertain, especially given the ongoing housing shortage.
Efforts to increase supply, such as reducing permitting fees, modifying restrictive zoning, and increasing as-of-right density, face challenges such as preserving neighborhood character and escalating construction costs. Reducing these costs, including interest rates, material costs, and labor costs, is crucial but difficult, particularly for labor. Addressing the need for affordable lower-income housing is even more challenging, as it intertwines with broader social issues such as health and addiction, which exceed the capabilities of standard property management and require more comprehensive solutions.
7. Investors Shifting Focus to Specialized Sectors
CRE portfolio construction is undergoing significant changes due to evolving property and financial markets. Traditionally, since the Employee Retirement Income Security Act (ERISA) in 1974 enabled pension funds to diversify into a wider range of assets, CRE portfolios have relied heavily on conventional offices and enclosed retail centers.
These assets offered stable cash flows, liquidity, inflation hedging through lease escalations, and the ability to invest large capital sums. However, the rise of e-commerce and the work-from-home trend have dramatically altered the market dynamics for retail and office sectors.
Overbuilding in retail and pre-pandemic trends in office space reduction contributed to these shifts. The pandemic further accelerated these changes, diminishing the investor appeal of enclosed retail and office spaces. The once “fortress investments” in malls and office buildings are no longer seen as secure storehouses of value. Multifamily properties have emerged as resilient investments. As a result, institutional investors are grappling with the challenge of finding stable investment alternatives to class-A offices and top-tier regional malls, which are expected to play a diminished role, leading to ongoing uncertainty about effective investment strategies in CRE.
Investors in CRE are reevaluating the concept of “core” investments, traditionally defined as office, retail, industrial, and multifamily properties, in response to changing market dynamics. With the diminished appeal of office spaces and regional malls, there is a shift towards more specialized or niche sectors. Core industrial is now expanding to include cold storage and self-storage, while core multifamily encompasses student housing and single-family rentals.
This expansion redefines conventional asset categories to incorporate these emerging subsectors. Investment confidence is growing in areas such as self-storage, digital infrastructure, and data centers, which are being recognized for their attractive returns. This openness to new sectors is reflected in the inclusion of these categories in indices such as those of the National Council of Real Estate Investment Fiduciaries (NCREIF), aiding investors in making informed decisions.
As investors shift focus to more specialized sectors, they face the challenge of deploying large capital amounts efficiently, previously invested in traditional assets, including malls and offices. A practical solution is investing in portfolios, such as acquiring many similar assets at once or buying significant stakes in large-scale properties such as data centers and life science buildings. However, these specialized sectors are generally smaller, offering fewer investment opportunities, which requires investors to be more selective about location and asset characteristics, especially in the current context of elevated interest rates and slower growth.
Additionally, managing these properties often demands more operational and specialized knowledge than conventional real estate types. This is particularly true for niche housing sectors such as student, senior, and lower-income housing, which entail providing services not typically required in conventional housing. To successfully venture into these areas, companies need to either develop the necessary expertise internally or form partnerships with entities that already possess it, highlighting the increasing importance of specialized knowledge in the evolving CRE landscape.
8. Suburbs Gain from Remote Work Boom
The adoption of remote work in the United States has significantly increased since the onset of the pandemic, as indicated by the U.S. Census Bureau’s 2022 American Community Survey.
The data shows that the percentage of workers operating remotely almost tripled, rising from 5.7% in 2019 to 15.2% in 2022, marking a gain of nearly 10 percentage points. This definition of remote work includes hybrid workers who predominantly work from home but may visit an office occasionally. The trend is even more pronounced in the nation’s largest cities, particularly those with a high concentration of tech jobs. Among the top 30 cities, the 10 with the highest increases in remote working saw their average rise more than double the national rate, jumping from 7.3% in 2019 to 27.6% in 2022, an increase of over 20% points.
The shift towards remote work, particularly in office-inclined sectors, has significantly impacted the American office sector and broader economic landscape. With the ability to work from home, many employees are choosing to live farther from their workplaces, contributing to interregional migration, particularly to the Sun Belt.
This trend includes both fully remote workers, who have a wide range of location options, and hybrid workers, who generally move to less-dense, more affordable areas within the same region that better facilitate home offices. This migration is shifting population dynamics away from downtowns towards smaller cities and inner suburbs.
The shift in migration patterns, accentuated by the rise in remote work, is poised to significantly influence various property markets. This change will increase the demand for housing in suburbs and smaller cities, as more employees working from home will shop and dine in local areas rather than downtowns where they previously worked. Consequently, there is a growing preference for buying or renting larger homes to accommodate home offices.
