It can be easy to get caught up in the trees of day-to-day investment work — capital calls and quarterly results, deal making and committee meetings, the movement of 25 basis points — without pausing to look up and see the forest. But there are deep underlying themes that can affect the investment landscape for years to come and sometimes cause seismic shifts in how real estate is used.
One of the most important decisions a real estate investor could make in the past couple of years was their choice of property sector. Different sectors have been affected in different ways by the megatrends pushing change through the industry. In some cases, the trends have been a tailwind supporting a sector, such as the rise of ecommerce and its positive impact on the industrial sector. But the same trend can also have been a headwind dragging against a sector’s performance, such as how the rise of ecommerce has affected the retail sector.
We polled Institutional Real Estate Americas’ Editorial Advisory Board members at the board’s September gathering, asking them what megatrends would affect commercial real estate investment in the coming years. Among the trends discussed were climate change, secondary markets, aging populations, deglobalization and remote work.
A number of megatrends will drive real estate performance in the coming years. The following takes a look at five of them. Savvy investors will be watching these themes.
MEGATREND: TECHNOLOGY
Primary impact: Improvements in every aspect of the investment process
Secondary impact: Technology-driven occupiers in office assets, life sciences facilities and data centers
Broadly, technology is where the world is moving. The digitization of the economy is one of the biggest trends affecting real estate, and new technology can be seen in every aspect of the real estate investment process, affecting every property sector, changing how we interact with the world. From the data center that holds digital information to the proptech applications that support leasing activities to the data that is mined for investment information, technology has found a place within the real estate industry — though it continues to lag other industries’ pace of adoption.
“The real estate industry continues to be slow to adopt new technologies,” says David Bitner, global head of research at Newmark. He says the most important developments will be advancements in data collection and systemization and, potentially, software that helps facilitate transactions.
Venture capital has been moving into the proptech segment in recent years, though the current market environment has seen a pullback.
“As the market has slowed, user interest in real estate technology has become more focused on solutions that provide tangible, near-term benefits to real estate owners and operators,” says Christopher Yip, partner at RET Ventures. “There’s no question that valuations have dipped somewhat, and venture investments will taper off to a certain extent. But we don’t expect to slow our capital deployment, and compelling companies that solve real problems for the industry should still find funding available.”
All property types can see efficiencies from greater technology integration, but single-family rental (SFR) as an institutional investment class depends greatly upon technology. SFR, especially scattered-site investments, would be a prohibitively labor-intensive sector without the addition of seamless leasing technology or electronic doors.
“Technology always has the opportunity to improve the real estate investment process, and that is particularly true at this stage of the market cycle. Inflation, rising interest rates and a slower consumer economy have made asset management decision making particularly critical, and technology can play a major role in improving this decision making,” says Yip. “More broadly, technology is also helping real estate operators address other key priorities, including driving operational efficiency, meeting ESG goals, and being mindful of resident affordability and financial constraints.”
The pandemic encouraged greater adoption of technology by the commercial real estate industry. A lot of people have taken the opportunity to look at their processes and ask, “Is there a better way to do this?” says Craig Hine, managing director, capital markets, with Juniper Square. He notes that fundraising in particular has seen an acceleration in adoption of digital tools, both for internal team collaboration and improving the investor experience.
“COVID-19 accelerated many aspects of real estate technology. When social distancing became a requirement in the early days of the pandemic, conventional apartment tours became a health concern, and self-touring suddenly rose to the fore. The components required to facilitate self-touring — smart locks, remote ID verification, property wayfinding — all existed before the pandemic, and each was gaining traction at its own speed,” says Yip. But now that such technologies have been adopted widely, they are here to stay.
Other technologies that were boosted by the pandemic were ones that facilitated real estate operations when commercial real estate companies went remote. Yip points to SightPlan, an RET portfolio company that streamlines resident and property staff communications for maintenance tasks, which more than doubled its units under contract since the beginning of COVID-19. “Generally speaking, technologies that facilitated social distancing, remote work or air purification saw demand spike when COVID struck in 2020; many of these — particularly, the ones that have value in more conventional times — have continued their upward trajectory since then,” says Yip.
