The Urban Land Institute (ULI) have published their latest report on the trends and data shaping the real estate sector in the United States and Canada. The report is based on the views of more than 2,000 industry experts and covers topics such as the impact of the pandemic, the changing investor attitudes toward climate risks, the rise of impact investing, and other real estate issues.
The main theme of the report is “The Great Reset”, which reflects the need for the industry to redefine its standards and practices in the post-pandemic era. The report argues that the industry cannot rely on past benchmarks to determine how the market will function in the future, but rather must innovate and adapt to new realities and challenges.
Some of the key findings of the report are:
- Retail is thriving. Contrary to the expectations of many, retail demand has surged in the past 18 months, as consumers continue to shop for goods and services in physical stores, even as e-commerce grows. The report projects that the US will add about 35 million square feet of new retail space across all types of shopping centers in 2023, and that the sector will remain resilient and profitable in the long term.
- Hybrid work is the new normal. The report acknowledges that the office sector will not return to its pre-pandemic state, as workers and employers prefer more flexibility and choice in their work arrangements. Office buildings have lost their appeal to investors, as sales transactions have declined significantly. The report suggests that some office buildings may need to be repurposed or demolished, while others may need to be redesigned to meet the changing needs and preferences of tenants.
- Sun Belt markets are still shining. The report highlights the continued attractiveness of the Sun Belt region, which encompasses the southern and western states of the US, for households, businesses, and investors. The region offers lower taxes and regulations, affordable housing, and a growing labor force. The report notes that 15 of the top 20 markets for “overall prospects” are located within the Sun Belt. However, the report also warns that the region faces increasing risks from climate change, which could affect its growth potential.
- Debt is a major concern. The report warns that the rapidly rising federal debt could have negative consequences for the real estate industry, such as slowing down economic growth, increasing interest rates, and crowding out private investments. The report also notes that credit availability has become scarcer and more expensive, leading borrowers to hold onto their existing debt. The report advises investors to be cautious and selective in pursuing deals, and to take advantage of undervalued assets.
- AI is a promising tool. The report explores the potential of artificial intelligence (AI) to enhance the real estate industry, such as improving the property search and analysis process, helping investors evaluate opportunities, improving customer service, and streamlining due diligence and fraud detection. However, the report also acknowledges that many industry professionals are still unaware or misinformed about AI’s capabilities, and that there are barriers to adoption, such as data quality, privacy, and ethics.
- Climate challenges require adaptation. The report emphasizes the urgency of addressing climate risks, as the number and severity of natural disasters increase. The report also points out the growing regulatory and ESG pressures, especially in leading real estate markets, that require property owners and managers to make ESG a priority. The report suggests that the industry should adopt more sustainable development practices, such as designing for disassembly, which could reduce the environmental impacts and costs of demolition and reuse of materials.
- Downtowns need to reinvent themselves. The report examines the future of downtown vitality, which depends on whether the economic forces of agglomeration continue to concentrate high-value firms and industries in cities. The report notes that downtowns face competition from alternative communities in suburbs, smaller cities, and even their own neighborhoods, that offer more live/work/play options. The report recommends that downtowns should diversify their economic base, enhance their amenities, and improve their livability.
- Housing affordability is a key challenge. The report identifies housing affordability as a persistent and worsening problem, as housing prices and rents have soared during the pandemic, while income growth has lagged behind. The report estimates that the US experienced the fastest-ever deterioration in housing affordability in the past three years. The report calls for more housing supply at all price points, as well as more public-private partnerships and policy interventions, to address the housing crisis.
This is the top 10 markets to watch in 2024, based on their development and investment prospects. These markets reflect the strong interest in the Sun Belt region, as well as the diversity and dynamism of the US real estate market.
- Nashville, TN
- Phoenix, AZ
- Dallas/Fort Worth, TX
- Atlanta, GA
- Austin, TX
- Raleigh/Durham, NC
- Charlotte, NC
- Denver, CO
- Orlando, FL
- Tampa/St. Petersburg, FL
Categorizing the top 80 markets into four main groups, each with three subgroups, based on their economic and demographic characteristics. These groups are:
- Magnets: Migration destinations for both people and companies, and most are growing faster than the US average in terms of both population and jobs. The subgroups are Super Sun Belt, Supernovas, and 18-Hour Cities.
- The Establishment: Long-standing economic engines, including central cities and nearby markets. The subgroups are Multi-talented Producers, Major Market–Adjacent, and Knowledge and Innovation Centers.
- Niche: Generally smaller or less economically diverse than the Magnets and Establishment markets, but typically have a dominant economic driver that supports stable growth. The subgroups are Boutique markets, “Eds and meds”, and Convention and Visitor Centers.
- Backbone: A wide variety of markets that offer enjoyable and interesting places to live and work. Many of these markets offer select investment and development opportunities. The subgroups are The Affordable West, Determined Competitors, and Reinventing.
The office sector is still facing the effects of the pandemic, as many workers and employers prefer to work remotely. This has reduced the demand and value of office buildings, especially in big cities. However, not all office properties are suffering. Some of the best buildings in the best locations are still attracting tenants and investors. Also, some smaller and growing cities are doing well in the office market.
Many companies that can operate remotely are likely to keep cutting their office space to save money and access more talent. This could make it harder for office owners and cities to fill the vacant buildings. Some experts suggest that converting office buildings to other uses may not be feasible or profitable. They think that tearing down the buildings and using the land for something else may be a better option.