9. Smaller Cities Lead in Post-Pandemic Recovery
Smaller U.S. cities have shown recovery post-pandemic compared to larger cities, with central business districts (CBDs) of the biggest cities experiencing a significant decline in visits.
According to a study by Georgetown University and the University of Chicago economists visits to CBDs in large cities (population over 1.5 million) are down by more than 40% from pre-pandemic levels, whereas downtown areas in cities with populations under 150,000 have seen less than a 5% decrease. This disparity is partly due to the greater adoption of remote work in larger cities, many of which are tech hubs where remote work is more feasible.
Consequently, large cities have faced more significant losses in residents, jobs, property values, and overall economic health compared to smaller cities and suburbs. The shift towards a hybrid work environment is likely to continue benefiting smaller, second and third-tier cities, marking a potentially permanent change in urban dynamics.
Today, many industry leaders interviewed believe in the enduring importance of agglomeration, with one urban economist expressing a bullish view on cities, citing the transition to a knowledge and innovation economy that thrives on proximity.
Recent Census Bureau data indicates a rebound in population growth in large counties, suggesting a reverse in the urban exodus seen during the pandemic. However, not all are convinced of this trend.
Some real estate economists argue that while agglomeration remains significant, the clear distinction between the urban and suburban in terms of functions and activities is blurring. Suburbs are increasingly resembling cities, and vice versa, in their range of activities and offerings. Additionally, urban cores are no longer the sole hubs of activity within cities, and the pandemic has shown that cities may not be as uniquely vital for innovation as previously thought. This evolving landscape suggests a more nuanced future for cities, with both agglomeration and dispersion playing roles.
Moreover, the concept of “15-minute cities,” traditionally associated with large urban centers, is now applicable to many small cities and inner suburbs. These areas offer walkability and diverse entertainment options without the downsides often associated with city living, such as crime, government dysfunction, and high costs.
Flexible work arrangements also have a dual impact: they encourage suburbanization, yet the more time spent at home, the more desirable a vibrant neighborhood becomes, potentially disadvantaging remote suburban areas. Interestingly, residential neighborhoods are becoming increasingly vibrant in some major metropolitan areas, offering a live/work/play environment that was once the hallmark of downtowns. These neighborhoods, previously seen as adjuncts to central business districts, are now emerging as competitive alternatives, increasingly accommodating a significant share of a city’s retail and office spaces.
The decrease in demand for urban space amidst a relatively fixed supply leads to a reduction in the value of this space, posing a critical question for cities on how to manage and adapt to this decline. This situation raises further concerns about how cities will finance the necessary infrastructure improvements and incentive programs required for their evolution. Without falling into an “urban doom loop” of declining revenues and property values, cities face the daunting task of maintaining financial stability while adapting to changing demands and property values in their commercial cores.
10. Robots and Real Estate: The New Team
The potential of Artificial Intelligence (AI) in CRE is vast.
So far, the integration of AI into real estate has been limited to relatively mundane tasks. Examples include enhancing customer service interactions and property management.
Firms are also exploring the diverse applications of AI across various aspects of real estate, including building design, operations, management, leasing, selling, analysis, and forecasting.
AI is currently employed for routine tasks such as content creation, including pitch decks, marketing plans, and memos. Its use is likely to extend to automated functions such as customer service, administrative tasks, and more complex areas such as legal document review and drafting. The ability of AI to automate processes is particularly appealing for firms aiming to cut costs and headcount.
However, industry leaders are most excited about the potential of AI for higher-value tasks. For instance, insurance companies and rating agencies use AI to better understand property climate risks.
Some firms are leveraging AI for sophisticated functions, such as mining large data sets for investment decision-making, while others are adopting a Bayesian probability approach for market forecasting, offering a more predictive perspective than traditional frequency statistics. AI could revolutionize portfolio construction strategies and asset management, enhancing sustainability throughout the real estate lifecycle.
The industry is still in the early stages of comprehending and integrating AI, with obstacles such as a general lack of understanding and prevalent misinformation. However, it’s important to note that the fear shouldn’t be of AI itself but rather of the competitive disadvantage that may arise from not utilizing it. As competitors begin to harness AI for efficiency, analysis, and enhanced decision-making, those who fail to adopt this technology may find themselves lagging. Therefore, the excitement about the potential of AI in the CRE industry is not just about the technology itself, but also about staying competitive in an increasingly tech-driven market.
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In this way, embracing AI and technology becomes a strategic necessity for firms looking to maintain a leading edge in the dynamic CRE industry.
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It’s akin to having an intelligent partner who works tirelessly, ensuring that you’re always ahead of the curve.