These megatrends do not necessarily operate in isolation, either. For example, one of the biggest trends in real estate technology is the movement toward sustainability, says Yip. “Real estate operators are being forced to assess and reduce their carbon footprint by legislation as well as their own stakeholders — investors, tenants, etc. — and technology can play a significant role in making buildings more sustainable. The Inflation Reduction Act also provided incentives for some of these technologies, which should improve the economics of many companies’ business models,” explains Yip.
He adds, “Demand has never been greater for technologies associated with sustainable construction, energy efficiency and ESG tracking/verification, and we are likely still in the early innings for this class of technology.”
MEGATREND: RISE OF RETAIL INVESTORS
Primary impact: New capital sources for real estate investment
Secondary impact: Changing appetites for investment assets and vehicles
One trend affecting the industry is the rise of retail capital, as well as how that retail capital is becoming more sophisticated and institutionalized — especially through multifamily offices and high-net-worth platforms.
The rise of retail capital goes beyond the much-publicized shift from defined benefit pension plans to defined contribution plans, says Richard Kleinman, head of the U.S. research and strategy group at LaSalle Investment Management and co-CIO for the Americas. “It’s been nothing short of amazing,” he says. Kleinman notes retail capital is not replacing institutional capital but bringing more capital to the real estate market.
“Private wealth/retail capital sources play a modest, but growing, role as direct investors,” says Bitner. And private wealth and retail investors will provide a great deal of the capital for institutional-quality investment vehicles, including nontraded REITs, traded REITs and private equity real estate funds.
When it comes to the retail investor side of the industry, the scarce resource is not capital — it’s access to high-quality managers, notes Hine. “If you can remove the investor relations hurdle for investment managers, what does that mean for the market?” he asks.
Once again, the answer is the wider adoption of technology.
The opportunity for innovation is massive, says Hine. He points to the 12.5 million accredited investors in the United States, who combined have more money to invest than institutional investors but lack the access and skills necessary to make wholesale shifts into CRE. But market fragmentation poses challenges for real estate investment managers trying to reach that capital. “It requires a technology solution,” says Hine.
According to Hine, “There’s been a lot of wealth created in the last 10 years.” He notes that crowdfunding was an early innovation in building a marketplace for high-net-worth investors in real estate.
When it comes to big institutional investors, “there’s risk in what used to be dependable capital sources,” notes Hine.
The current environment, with the denominator effect wreaking havoc on portfolios, is an example. “Institutional LPs can sometimes press pause,” Hine says.
“The money for real estate is not going to be there, unless it’s coming from growing plans such as sovereign wealth funds,” says John Flynn, senior managing director at Kennedy Wilson. By contrast, a lot of corporate pension plans have closed to new members and are shepherding a dwindling pool of capital.
Another element that has changed the way retail investors look at commercial real estate is the rise of new vehicles sponsored by established institutional names. Blackstone, Starwood and other firms have splashed out into the market. “They’ve proven out the demand curve,” notes Hine.
Flynn agrees: “The big shift is into these nontraded REITs.”
The quality of sponsorship in the past decade, with institutional investors launching NAV REITs and nontraded REITs, has made the space more attractive to retail investors. Kleinman notes a product such as JLL IPT can make the case for real estate, while the structure, fee value and valuation transparency are a far cry from the nontraded REIT products of two decades ago.
High-net-worth investors can be a bit different from institutional investors. For example, they do not like to invest in blind pools, notes Hine, and they look to other alternative asset classes, such as venture or private equity, and bring elements of those to their approach.
And non-institutional investors can be more open to new types of investment.
