Real Estate 2022

Real Estate: an Introduction

Real estate's place as a global asset class

Real estate is the world’s biggest store of wealth. Savills estimates that the global value of real estate reached USD326.5 trillion at the end of 2020, making it more valuable than all global equities and debt securities combined, and almost four times the size of global GDP. By comparison, the value of all gold ever mined is USD12.1 trillion, just 4% of the value of global property. It’s no wonder that real estate has become a significant investment asset class for investors around the world.

Real estate’s pandemic recovery

As with every other asset class, real estate was severely impacted by COVID-19. During the height of the pandemic, with travel restrictions and lockdowns in place across the globe, real estate transactions came to a virtual standstill. Some were quick to predict the demise (or at least decline) of office buildings and a significant decline in the desire of people to live or work in high density urban areas. But what a difference a year makes! Eighteen months ago, who would have predicted that early 2022 press headlines would include things like: “2021 CRE Investments Hit Record USD746 billion”; “Global Commercial Property Sales Rocket to Record in 2021”; and “Foreign Investment in US Commercial Property Exceeds Pre-Pandemic Levels”?

Assisted by historically low interest rates, governmental stimulus and solid fundamentals in many asset classes, the commercial real estate market staged a swift and dramatic recovery. According to Real Capital Analytics, global commercial real estate sales exceeded USD1.3 trillion in 2021, with the US, Asia-Pacific and European markets all posting record trading volumes. From 2020 to 2021, commercial real estate transaction volume doubled in the Americas, and rose by 28% in EMEA and 22% in Asia-Pacific. According to CBRE, during the fourth quarter of 2021, commercial real estate investment volume in the US reached a record USD296 billion, representing a 90% increase over the fourth quarter of the previous year.

Foreign investment in the US commercial real estate market in 2021 exceeded pre-pandemic levels. Based on data from Real Capital Analytics, pension funds, sovereign wealth funds and other non-US investors purchased USD70.8 billion of US commercial real estate in 2021, which was the largest amount of non-US investment in US commercial real estate since 2018 (USD94.6 billion) and nearly double the amount of non-US investment in US real estate in 2020. Much of this investment went into logistics, apartments and life sciences-related real estate. Indeed, Real Capital Analytics reports that the top three global targets for cross-border real estate investment capital in 2021 were US/industrial, US/apartments and US/office, followed by UK/industrial and UK/office.

Forecasts for 2022

As 2021 came to a close, many observers were optimistic about the prospects for commercial real estate in 2022. For example, Richard Barkham, Global Chief Economist & Global Head of Research for CBRE, wrote: “We foresee a record year for commercial real estate investment, enabled by high levels of low-cost debt availability and new players drawn to real estate debt’s attractive risk-adjusted returns. Commercial real estate values will rise, particularly for sought-after industrial and multifamily assets.”

In the US Real Estate Roundtable’s Q1 2022 economic sentiment index, the overall index registered a seven-point increase year-over-year, while the index assessing current market conditions is up 27 points from a year ago. In ULI/PWC’s 2022 Emerging Trends Europe report, 59% of survey respondents predicted that they will be net buyers of real estate in 2022 (up from 55% for 2021), and approximately half predicted that business confidence and profitability will improve (up from 23% for the previous year).

Henry Chin, Head of Asia-Pacific Research for CBRE, wrote that: “Overall, the outlook is bright for the Asia-Pacific real estate market in 2022, with significant opportunities across all sectors.” According to a Hodes Weill & Associates survey of institutional global investors with a total of USD1.2 trillion in real estate assets, global real estate investors are expected to increase their real estate allocations by an average of 11% over the next 12 months, an increase of 30 basis points and the largest increase since 2014. While two months of data is a small sample set, these optimistic forecasts have been borne out so far in the US, where the US National All-Property Index rose 19.4% from the previous year and 0.8% from January.

