Dynamic changes to real estate demand add new challenges and opportunities beyond sector allocation and market selection to detailed assessments of demand at the asset level.
Location analyses now emphasize the submarket and microlocation, including block-level analyses.
Asset resilience to climate and digitization joins demographics and cyclical factors in this new approach to asset selection.
“Back to basics focus for operators: maintaining property quality and experience while navigating rising costs.”
The economic fog around future costs and tenant demand are creating caution on asset selection and reinforcing the importance of maintaining asset quality, desirable amenities, and efficient operations. These factors are challenging to address holistically when costs are rising. However, the bifurcation of performance across sectors makes operational excellence and granular asset selection criteria central to achieving income growth through the fog.
Demand risk
Operating performance is expected to drive total returns over the near term due to the uncertain path ahead for inflation and interest rates, while operations face their own challenges.
“The best bet for 2026 is not a single market or asset class, but a shortlist of resilient geographies and thematic sectors that align with demographics, technology, and shifting consumer demand.”
Inflation, along with tariffs on building materials, has increased operating costs and capital expenditures. Alongside this development, tenants are exhibiting strong preferences for new or improved assets. The payback of property improvements and upgrades through new leases or higher rent is a typical assessment, but today’s owners and investors have a murky view of costs ahead, turning their attention to micro-level prospects for demand.
Demand for residential subsectors ties directly to local demographics and migration trends. The aging U.S. population has implications for subsector selection with the number of people aged 65 years or older is now equivalent to those aged 15 years or younger. At a national level, this may encourage a shift toward senior housing, while micro-level analysis of a small town with a large public university may encourage student housing investment. In both cases, net international migration could be a material consideration in as much as it impacts student enrollment and the health care labor supply.
In other commercial sectors, consumer spending, employment, and the industry concentration in the local area are considered along with demographic factors. Retailers currently face a divergence in consumer demand with luxury and value categories performing well. Local incomes and population growth may tilt toward one end of this spending-category “barbell” or the other. However, an analysis of local employers provides a better view of what may lie ahead. Areas dominated by a single employer or industry can signal weakness or strength, depending on which industry is present. Also, the outlook could be cloudy if local employees are vulnerable to technology-driven downsizing.
As industry leaders determine the depth of demand for an asset relative to its local competitive properties, submarket, corner and block-level analyses assist with picking the right property investments to serve future demand as well as value existing properties.
Submarket and block
Each sector has winners and losers within their subtypes, and understanding the market, submarket, and microlocation dynamics is critical to outperformance in the next cycle.
“Strategy is shifting from macro-driven to micro-driven: specific asset, location, or street corner.”
Sector selection and allocation decisions often define a set of target markets, but each target market is rarely approached broadly. Over the years, deeper geographic dives have led to submarket-level analyses and forecasting, while today’s prop-tech firms and generative artificial intelligence (AI) tools offer more granular data and modeling options. Tech-enabled solutions can also unlock internal data for more granular research, especially among larger firms.
Strategy considerations and portfolio construction are likely to keep industry leaders from piling in on the same block. Some are pursuing suburban opportunities, while others remain focused on center-city density. The Midwest is gaining attention from investors who see better relative pricing, while others prefer the Southeast for lower labor costs.
Within regions, granular demand analysis may drive investors to seek opportunities beyond primary markets to secondary and tertiary cities where the local demographics and industry composition align with their favored sectors. Whichever direction investors look, the asset analysis only gets more granular from there.
“Underwriting has shifted to greater certainty and discipline, with costs locked in upfront and risks fully accounted for.”
Asset resilience
Investors seeking high-quality assets in prime locations need to maintain their relative quality to retain tenants. Higher costs for construction materials limit new supply, while also increasing costs for regular maintenance and property upgrades. Less new supply will support relative asset quality, but keeping tenants in place requires consistent asset quality.
Tenant demand across subsectors is diverging—intense competition for top-tier assets contrasts with persistent vacancies in lower-quality properties. Property upgrades in this environment can have a large impact on demand.
Utilities and insurance costs can be mitigated, at least to some extent, through efficient systems and operations. Beyond the operating benefits of lower costs, climate resilience and energy efficiency add value and improve tenant retention.
“Risk-adjusted opportunities exist on a scenario-specific basis. Investor focus has shifted from pure returns to risk-adjusted performance.”
Asset selection focused on locations less vulnerable to climate risk helps mitigate both expenses and operational disruption. Higher property insurance premiums, especially on the coasts, are unlikely to reset to a lower share of property value, making evaluation of a downside case for these costs important in most major markets. Climate risk affects inland markets, particularly through exposure to fire and flood events. Plans to manage these risks, and their associated costs, will protect net operating income.
The tools available for property managers to achieve operational excellence are plentiful and, with increased adoption of generative AI tools, expanding rapidly. Operations will be a critical component for outperformance in this cycle, distinguishing local market leaders by asset quality, climate resilience, and exceptional building services.