Each trend calls for a proactive approach to harness the potential within these shifts. The investors who are ready to adapt, innovate, and pivot will find themselves at an advantage in this dynamic landscape.
Property Market Projections
Building on our understanding of the current key trends, these property market projections presented through charts show a clear, data-driven perspective on the evolving real estate market.
Industrial spaces are experiencing a recalibration after a surge in 2021, aligning with the e-commerce spike. The cooling trend suggests a cautious approach to this sector due to potential oversupply.
The multifamily housing segment remains stable, indicating a consistent demand for rental options, particularly in urban settings.
After a period of uncertainty, retail is on the upswing, reflecting an adaptive response to changing consumer behaviors and the potential for innovation in commercial spaces. Hotels are also recovering, paralleling the resurgence in travel and tourism.
Office spaces, however, exhibit a downward trend in investment and development prospects. The shift towards remote work has cast a long shadow over the demand for traditional office environments.
Retail Resurgence and Hospitality’s Recovery
Retail’s rebound is noteworthy, perhaps attributed to a strategic reimagining of retail spaces. The substantial rise in development prospects by 2024 suggests renewed confidence in the sector’s potential.
Hospitality, tracking closely with the revival of global mobility, shows promise of returning strength, highlighted by an uptick in investment prospects.
Strategic Insights for Investors
These charts offer investors strategic insights, highlighting the potential in residential and retail property investment. While industrial and office sectors may require more innovative approaches to unlock value, multifamily housing, and data centers present steady investment opportunities.
The commercial real estate market is dynamic, with certain sectors showing growth potential and others inviting a more strategic, perhaps transformative, investment approach. These insights are invaluable for developing a responsive and forward-looking real estate portfolio.
Real Estate Markets on the Rise
Diverse Market Performance
Based on the data above, we see a trend where markets such as Nashville, Phoenix, and Dallas/Fort Worth lead the rankings, suggesting strong investor confidence and potential for growth. These markets, particularly in the Sun Belt region, are noted for their favorable cost of living, quality of life, and business-friendly environments. This has maintained their appeal in spite of broader economic slowdowns.
Comparatively, traditional powerhouses such as Los Angeles and Washington, DC – Northern VA have seen a relative dip in their standings, which could be due to market saturation, higher costs, or a shift in investor priorities towards emerging markets with higher growth potential.
Investor Caution and Selectivity
The shift highlighted in the report emphasizes a more cautious and selective approach by investors, focusing on markets that offer satisfactory returns in a slower growth environment. This strategic selectivity is important in times when blanket investments across regions may not yield uniform benefits.
Sun Belt Continues to Shine
Consistently, Sun Belt markets such as Austin, San Antonio, and Tampa/St. Petersburg ranks highly for both investment and development prospects. This sustained interest is likely due to the migration patterns favoring these areas, driven by more remote work options, a trend towards suburbanization, and a search for more temperate climates.
Strategic Implications for Investors
For commercial real estate investors, these rankings and the underlying trends provide critical data points for strategic decision-making. They suggest a careful examination of local market conditions, with an eye on long-term demographic and economic shifts. Investors may find opportunities in markets that have been historically overlooked but now present growth due to evolving preferences and economic factors.
The Next Chapter for Real Estate
It’s clear that the commercial real estate landscape is undergoing significant transformation. The discussions at the ULI Fall Meeting have highlighted the ‘Great Reset’—a period of recalibration where adaptability is key, and making informed decisions is more crucial than ever.
From the resilience of office spaces despite economic headwinds to the cautious recalibration within the industrial sector and the remarkable resurgence of retail spaces—each trend offers a unique perspective on potential growth areas. The evolving dynamics of office spaces underscore the need for a strategic pivot, embracing the remote work revolution and the potential of AI.
Through it all, Smart Capital Center exemplifies the forefront of technological advancement in the real estate sector, providing an AI-powered platform that enhances every step of the investment lifecycle, including Deal Sourcing, Underwriting, Deal Management, Asset Management, and Debt Management. This platform isn’t just a reactive tool; it’s a proactive solution that empowers investment and asset management teams to significantly speed up deal underwriting, cut transaction costs, and secure better financing with deep market and deal insights.
The commitment of Smart Capital to innovation is further reflected in its adoption of cutting-edge tools such as ChatGPT and generative AI, positioning real estate investors to take advantage of increased automation and insight as the market and transaction velocity are poised to increase.
Investors using Smart Capital have access to a constantly updated suite of tools that ensure efficiency, foresight, and leadership in an increasingly competitive market. This approach transforms emerging challenges into opportunities.
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