War in Ukraine

The bullish predictions referenced above were made before the start of the war in Ukraine. Most global real estate investors have limited or no exposure to assets in Russia or Ukraine. Based on a recent Real Capital Analytics report, outbound real estate capital flows from Russia averaged just USD330 million for the last five years, while inbound flows for the same period averaged only USD960 million. According to the same report, the average annual commercial real estate transaction volume in Ukraine from 2017 to 2021 was USD418 million. As a result, any impact of the conflict in Ukraine will likely be the result of indirect effects, such as higher commodity prices (particularly energy), inflation and bond yields. Investments across Central Europe could also be negatively affected, especially in those areas that could be adversely impacted by sanctions imposed on Russia.

On the other hand, a recent report by Real Capital Analytics entitled “Russia Invades Ukraine: The Picture for Commercial Property” emphasises that real estate is a long-term investment and that a secure income stream from core assets can act as a buffer against volatility in other asset classes and the outside world. Although experts have differing opinions on the ways and extent to which the war in Ukraine may impact the global commercial real estate market, most agree that there is currently too much variability and uncertainty to allow for anything other than high-level predictions. In the words of Constantine Korologos, clinical assistant professor and faculty director of the Hirsh Fellows at the New York University’s School of Professional Studies at the Schack Institute of Real Estate, “When you don’t know how long something volatile will be in place, it’s hard to predict what the risk is.”

Inflation and interest rates

In February 2022, US inflation reached a four-decade high of 7.9%. From January to February, Euro area inflation increased from 5.1% to 5.9%. Experts are divided on the extent to which this inflation is transitory.

Commercial real estate is generally viewed as something of an inflation hedge because owners can often raise rents to keep up with inflation, especially in asset types such as hotels and apartments. In addition, some of the factors driving the current increase in inflation, such as increased labour costs and supply chain shortages, can benefit the owners of commercial real estate by making new development more expensive. According to a recent report by HIS Market, construction costs in the US and Canada are the highest they have been in the last ten years, and labour costs in all regions of the US and Canada increased in March.

On the other hand, monetary policy makers often raise interest rates to slow inflation; for example, on 16 March 2022, the US Federal Open Market Committee (FOMC) – the body charged with setting and implementing US monetary policy – voted to raise the federal funds rate by 25 basis points. Projections from the FOMC suggest that six additional rate hikes of 25 basis points each are likely over the balance of the year, followed by another three rate hikes in 2023. Although rising interest rates could be detrimental to commercial real estate by increasing the cost of borrowing, a Cushman & Wakefield report predicts that the FOMC’s decision to raise the federal funds rate will ultimately benefit the long-term health of the commercial real estate market by reducing the risk that inflation will become entrenched, forcing more aggressive rate hikes in the future that could create a recession risk.

Asset Classes

Office

The uncertainty that jolted office markets globally early in 2020, and continued into 2021, has now started to manifest as longer-term effects as we emerge from the COVID instability. There are still some questions to be answered regarding the net effects of hybrid working arrangements, and whether corporations and professional service firms will permanently reduce their rental footprints and by how much, but for now some trends have started to emerge. Primarily, those include a compaction of average space usage, filling sublet market supply in central business districts and hurting older stock, and red hot suburban markets. This would suggest that, while some professionals do not anticipate working out of their own homes forever, a lot of them have determined that the days of commuting to the office five days a week are mostly in the rear-view mirror.

In North America, pre-COVID markets were already seeing growing competitive pressure, even in Class A buildings, due to a significant amount of new construction. While the pandemic slowed the delivery of office space, almost 50 million square feet of new office space will come online in the United States in 2022. As these new buildings are typically engineered for more flexible use, have greater amenities and are often eco-friendly, new construction is currently commanding significantly increased rental rates compared to other older buildings and the sublease market. At the same time, suburban vacancy levels have dropped significantly from their pandemic heights. In the fourth quarter of 2021 alone, nearly 10 million square feet of suburban office space was let in the United States, compared to a contraction of rented space in central business districts.