“They’re not necessarily attached to old stereotypes of what real estate is,” says Kleinman. “They’re not stuck in any property sector.” Such investors have much more limited exposure to office and are much more accepting of niche or specialty property sectors.
Looking to the future, there is an opportunity to bring fractionalization and tokenization to the real estate industry, though it is unclear how large the opportunity may be.
“We will see some more crowdsourcing of investment funds and CRE tokenization, etc., but it will remain a small part of the market,” says Bitner.
MAGETREND: DEGLOBALIZATION
Primary impact: Increased demand for warehouse space; broadening of attractive markets beyond West Coast hubs
Secondary impact: Increased demand for biomanufacturing properties
The 1990s saw an acceleration of globalization and a move toward a more connected world. But the pandemic has introduced a reversal of that trend. As links in supply chains have broken, there has been a shift away from “just-in-time” manufacturing and greater interest in onshoring and nearshoring. When it comes to deglobalization, the onshoring effect and increase in inventories are exacerbating pressures on the logistics chain and driving leasing in the industrial market.
“It’s clear that manufacturing is moving back to the U.S.,” says Flynn. “Much of the recent activity is seen in the western and southern states. For example, Intel has broken ground on a $12 billion, 3.8 million-square-foot manufacturing complex in Phoenix.”
From Brexit to COVID-19 to the conflict in Eastern Europe, the trend is toward a less connected world. Regionalization could replace globalization, with the world fracturing into separate spheres of influence.
Bitner says, “Patterns of trade are slow to adapt, so the effects have been fairly muted thus far, outside of some highly visible projects,” such as the recently enacted CHIPS and Science Act, which includes the “FABS Act” investment tax credit for semiconductor manufacturing facilities in the United States.
“My expectation is that both now, and in the future, we will see more nearshoring and ‘friendshoring’ versus reshoring. Nearshoring is supported by the USMCA [United States-Mexico-Canada Agreement], while we are likely to continue to see shifts in Asian supply chains from China to Vietnam, Malaysia, Philippines and Indonesia,” says Bitner.
When it comes to nearshoring, Mexico has better demographic trends than China, though it has a different sort of political volatility driven by the challenges posed by organized crime. And while the USMCA free trade agreement has extended and refined NAFTA, there remains the risk of a backlash against free trade.
In addition to the industrial segment, the influence of deglobalization can also be seen in the trend toward onshoring of biomanufacturing plants. More than 70 percent of manufacturing facilities making active pharmaceutical ingredients for U.S. drugs are located overseas, according to the Food and Drug Administration.
MEGATREND: HYBRID WORK
Primary impact: Changing layouts and usage patterns of office buildings; potential decrease in demand for office space; desirability of other asset types, such as life sciences
Secondary impact: In residential, greater need for home office space; in retail, greater demand in residential neighborhoods
The office sector continues to face challenges, and the trend toward remote work or hybrid schedules has had an impact on leasing velocity. Many in the industry see the office sector as one where fundamental values may be in flux, but it is not yet clear where those marks will settle.
Getting any visibility into future demand for office is difficult, and it is too early to say whether we will return to the levels of office usage seen prior to the pandemic. “We see people returning to the office, but probably not at the level it was before,” says Kleinman, who notes it only takes a little dip in demand to upset a market for a time.
“Hybrid/remote work is the new paradigm,” says Bitner. “The main debates are how many days in the office on average hybrid work entails and how large the fully remote segment will be.” He notes most survey evidence points to a relatively small, fully remote share, settling at 10 percent to 15 percent, with around a quarter of professionals in the office four to five days per week and the rest anywhere from one to three days.
“There has been some incremental return to office this fall, but less than was hoped by some,” says Bitner.
One advantage for office landlords is that while the number of days in the office has been reduced, the amount of space required has not, as employees prefer to come in on the same day as their colleagues.
Kastle Systems, which tracks office occupancy through keycard swipes, has reported a dramatic difference in attendance levels based on day of the week. Tuesday and Wednesday are the most popular days in the office, while Friday is the least popular, with a spread of 20 percentage points or more across most major markets.
