Real estate: US Deals 2023 outlook

Despite uncertainty, the sector continues to demonstrate resilience

  • Commercial real estate deal activity moderated in the third quarter of 2022 compared to the same period in 2021, with the volume of asset-, portfolio- and entity-level transactions decelerating, primarily as a result of macroeconomic uncertainty, resulting in buyers and sellers unable to agree on pricing.
  • While this moderation has been seen across all sub-sectors when comparing the third quarter of 2022 with the searing third quarter of 2021, deal activity is actually up compared to the same periods in 2020 and 2019 by 123% and 6%.
  • Transaction volume in the industrial space has continued the momentum seen in previous quarters as demand continues to exceed supply for well located assets, underpinned by the sustained e-commerce surge and the need to stockpile inventories as a result of ongoing supply chain constraints.
  • Meanwhile, the office sub-sector remains characterized by the push-pull battle between employers and employees as companies seek higher-quality assets to lure workers back to the office.
  • Retail continues its bifurcated story. Consumers continue the post-pandemic return to the high street but are notably choosey in search of experiential and high-quality retail therapy.
  • In the face of uncertainty on many fronts, we believe that commercial real estate deal activity in 2023 will continue to display its proven resiliency.
    • Investors continue to rightsize their portfolios and take flight to quality and safety, while doubling down on long-term, high-conviction themes.
    • Non-traded real estate investment trust (REIT) sponsors continue to deploy the record levels of capital raised.
    • Long-term investors are recapitalizing existing funds through continuation vehicles in sectors experiencing strong demand drivers and favorable supply.
    • The listed REIT industry continues to consolidate given growing importance of scale, growth and capital considerations.
    • More opportunities are emerging given current levels of replacement cost, financing maturities and equity market valuations.

Explore national deals trends

Moderation, but fundamentals remain strong

The post-pandemic surge in commercial real estate activity has shown signs of moderating. During the third quarter of 2022, total volume was down 21% compared to the same period for 2021.

So what happened? Most notably, transaction volume in the third quarter of 2022 for office was down 33% versus the third quarter of 2021, driven by a lag in return to office and the associated increase in subleases, combined with record lease expirations. Hospitality was not far behind, with a 21% decrease for the third quarter of 2022 as compared to 2021. However, the post-pandemic recovery is continuing and we expect it to do so, particularly given the demand from leisure travelers willing to spend on experiential hospitality, as well as the status of the sub-sector as a high-conviction theme in the portfolio of many asset managers.

Deal activity in the industrial space declined by 18%, as compared to the red-hot comparative 2021 period, but we believe the sub-sector will remain buoyant as companies continue to play catch up in building out their logistics and storage capabilities, underpinned by the need to stockpile inventories for the ever-booming e-commerce market and capacity constrained supply chains.

Meanwhile, despite facing increasing interest rate rises, we expect transaction volume in the multifamily sub-sector to remain robust as activity is supported by attractive returns relative to risk, the ability to reset rents to market on a monthly basis, which are rising month-over-month in many markets, and a progressively more challenging for-sale housing operating environment.

Finally, deal volume in the retail sector was 9% below the levels seen in the third quarter of 2021. The comparative period was particularly strong as a result of the post-pandemic surge in consumption. Going forward we expect retail to be a bifurcated story with high-quality, well-located assets winning out as older, technologically obsolete assets face headwinds.

Sub-sector outlook

The future is flexible and smart

While some executives remain optimistic about a voluntary return to office, the reality through the second half of 2022 is one of a slower comeback as employees favor increased flexibility, productivity gains and a better work-life balance. Companies that continue to offer flexible work options are successfully attracting and retaining talent, in addition to achieving substantial cost savings, and those with smart buildings offer employees seeking to return in-person a happier, healthier workplace. The lag in return to office and its impact in driving subleasing, combined with record lease expirations, means sub-sector supply continues to outstrip demand — creating a challenging environment, particularly for older assets.

Fundamentals remain strong

Industrial leasing remains strong with record low vacancy rates and sustained demand for high-quality, well-located Iogistics facilities. While investor confidence remains robust, transaction volume has decelerated, tempered, in part, by interest rate rises. While consumers in search of experiential retail therapy have moderated e-commerce pandemic highs, the sub-sector remains strong due to increased capacity demands necessary to maintain inventory levels and offset supply chain volatility. Demand outpacing supply, compounded by new asset delivery constraints due to input cost inflation, has been seen as rents continue to climb. Rents, however, are expected to slow in certain markets as new supply comes online. Overall, the structural demand trends for industrial spaces remain strong in spite of some headwinds.


Endurance despite headwinds

Multifamily performance continues to be robust, albeit at a slower pace. Demand remains high, occupancy low, and the sector continues to benefit from chronically low inventory. The US has a net shortage of housing units and this trend is forecast to continue for the foreseeable future due to pervasive roadblocks including zoning and labor shortages. Redevelopment opportunities paired with demand and incentives for including components of affordable housing and sustainable focused construction provide attractive opportunities for developers and investors. While rising interest rates are inevitably postponing new home purchases for some, supply constraints and pent up demand in certain markets means continued momentum.

