The commercial real estate industry is bracing for a year of dramatic and unpredictable change.
Economic uncertainty, global events and policy shifts could influence every sector.
During a CPEVoices webinar moderated by CPE Editorial Director Suzann Silverman on Nov. 17, five CEOs from leading investment, finance and advisory firms made the case for cautious optimism as well as for making adjustments in the face of retrenchment.
Nearly all participants welcomed recent signs of slowing inflation, though it remains at a 40-year high, even in the face of repeated interest rate hikes. Of note was how this affects the dealmaking landscape. Marcus & Millichap President & CEO Hessam Nadji welcomed the cooling trend as a “step in the right direction.” Still, Nadji voiced his concern about the possible lag effects, particularly regarding the recent interest rate hikes. “How much damage have they done that is not visible yet?” he asked.
Other participants saw the public markets’ quick adjustment to inflation and rising interest rates as another positive development.
As John Gates, CEO of Americas markets at JLL, observed, “Everyone has realized that the increase in rates isn’t temporary… assets will reprice in this higher-yield environment.”
Nadji agreed, cautioning against rosy speculation. “I don’t see a scenario in the near term where rates are being lowered again and there is another round of stimulus… we need to come to terms with the fact that normalized rates are here to stay.”
Nonetheless, the combination of unknowns is having a pronounced effect on dealmaking and leasing. Camille Renshaw, co-founder & CEO of B+E doesn’t see the current interest rates as the peak.
“None of us have crystal balls, and our clients don’t, in terms of timing,” Renshaw said.
Jonathan Martin, CEO of AEW Capital Management’s North America division, also attested to this trend, noting,
“All of our clients are waiting for those adjustments to take place,” Martin said.
Kicking The Can
Given the opaque economic outlook, the office sector has taken something of a beating. Chuck Schreiber, chairman, president & co-founder of KBS, reported that tenants are tending to postpone more consequential leasing decisions, despite those clients’ efforts to encourage employees to return to the office.
“Some have put off making decisions about their space for almost three years; consistently, they want employees back in the office,” Schreiber said.
Consequently, KBS is emphasizing the essentials.
“What we’re focused on is that cash yield, and delivering that yield to our investors,” Schreiber added.
Nearly all the executives are adopting a wait-and-see approach. Renshaw is encouraging B+E’s net-lease investor clients to pause.
“In the coming months, we need to sit with client after client and advise them on what is best…if you have a situation where you have rent escalations, you should be slow to move,” Renshaw said.
With harder times on the horizon, an additional priority is to further strengthen client relationships. Nadji detailed Marcus & Millichap’s approach to investor service.
“We invest so much in research and content as a way of helping clients navigate… it’s all about client outreach and contact,” Nadji said.
At the same time, he emphasized the importance of a defensive stance.
“It requires looking at expenses and non-essential investments and prioritizing.” Martin concurred. “It’s about being proactive. Look at capital structures, look at reserves and tackle issues early.”
Who Will Buy, Lease And Occupy
The panelists offered insights into how 2023 will look at ground level. Gates predicted an erosion of office jobs, due to both shifting demographics and the changed nature of in-person office work. As such, office leases are likely to decline, which will trickle down to further overall job losses.
Gates predicted, “You’ll see further erosion of leasing in the office markets … in a time of uncertainty, you’ll have job losses. With that in mind, operators and tenants are likely to pause before making long-term decisions. I’ll sign a three-year renewal if I can, as opposed to a 10-year space.”
Industrial construction was predicted to sputter as well, due to prohibitively high expenses and continued supply chain struggles.
“A runup in construction costs will impact the net rents tenants are paying,” Gates added.
Health-care offers a major bright spot. Nadji spoke of the “incredible demand” for life science and medical office space. In some cases, those tenants are backfilling obsolete retail space.
One area where the participants saw particular challenges was procuring debt financing. As Schreiber put it, the difficulty regarding the availability, costs and terms stems from the markets’ murky future.
“It just drops the transactions,” Schreiber said. “There are a number of institutional investors who have to put their plans on hold… whether they anticipate a receiving of gain or the ability to finance new acquisitions.”
Part of this dearth of debt is motivated by anticipation of a recession, rather than current conditions.
According to Martin, “It’s hard to underwrite improvements in performance because you’re worried about an economic slowdown.”
The biggest beneficiaries in this environment are those with deep pockets. Nadji sees the “private, cash-rich buyer” as having the most to gain in this environment, with a prime opportunity to be entrepreneurial.
Gates warned of the long-term consequences of this trend and its impact on transaction volume across commercial sectors.
“Buyers can’t be sellers anymore,” Gates said.
Despite the challenges ahead, the executives ended on a note of optimism.
“There will be both challenge and opportunity for existing portfolios… there will be opportunity to step in, recapitalize deals, and take advantage of them,” Martin said.
Source: Commercial Property Executive