Could a recession bring more people back to the office?
When it comes to space utilization, “people are going to be a lot more careful about expanding in tough times,” cautions Flynn. Though he suggests that big employers are likely to eventually increase their demand for office space.
“You’ve got to have productivity,” says Flynn. In a rising-GDP environment, employers may be more tolerant of remote and hybrid schedules, but in a recessionary environment, such flexibility may disappear.
“There is some speculation that a weakening labor market could increase attendance, both as managers have more bargaining power with employees and employees instinctively know that professionals who show up have more job security. Despite the solid intuition for this speculation, I would be conservative in estimating the size of any resulting shift,” says Bitner.
One important element of the office market’s changing fortunes is the bifurcation of the market between class A office and everything else.
“While it is certainly the case that many leases are being shrunken on renewal, the effect has been less than it otherwise would be. Interestingly, we have also seen occupiers moving upmarket even as they downsize their space requirements,” notes Bitner. “This trend reflects the idea that office space needs to be attractive to the worker and conducive to collaborative work and client engagement. As such, the outlook for class A/trophy office is significantly brighter. For commodity office, the outlook is more fraught.”
Value-oriented occupiers are likely to demand less space, and in the soft leasing markets, they will be able to opt for better commodity spaces, notes Bitner. “With this in mind, a significant chunk of the commodity market could become permanently obsolete, needing to be rode down to residual value, demolished, redeveloped and/or converted,” says Bitner. “I believe that public incentives could play a critical role in hastening these transitions.”
Owners of traditional office properties have been slow to mark down valuations, and investors who do not need to sell are taking a wait and see approach. But while many office jobs can be done remotely, some jobs continue to require dedicated facilities. For that reason, many office investors are now looking toward the life sciences segment of the market.
MEGATREND: NICHE SECTORS BECOME CORE
Primary impact: Increasing institutional ownership of alternative asset classes
Secondary impact: End of the dominance of the “four main food groups”
The broadening of core to include specialty real estate is another trend to watch. The shift can be seen clearly in the changing preferences by institutional investors in their portfolio allocation plans.
“Nontraditional real estate classes, specifically those that are demographic driven, have gone through varying levels of institutionalization over the past two decades,” says Thomas Errath, managing director and head of research with Harrison Street. “Most notably, alternative real estate displayed its resiliency and the defensive nature of its underlying demand drivers throughout the global financial crisis and the global pandemic.” Data is now available to show the benefits these sectors can provide to an investment portfolio across economic cycles, adds Errath.
“The niche asset types tend to have robust secular drivers,” says Bitner. He notes senior housing and medical office are driven by aging populations, purpose-built student housing by the transformation of more colleges into highly amenitized facilities and increased college attendance rates among Gen Z, data centers by the expansion of the internet revolution, and life sciences space by biotech and work-from-home resilience. “Many of these drivers are separable from economic drivers, potentially making them diversified in a portfolio context,” adds Bitner.
“Finally, the shift away from office in institutional portfolios presents a challenge, which cannot be entirely filled by multifamily and industrial,” says Bitner.
The public market, such as listed REITs, has been faster to adopt alternative property types than private markets. Alternative real estate represents only 6 percent of the NCREIF Property Index, while niche REITs comprise nearly 60 percent of the FTSE Nareit Equity REIT Index, notes Errath. He suggests this may be because alternative real estate asset classes, such as senior housing and self-storage, are operating businesses and typically require a vertically integrated and well-capitalized platform to effectively manage the assets and scale the business. “Publicly traded REITs have access to a broader array of capital sources and typically at more favorable pricing than private markets,” says Errath.
But the private market is on the path to catch up with the public market. “We do believe there will be continued expansion of alternative real estate in the private market index going forward,” says Errath.
Loretta Clodfelter is senior editor of Institutional Real Estate Americas.