In European office markets, vacancy issues are more limited, leading to a perception that more development is in the near future. Office rental rates in the European market actually rose in 2021, with 1.5–3% growth anticipated for 2022, according to CBRE. That said, some of the same patterns observed in the North American markets are expected in EMEA. As hybrid working models become firmer, and tenants can gauge their longer-term reduced footprint needs, higher quality and newer space is expected to take centre stage and put significant pressure on less flexible and aged stock.

To date, this flight to quality trend has been seen less in Asia-Pacific markets. 2021 was a stellar year compared to 2020, with close to 50 million square feet of commercial office space absorption in the region overall and rental rates beginning to increase throughout the continent. Some downsizing in the Tokyo and Singapore markets had effects on absorption, but this was more than made up for in mainland China leasing activity, and vacancy levels in the region peaked mid-year. Pricing seemed to generally plateau as well, again with Tokyo as a potential long-term exception. There is some possible regional distress on the horizon, however, with close to 70 million square feet of new development office space set to enter the market in 2022.

Retail

Globally, supply chain disruption and solidifying preferences during the pandemic for online shopping rather than in-store shopping meant the recovery in the retail sector was overall much less substantial than in other sectors in 2021. Capital is broadly being siphoned from bricks and mortar retail into the distribution and logistics asset class, and appears set to continue doing so. One factor to keep an eye on is inflation, which has been hitting markets globally, not just in the US, and could slow down the recent upturn in consumer spending.

In Europe, anticipated endemic flare-ups in COVID-19 and attendant rolling lockdowns or other mandated restrictions on in-person interaction have led to unease within retail investment. While some uptick was inevitable in the 2021 market compared to the previous year when there were widespread lockdowns and many stores were forced to close, overall investment volume in European retail in 2021 was generally less than half of what it was in 2018 and 2019. Continued consumer goods price increases due to inflation and supply chain issues could continue to depress the market in retail.

Asia suffered through eight consecutive quarters of retail rent declines, beginning immediately prior to the emergence of COVID-19, but this negative trend appears to have stopped during the 4th quarter of 2021. Sales growth in stores registered an uptick toward the end of 2021, and rent levels in mainland China started to increase enough to raise the region’s average. General investor outlook appears cautious at best, however, with a dramatic decrease in international travel to the region causing significant disruptions to high street, luxury brand tenants and their businesses, which could drive up store closings and renegotiated lower rents for some time.

North American retail recovery over 2021 was significant, as well. Given the continued growth of online retailing, which could cut into bricks and mortar consumer good sales for the foreseeable future, a decrease to a 6.5% vacancy rate in retail at the end of 2021 is a significant improvement from mid-2020 when retailers were struggling to find both consumers and employees. This appears to be driven by a swift recovery in food and beverage, stimulus money to consumers combined with pent-up demand, and the very swift macroeconomic recovery in the US, where unemployment has reached its lowest point in 40 years just a year after the depths of the pandemic.

Logistics

The industrial/distribution/logistics asset class was already the darling of the global real estate investment world before COVID-19, but the pandemic has acted as an accelerant to the fire. In Europe, cap rates have been closing in on 3.00 in some markets, with 4% year-over-year rent growth, and close to EUR40 billion in investment in Europe in the first three quarters of 2021 alone, which was up over 60% from 2020. Most analysts expect continued heavy flow of capital into new development to keep up with demand, given close to 60 million square feet of new take-up in the last two years.

Asia saw very similar trends in 2021, with over USD56 billion worth of transaction volume in the asset class, an 82% increase over 2020 and close to one and one-half times the average from 2015 to 2019. There is still room for growth, as well, with a high level of logistics and warehouse facility obsolescence in China, and permanent consumer behaviour patterns just settling in.

North America may perhaps be a little further along on the curve. Trades were heavy in the market in 2021, but there are indications that the construction boom that started prior to the market upheaval in early 2020 has satisfied most of the market’s appetite for new facilities. Over the course of 2021, according to Globe Street, cap rates in the sector in the US were on average closer to 5.5, suggesting the imbalance between supply and demand seen in Europe had mostly been closed.

