We speak with Aaron Jodka, National Director of Capital Markets Research for Colliers, about the state of commercial real estate investing, including its trends and how interest rate hikes are impacting the commercial real estate market. Jodka also shares the outlook for commercial real estate investing.
What are some of the top trends shaping commercial real estate investing?
There is a near record amount of uninvested capital that remains on the sidelines targeting commercial real estate investment. Investors are shifting their focus to debt strategies and value-add and opportunistic plays. With the market undergoing an adjustment, they’re pursuing opportunities across asset types. Some are seeking preferred equity and mezzanine debt strategies, and others are looking to value-add, conversion and redevelopment. Defensive assets, such as multifamily and industrial, which have benefitted from strong fundamentals, are the top two asset types domestically in our recent Global Investor Outlook Survey.
How do federal interest rate hikes impact the commercial real estate market? How have higher borrowing costs impacted real estate investing activity?
Context is important here: A low-interest rate environment has long supported the commercial real estate investment market. Higher borrowing costs are causing investors to inject more capital into transactions in the form of equity, with lower loan-to-value ratios driven by the banks.
Some lenders, particularly the big money center banks, reached their commercial real estate ending allocations earlier in 2022, creating opportunities for other capital sources to fill the void. Today, it’s simply a question of math. The higher cost of capital is driving the price of assets down.
However, most asset classes are performing very well, with strong occupancies and high rents, so owners are unwilling to part with assets unless they have a liquidity need or event. This has, in aggregate, lowered investment sales activity. We are also coming off a record-setting 2021, so the recent slowdown in sales volume feels more acute on a year-over-year basis.
What types of spaces are investors looking for today? What remains attractive?
What investors are looking for will differ across asset types. In our recent Global Investor Outlook survey, investors focused on the U.S. and Americas are looking to last-mile and big-box distribution properties on the industrial side, grocery-anchored retail, luxury hotels, ESG-compliant office properties and urban multifamily assets. These all fall under a broader theme of safety. Investors view these asset classes as safe harbors or more resilient. Meanwhile, investors are still interested in alternative asset classes, with life sciences, data centers and student housing ranking at the top of the list.
Another key difference in investor focus is on growth markets. The Sunbelt has seen an increasing share of total investment dollars in recent years, and our survey showed that domestic investors are far more focused on growth markets than they are in EMEA and APAC.
What are the top markets investors are focused on for 2023?
Similar to the types of assets investors are looking for, their locations will also vary. Diverse investment targets allow investors to deploy capital in several different markets. Locations range from gateway cities like Boston, New York, Washington, D.C., Chicago, Los Angeles and San Francisco to growth markets such as Phoenix, Dallas, Atlanta, Charlotte, Nashville, Raleigh, and others.
Central business district office and multifamily strategies will lean in certain directions, likely gateway markets, while last-mile distribution and grocery-anchored opportunities will be available across many cities. Capital will flow to luxury hotels in cities and leisure destinations, while alternative assets will drive investment to life sciences hubs, such as Boston and San Francisco, and data center markets in Santa Clara and Northern Virginia. Finally, the nation’s largest colleges and universities should be hubs for student housing activity.
What is your outlook for commercial real estate investing in 2023?
We expect to see stronger market stabilization in the second half of the year. Year-over-year volume comparisons will be in the red in the early months of 2023. Pockets of distress will emerge across asset types, offering unique opportunities for investors to acquire properties at a discount. Debt plays will be popular, and a fresh round of capital allocations from banks and other lenders reset on January 1.
Tenant credit, location durability and real estate fundamentals will be more important in 2023 than in recent years. It will be exciting to see the evolution of certain assets as the year goes on, from reinvestment strategies to conversion, redevelopment and repositioning.