Real estate: US Deals 2023 midyear outlook

Opportunities remain despite headwinds

Commercial real estate deal activity continues to moderate in the face of challenges caused by shifts in monetary policy to combat inflation, including several interest rate hikes by the Federal Reserve that have increased borrowing costs. The subsector is also being severely affected by the ongoing evolution of how people live, work and play in a post-pandemic world.

Further, general declines in credit availability and a continued disconnect in buyer and seller valuation expectations in some areas of the market, including office, are bringing a capital market-driven wait-and-see dynamic, despite solid fundamentals.

Despite these challenges, we believe the sector is not in a crisis, as successful dealmakers will find opportunities, with green shoots evident across all subsectors, including the much-maligned office subsector.

Transaction volumes in the first quarter of 2023 were down across all subsectors compared to the red-hot comparative period in 2022.

Explore national deals trends

  • Most notably, office was down 68% due to a slower-than-anticipated return to office, growth in sublease inventories and lease expirations.
  • Apartment was not far behind, with a 64% decrease. This can be attributed in part to a “return to normalcy” in terms of growth and occupancy rates on the back of record appreciation and rent growth.
  • Hospitality experienced a 55% decrease. Still, the resurgence of leisure and individual and group business travel continues and sector performance in terms of occupancy levels and RevPAR has outperformed general expectations.
  • Industrial was down 54% and, while demand is cooling, national level occupancy is forecast to remain below 5% as supply moderates.
  • Retail continues its omnichannel journey with record-low availability and sustained demand for prime locations.

In addition to these core subsectors, data centers, wellness real estate, student housing, self-storage and life sciences are becoming subsectors in their own right as they gain relevance and prominence as institutional property types. 

Transact to transform

Companies face markets being reshaped by technology and disrupted by geopolitical unrest, a global pandemic and economic shocks. As a result, CEOs are turning to transformative acquisitions to reposition and reinvent their businesses for long-term success. Companies are also beginning to crack the code on how to make big, transformative deals successful: leveraging experience, early and sustained investment in integration, and a commitment to creating and implementing new long-term operating models.

Learn more about leading practices and transformational mindsets in PwC’s new M&A integration report.

Key deal drivers

Opportunity amid uncertainty

The financing landscape today is vastly different to that of just a few months ago, and it’s affecting acquisitions, development and refinancing. Commercial real estate assets are facing multiple challenges against the backdrop of higher interest rates and reduced appetite for bank lending into the space. The increased cost of debt is forcing dealmakers to take more time upfront to assess the right debt/equity mix to finance transactions and has elongated negotiations as buyers and sellers slowly align on valuation expectations. This dynamic has been further exacerbated by increased regulatory oversight on the lending community and Fed pressure on banks to reduce commercial real estate exposure. With the tightening of traditional credit availability, dealmakers are looking to alternative financing routes, including the lending arms of private equity firms as well as insurance companies. Insurance companies are known to be the most conservative lenders focusing on class A and core assets, which creates even more demand for lending through private equity for opportunistic or value-add property acquisitions. Alternative sources of financing such as preferred equity and minority interest investments have also seen increased popularity.

Resilience and innovation for growth and sustainability

Amid an extended period of macroeconomic uncertainties due to persistent inflation and rising costs of capital, many real estate owners and operators are concentrating on the long-term. Instead of pulling the plug in response to price pressure and operational challenges, real estate professionals are identifying strategic solutions to create future sustainable values within current constraints. The retail sector has been rapidly capturing value through transforming and adapting existing spaces to embrace evolving demand from brands and consumers. Similarly, there’s been an uptick in the repurposing trend within the office sector where the value of properties is capitalized by repositioning the properties for their highest and best use.

Meanwhile, the hotel sector has been quick to capitalize on the momentum generated by the return-to-normal travel demand while carefully monitoring margins amid a rising inflation environment, which is keeping operating costs high. As high-quality assets are winning out while older, technologically obsolete assets struggle, the future appears brightest for those who recognize the changing fundamentals while embracing digital solutions and sustainability. However, after an extended period of cap rate compression, a new normal of cap rate expansion should not be unexpected, especially for broken deals in the value-add and opportunistic categories.

Shift in regulation, tax and trade

The market continues to experience regulatory uncertainty, partially as a function of changing administrative policies as well as continued federal regulation impacting real estate from land use to environmental priorities and taxes. Anticipated environmental, social, governance (ESG) reporting requirements are impacting real estate development, operations and associated services, as companies seek to right size their real estate footprint and reach carbon neutral goals. There are also new state and local regulations intending to shape land-use patterns and encourage affordable housing availability and options. The Inflation Reduction Act (IRA) enacted a number of sweeping tax changes of particular interest to the real estate sector. These include extending and modifying existing tax energy credits, creating new tax credits and modifying certain deductions, all of which require a thoughtful strategic response. These changes provide a broader set of taxpayers (many of which own significant amounts of real estate) the ability to utilize tax credits that otherwise have not been available as a practical matter and may help spur further investments in ESG initiatives. Outside of geopolitical risks, trade continues to be impacted by the ongoing Russia and Ukraine conflict. As a key exporter of energy and food commodities, trade prices continue to be influenced by the ongoing conflict.

Necessity for business reinvention

Current macroeconomic uncertainty and market volatility creates opportunities for market participants to develop complementary and synergistic service and product offerings. In the face of unknown future space needs by tenants, and a significant decline in transaction volume, real estate service provider market participants will look to establish and/or grow recurring revenue streams. While only halfway through 2023, we expect leasing activity and deal flow to return as clarity on pricing, interest rates and economic policy improves. New and innovative offerings will offset declines in traditional revenue streams. A natural extension of the industry’s “boots on the ground” services — often on a global scale — would be to expand and grow their investment management services. Such offerings would provide fee revenue that is less episodic and contribute to more predictable earnings forecasts.

Similarly, additional product offerings are likely to be added to the menus of investment and alternative asset managers as they look to compete with mega managers. There’s already significant interest in establishing new private debt platforms from both experienced lenders and new entrants. Regulators have effectively communicated that even small regional banks may be too big to fail. Many of these banks may soon be regulated in a manner consistent with a lower risk tolerance, affecting lending capacity and increasing cost burdens. Private platforms are looking to capitalize on this dislocation, though doing so requires depth of knowledge related to processes, controls and systems beyond establishing market share. As a result, market participants may look to acquire or merge with established providers or seek to grow organically. Market participants cannot rely solely on the same ways of the past cycle to generate revenues and returns and, therefore, will seek to innovate and reinvent their offerings to continue their growth trajectories. In addition to acquisitions, PwC’s recent divestiture study also found that companies can reinvent themselves and increase their chances at creating value through timely and objective divestiture decisions.

“The real estate deal environment has been significantly impacted by shifts in monetary policy and ongoing changes associated with a post-COVID world. However, we continue to see significant opportunities for patient and creative market participants who are willing to take the long view.”

— Tim Bodner, Global Real Estate Deals Leader
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