A tale of two halves

The post-pandemic retail recovery is a tale of two halves. The outlook for well-located assets is positive as sustained demand signals that consumers are continuing to point their wallets at high-quality, experiential retail therapy. In response, developers and retailers continue to double down on omnichannel strategies, including click-and-collect, curbside pickup and ship-from-store. Still, poorly located, outdated and technologically obsolete assets will continue to struggle — the challenge being how to rightsize oversupply and repurpose these assets. With investor sentiment toward the sub-sector mixed, even those bullish on retail and its proven resilience, buoyed by the strong post-pandemic recovery seen in 2021 and beyond, inevitably have one eye on the economy.

The recovery continues

The hospitality sector continued to recover in the second half of 2022, driven by ever-increasing leisure demand through the summer months as well as the return of individual and group business travel. Leisure travelers continue to seek out experiential and immersive hospitality, with the goal of connecting with a given destination, and they are willing to pay for it. While overall deal volume through Q3 has slightly decreased from 2021, the sub-sector remains a long-term high-conviction theme. Single asset sales are more desirable than portfolio sales, given that the recovery remains uneven across different markets, with limited-service properties accounting for more than half of transactions. Macroeconomic uncertainty may lessen leisure demand in some segments, but continued expansion of business traveler demand is expected to compensate.

Divestitures to shape business mix

Business portfolio review is another lever companies can pull to foster growth and build shareholder value as the economy softens. Management’s objective in a review is to allocate capital to the most promising businesses and consider whether it is appropriate to divest less attractive units.

In this age of continuous disruption, divestitures can be a critical tool in transforming and reconfiguring a firm. PwC’s upcoming divestiture study shows that executing a divestiture in a timely manner can help increase the chances for value creation.

A key barrier to moving quickly to divest, however, is inertia. Many factors can create inertia, including entanglements, emotions and cognitive biases. A firm’s directors can play an important role in overcoming inertia. The degree of board governance is significant in increasing the likelihood that a company will consider divestment, the study shows. Having a positive attitude towards divestitures and developing a reinvestment plan also can help companies overcome inertia. 

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“Throughout 2022, we have continued to see resiliency in the real estate deals environment amid a challenging macro set-up. Moving forward, we expect this to continue and for experiential themes to comprise a more significant share of overall volume.”

— Tim Bodner, Real Estate Deals Leader

Key deal drivers

Continued resilience

In the face of macroeconomic headwinds, including inflation and rising interest rates, commercial real estate is continuing to demonstrate resilience as investors adapt and seek new and innovative ways to take flight-to-quality as well as flight-to-safety. Intensified underwriting assumptions have resulted in investor attention becoming laser focused on high-quality, performing real assets, with portfolios being adjusted and rightsized to ensure exposure to the right kinds of assets that will support long-term, high-conviction, themes. Newly constructed and redeveloped assets with strong ESG credentials are expected to win out, with older assets experiencing headwinds.

Private capital influence on M&A continues

As highlighted in previous deal outlooks, dry powder levels remain at all-time highs, with increasingly higher levels being raised through private vehicles such as non-traded REITs and private equity funds. Continuing a trend from last year, non-traded REITs raised record levels of capital during the first half of 2022, with the largest share continuing to go to Blackstone ($11.6 billion), followed by Starwood ($3.3 billion), according to Stanger. These inflows are likely to increase as new players enter this space. This private capital has allowed for the continued trend of large REIT M&A consolidation seen in 2021, as highlighted by Blackstone’s $12.8 billion acquisition of American Campus Communities in April 2022 and other large REIT acquisitions such as Cedar Realty Trust, PS Business Parks, Inc., and Preferred Apartment Communities, Inc.

Return to capital discipline

While dry powder levels remain high, given higher costs of capital and the overall inflationary environment, investors are increasingly focused on capital efficiency as they look to deploy capital which has caused some volatility in the market. This has had more of an impact on growth investment propositions such as proptech and special purpose acquisition companies (SPACs) as investors show increased caution and focus on fundamentals, profitability and cash flow. SPAC transaction levels have fallen off in 2022 for these reasons. While higher costs of capital add to the overall deal consideration, inflationary pressures also affect the replacement costs of assets, leading to increased competition for existing assets as investors look to deploy dry powder. 

Navigating uncertainty

Global economic uncertainty, persistent inflation and rising interest rates have increased the cost of capital and overall capital market volatility. But despite these headwinds, we expect the commercial market to perform well, especially in the short-term. Outside of the office sector, which is lagging behind as employers allow increased remote work flexibility to keep and attract talent, commercial real estate fundamentals continue to strengthen. The industrial sector remains strong, as does retail, in parts. The hotel industry is recovering, apartments are doing very well and rents are rising in all sectors driven by lack of supply and inflationary pressures.

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Tim Bodner

Tim Bodner

Real Estate Deals Leader, PwC US

Andrew Alperstein

Andrew Alperstein

Real Estate Acquisitions Leader, PwC US

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