But some experts are optimistic about the future of the office sector. They think that the office sector can learn from the retail sector, which adapted and recovered from the threat of e-commerce. They believe that office buildings can still offer value and benefits that remote work cannot.
The debt levels of US households and businesses seem manageable and do not indicate much financial trouble. This is generally good news for commercial real estate. However, the fast-growing federal debt could pose a bigger challenge, as it could reduce the private investment in the industry, slow down the economic growth and increase the interest rates. All of these factors could hurt the construction, investment and returns in the long run.
Most of the industry experts we surveyed said that credit became harder to get since the Fed started to raise interest rates in March 2022.
The lending activity has dropped among all major debt sources, such as banks, CMBS and life insurers, although some private debt sources are sometimes filling the gaps where others have cut back on lending. Many survey participants also blamed the lower credit availability for the decline in sales transactions in 2023.
Credit is not only scarcer, but also more costly and strictly underwritten. Instead of getting new credit, borrowers have been keeping their existing debt, which is shown in the rising amount of outstanding CRE debt. This has allowed banks to grow their portfolios despite making fewer new loans.
One of the main trends of this year’s Emerging Trends is that commercial real estate investors are becoming more careful in their outlook and pickier in their asset choice. We see that investors are slowly getting ready to take advantage of undervalued assets and acquire new assets. For instance, the Emerging Trends Barometer for 2024 had its highest buy rating since 2010, probably reflecting the recent and expected price drops, making this a more attractive time for acquisitions after a decade of continuous appreciation.
But even optimistic investors, who have been actively raising capital for distressed properties, are finding a few opportunities that are worth pursuing. These investors have moved to the sidelines in hope that there will be more favorable opportunities later. Deal activity in the real estate industry will likely depend on how interest rates change, as the Fed’s low-for-long policy on interest rates is likely to slow down economic growth.
2023 is on track to be one of the hottest years ever recorded, after another summer of record-breaking heat. The frequency and severity of climate events that cause losses of more than a billion dollars are also increasing.
Property owners and managers are facing more government regulation and ESG (environment, social and government) requirements. Some cities in some CRE markets have passed laws in recent years that require regular energy audits and energy-saving measures for commercial buildings.
Property owners are also more concerned about their insurance costs, which have gone up significantly in recent years. Insurance premium increases are usually passed on to tenants, but some professionals we interviewed worry that tenants might resist or the costs might limit future rent increases. And that depends on whether property owners can even find coverage, as many insurers have stopped offering plans in areas that are prone to extreme climate events such as California and Florida.
Besides rising insurance costs, the growing link between real estate assets and sustainability performance is another key reason why the industry should plan with sustainability in mind. Over the years, CRE investors and fund managers have faced complex and difficult choices in how to deal with sustainability. Now, decarbonization and energy efficiency, indoor environmental quality, climate resilience and related issues are becoming more urgent as extreme climate events increase and the risks and costs to owners increase. Going forward, investors will likely be more risk-averse and will do more due diligence to understand the risks and potentially change their investments.
Source: National Centers for Environmental Information
Last year’s Emerging Trends highlighted that housing affordability had reached its lowest point in over 30 years, as both home prices and rents hit record highs. This year, the situation is even worse, especially for homebuyers. Rents are also higher, but they’re growing more slowly in some markets.
The industry’s attention on housing affordability will likely continue in this era of “low-for-long” interest rates. A worrying mix of rising home prices and fast increases in borrowing costs has made home purchases more unaffordable for more people.
The current housing affordability crisis, however, has been more beneficial for renters lately as rent growth nationally is flat or minimal, after reaching its peak in early 2022. This is the result of healthy additions to supply, including apartment construction, which is expected to add over 460,000 units in the US this year, on top of over 700,000 units since the start of the pandemic.
As we’ve discussed before, the solution to the nation’s housing crisis is to build more of it, preferably at all price points. But the reality is we do not build enough units affordable to lower-income tenants especially — so not all new supply will necessarily improve affordability.
Artificial intelligence (AI), including generative AI, is showing potential in the real estate industry. For one thing, AI is starting to improve the property search and analysis process. It’s changing how real estate investors evaluate potential investment opportunities, enhance customer experience, help simplify due diligence and improve fraud detection in real estate transactions, among other activities.
In addition, some investors we interviewed for Emerging Trends mention the potential for AI to create a new source of demand for office space, especially in traditional tech markets like San Francisco, where most of the venture capital and AI employment is based.
That said, although AI has been used in real estate for years, many of the technology’s capabilities and functionality are still largely unknown to the leaders we interviewed. Besides a lack of understanding, interviewees cited AI misinformation as a key barrier to adoption.
To help fight misinformation and other risks, leaders should thoroughly research the topic and learn how to make responsible AI part of their larger AI strategy. Firms must also consider data privacy and security, especially for systems that rely on large data sets, as protecting personal and sensitive information is critical.
Key takeaway:
There are hundreds of potential AI use cases across a real estate firm’s operations, finance, sales and marketing, IT and HR functions, among others. However, if you’re starting with this use case or that one, then you’re likely missing what makes AI such a big deal.
We have seen that pilots of individual use cases often miss the bigger value and impact of generative AI. There’s a better way, however. By linking sources of value to common AI patterns rather than individual use cases, firms can deliver outcomes with greater speed and reusability, which results in faster outcomes.
