Report: CRE in 2023

PwC and Urban Land Institute’s report, “Emerging Trends in Real Estate: 2023” is an excellent, well-written report that, at the risk of invoking a cliché, has something for industry experts and everyday readers alike.

• PwC/Urban Land Institute: “Emerging trends in real estate: 2023” – https://www.pwc.com/us/en/industries/financial-services/asset-wealth-management/real-estate/emerging-trends-in-real-estate.html
  • I posted this report last week in the Gray Report newsletter, but I did not catch it in time to include it in last week’s video. It’s well worth including here.
  • There’s a lot of great information in this 125-page report, which covers multifamily, single family homes, industrial, office, retail, and hotel real estate, and they do a great job of pulling in different pieces of information to compare the trends within each market.
  • I will admit, however, that the catchy language is a little bit of a signal that some of this information is stuff that you’ve read before if you’re already following commercial real estate, but these gestures toward mass-market appeal don’t detract from the really interesting stuff throughout the report
    • The prevailing mood among real estate professionals is not much different at all from what we’ve been saying on the Gray Report for the better part of this year.
    • The report’s authors “find it striking that so many people in the industry are willing to look beyond cyclical headwinds. As one real estate professional told us, ‘We’ll look back in 10 years, and the prices that seem astronomical today will seem like a bargain.’” Not to repeat myself, but we do not find this mood to be quite so unusual or unexpected.
  • As optimistic as investors are on the long term, the short-term plans were as actively “wait-and-see” as possible. There may be a rush to finish a deal or two before the end of this year, but this is likely temporary as investor capital is expected to shrink and debt terms are expected to get more stringent.
    • Also this: “And while interest rates are increasing, equity and bond prices have been falling, triggering the “denominator effect” for some institutional investors with asset allocations that must remain in balance. The denominator effect can be magnified because CRE values in a portfolio are generally appraisal-based, which tend to be backward-looking.”
    • I will need an explanation for this.
  • They do a nice overview of the housing market, and I appreciate the effort they spent explaining how hard it is going to be to build new housing supply. All the difficulties associated with building a building during the pandemic, have, as Spencer noted last week, meant that the housing that does come onto the market will need to be more expensive in order for builders to recoup their costs. I mean, yes, these builders could take a loss, but that’s not going to be their first choice. Their first choice is not going to be to take a loss.
  • Interestingly, this report suggests that, in this environment with unaffordable housing, where new homes have high prices that don’t really bring down local housing prices enough, we could see increased migration to more markets where housing is cheaper.
  • I know I undercut the appeal of the report when I called out its clever turns of phrase as a gesture to mass market appeal, but I do love the freewheeling references to the “classic 1961 urban planning treatise, The Death and Life of Great American Cities” in a section about the importance of older buildings.
    • “‘If a city area has only new buildings, the enterprises that can exist there are automatically limited to those that can support the high costs of new construction.’ How boring and monotonous that would be. Jacobs points to all the small local businesses that occupy these older structures that give the neighborhood its diversity and vitality.”
    • Typically, a report aimed at a broader audience will go for a simplified account of the issues at play, judging, correctly, that readers don’t want to be bogged down by details that are only interesting to industry insiders.
    • This report is throwing curveballs, and I love it. What Yardi Matrix report is going to cite Jane Jacobs? What Marcus & Millchap report would quote Lewis Mumford? Sometimes, it’s nice to have a theoretical framework alongside the numbers and trend lines!
  • The report lists 10 emerging trends for 2023 and beyond, some of which we just mentioned.
    • Normalizing – a return to typical asset performance and not the kind of supercharged growth we experienced last year.
    • Persistent changes like remote working arrangements
    • Capital moving to the sidelines as investors “wait-and-see” and debt gets more expensive
    • Housing remains unaffordable, a problem that is and will be difficult to remedy
    • Real estate investors become increasingly selective, with greater attention to higher-quality or niche assets
    • Repurposing, converting, or continued utilization of older buildings will facilitate the rebalancing of CRE demand
    • Varied performance in the high-flying Sun Belt markets of 2021
    • Smarter fairer cities through infrastructure spending. This one sounds like a government spending thing. I can’t speak to the specifics of this one, but my guess is that it’s going to be a local-market issue rather than a broad trend.
    • Climate change. I don’t disagree with this. This is just a hypothetical, but what would happen if every 5 years, a hurricane hits the same city. My question is, how often does an extreme weather, property damaging event have to happen before insurance costs make living somewhere prohibitively expensive? Look, I’m sure we have a long ways to go before people move away from any coastline in America. But how much insurance are people willing to pay to live on the beach? Again, hypothetical, but what if it gets to the point where people have to pay the replacement cost of their home every five years in cumulative insurance payments?
    • Action through Regulation is the last trend, and it deals with ESG and rent control policies. This is a really weird one, only because the regulations and policies they cite here have an unmentioned counter-example in the increasing acknowledgement of deregulation as a driver of housing supply increases, specifically seen in the White House’s own housing supply plan.
    • Multifamily Section has some great writing:
    • Still, the throes of land use policy drag on development. But beyond local policy barriers, tugging housing to its future, are a trio of macro forces—work/life balance, an urgency to stall the climate effects of global warming, and an array of technologies—in business management, livability, and construction.
    • Can this darling of real estate asset classes sustain its hold on global investment inflows, unleash construction’s modern manufacturing era, turn the tide on local political will, and win over the hearts, minds, and pocketbooks of consumer households to pull off such a feat? If you had to guess today—with residential rental vacancies at historical lows of 6.2 percent and occupancy rates and median asking rents for vacant units at historical highs—the answer would be a cautious “yes.”