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Real estate: US Deals 2024 outlook

Real estate’s next chapter comes into focus

In 2022, the plan for the real estate industry was simple: Ride out current risks and reposition assets and portfolios for a period of sustained growth and improved returns.

However, industry leaders no longer expect a return to a pre-pandemic real estate market. Instead, they have accepted the possibility that many employees will not return to the office, or at least not nearly as often, and that the funding landscape has significantly shifted, with reduced credit availability and higher-for-longer interest rates.

Despite these headwinds, there are many green shoots. For example, we believe the worst of inflation is behind us, which should give the Federal Reserve a reason to pause interest rate hikes or begin reversing them. Such moves may result in a reopening of the real estate debt market. In addition, burgeoning investor appetite for the acquisition of new and high-quality assets remains, particularly in emerging property subsectors such as wellness, digital infrastructure, affordable housing and other residential-oriented themes. Opportunistic investors also continue to watch and wait on the sidelines, ready to deploy record levels of dry powder.

These factors, coupled with megatrends, which are driving change across the industry, keep us optimistic as we see significant opportunities for patient and creative market participants across the investment landscape who are willing to take the long view.

Explore national deals trends

Key deal drivers

Credit crunch challenging real estate leaders

The rising cost of debt and lack of available credit is top of mind for real estate leaders. During the first half of FY 2023, loan originations dropped by more than 50% compared to the prior year, with this trend continuing through the second half of FY 2023. In addition to credit constraints, available funding is more expensive and difficult to obtain against the backdrop of higher-for-longer interest rates and more stringent underwriting standards due to increased regulatory scrutiny banks are facing. 

In addition to the challenges that reduced credit availability and higher financing costs are creating, the rise in zero-sum thinking from a geopolitical perspective and conflicts around the world are further exacerbating the market. For example, access to capital from certain sovereign wealth funds (SWF) is less abundantly available as they temporarily moderate cross-border activity. SWFs are also altering their deployment strategy to focus more on issuing credit, opposed to equity, given the more compelling risk-adjusted return. In the face of this challenging lending landscape, private credit providers are filling a portion of the financing gap given the regulatory oversight such lenders face is less stringent than as for banks.  Investors see the potential for more attractive yields from credit investing rather than equity given present interest rate levels.

With slower economic growth, leaders focus on business models

There is growing consensus that the U.S. economy is headed for a soft landing, with slower economic growth, moderating job growth and higher interest rates, which will present a different landscape for generating returns than the past. It seems as if no asset class is immune, as slower macroeconomic growth will pressure corporate demand for office space within the commercial subsector and new supply and deflationary pressures have been slowing rental growth in the multifamily subsector. 

Still, such impacts will take time to flow through to the bottom line. Notably, survey results from our Emerging Trends in Real Estate 2024 reflect adjusting return expectations, with about 40% of respondents saying they believe returns will remain at current levels in 2024, but nearly 70% of respondents saying they expect returns to decline over the next five years. In response, market participants will increasingly focus on operational levers at an asset, portfolio and corporate level to enhance cash flows and returns. The focus on operational levers is further necessitated by increases in other components of the cost structure such as real estate taxes and insurance, which have risen significantly over recent years. 

In the case of insurance, the lack of availability may make certain geographies deemed uninvestable in the future or require changes in capital allocation philosophies. Therefore, operators will focus on those costs they can control or influence through creative structuring while simultaneously continuing to deliver real estate as a service, not just a product, to both capture and retain demand.

Opportunity amid uncertainty

Headwinds in certain subsectors are not indicative of the overall health of the real estate market and industry leaders continue to describe real estate as not being all equal.

For example, data centers and the demand for industrial assets will be further fueled by the impact and use of AI by businesses, leading to a further increase in large mark-to-markets embedded in industrial valuations. The limited supply of single-family homes has been balanced by the increased demand for multi-family rentals as the buy versus rent cost spread has widened significantly over the last 12 months. 

There continues to be a disconnect between property fundamentals and capital markets. Fundamentals remain strong but transaction levels remain subdued, as certain investors are on the sidelines waiting for the right entry point when owners capitulate, and prices adjust, even temporarily, to a level that provides returns in line with thresholds. Investors are also waiting for greater clarity from the Fed about the duration and extent of higher-for-longer interest rates, and confirmation that the current rate hike cycle has ended. The current environment may present opportunities for investors to take advantage of future cap rate compression, which could bolster returns in the face of slower growth and lower demand. The expectation for further price declines in real estate prices could lead to a favorable entry point for acquisitions and an increased “buy” outlook — sparking a fresh appetite to be accretive especially among opportunistic investors.

Climate, AI key to value creation

Dealmakers looking to transact in the near-term are increasingly having to consider the impacts and opportunities of climate change and technological disruption. These two megatrends have permeated the industry with growing magnitude, making it essential for business leaders to embrace them as an integral part of a businesses’ value creation strategy. Besides the growing number of climate regulations and sustainability mandates, the push for more climate-focused opportunities from investors — who are increasingly knowledgeable about this issue as they look to drive value creation in deals. 

Inherently, we believe companies who implement energy-saving measures, invest in clean energy transition and are focused on sustainability will be able to differentiate themselves and command premium pricing. In a rapidly changing business environment, artificial intelligence (AI) provides an opportunity for CRE professionals to increase efficiencies and effectiveness, from, for example, the automation of routine administrative tasks to the more sophisticated deployment of AI including the development of probabilistic models to help predict property climate risks. While practical CRE use of AI is limited today, its potential deployment is likely to expand quickly given the interest and volume of venture capital investment going into the sector. 

“As the industry continues to navigate this period of transition, recent market signals on inflation and interest rates are encouraging leaders to believe that the deals market in real estate may pick up sooner than anticipated.”

— Tim Bodner, Global Real Estate Deals Leader

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