Multi-family

Residential real estate, especially multi-family assets, has continued to outperform expectations during the macroeconomic turbulence of the pandemic. In the North American and European markets in particular, while much analysis (based on what was seen in the markets in the spring and summer of 2020) predicted large-scale, permanent de-urbanisation, the lag in new construction brought on by working restrictions and supply tightness has instead led to an increase in multi-family demand. An ongoing shift in living patterns to suburban and secondary/tertiary markets might yet materialise, as hybrid and work-from-home employment becomes a permanent fixture in the landscape, but by and large this has been contained so far.

These underlying fundamentals seem to be holding in Asia as well, where Japan, the largest multi-family investment market by far, continued to see strong investment transaction volume throughout 2020 and 2021, and despite high construction costs, increased urbanisation (especially in China) is viewed by most analysts to portend continued apartment investing for the foreseeable future.

In the United States, close to USD240 billion in apartment property sales closed in 2021, with almost USD90 billion in large multi-family sales, as the asset class was the busiest in the US for the third year in a row. This is despite a continued low interest rate environment and incentives to move to single-family homes, where remote working is significantly more feasible than in apartments. European residential investment volume increased in 2020 over 2019, and shot up by close to 20% again in 2021, driven primarily by multi-family. New construction in the US in 2021 was heavily focused on multi-family as opposed to single-family homes.

Hospitality

This asset class was perhaps the most hard hit by the pandemic in 2020 and was among the slowest to recover as travel restrictions, combined with long-term changes in business travel patterns, make for a difficult market for years to come. While vacation travel has largely returned to pre-COVID levels, the ongoing changes in the way we work (and the location from which we do so) may have effects on the hotel market for years to come. Despite those headwinds, investments within the asset class returned with a vengeance in 2021, with USD66.8 billion in global transaction volume.

Asia-Pacific’s hospitality asset investments saw somewhat weaker recovery than the rest of the world in 2021, with USD8.5 billion in transactions representing a decrease of 40% below 2019 levels. This slower rate of recovery, along with lower utilisation numbers throughout most of the region, is largely blamed on the heightened restrictions on travel in China, Japan and Australia. Slower or less effective vaccination rollouts in India, China and other locations, as well as the Delta variant emerging just as travel was starting to open up, were also factors. Full recovery in the market appears dependent in large part on Chinese citizens being freed up to begin roaming the continent again.

In the United States, the immediate plunge in leisure travel as a result of the early pandemic restrictions (bookings were down close to 60% in the summer of 2020) was mostly erased during 2021, with RevPAR numbers returning to approximately where they were in 2019 by July 2021. However, there is some continued unevenness in the class based on location; not surprisingly, coastal and larger cities that are more dependent on international and business travellers are still feeling the pain in the hotel sector, with some gateway cities still down close to 2/3 on their 2019 RevPAR numbers.

International travel to European destinations is not expected to fully recover to 2019 levels until 2025, despite the recent loosening of travel restrictions globally. Ongoing military conflict on the continent, as well as discrepancies from one Eurozone nation to another in vaccination levels and travel restrictions, may create medium-term headwinds.

Data centres

Although demand for data centres was increasing before the arrival of COVID-19, the pandemic accelerated this trend as businesses across the world faced a sudden need for greater cloud-based technology in order to allow their workforces to function effectively in a remote work environment. Major data-producing companies such as Google, Amazon, Alibaba and Apple are increasing their data centre footprints around the world. According to a recent report by Cushman & Wakefield, the top global data centre markets are:

• Northern Virginia;
• Silicon Valley and Singapore (tie);
• Atlanta and Chicago (tie);
• Hong Kong;
• Phoenix;
• Sydney;
• Dallas; and
• Portland and Seattle (tie).

Madrid moved from 34th place to 19th place in the Cushman & Wakefield survey, and new markets were identified in South Asia, Sub-Saharan Africa, South America, Southeast Asia and the Nordics. A recent CBRE report predicts that, with emerging technologies like 5G, AI and edge computing, data centre development will increase in 2022, spurring growth in primary, secondary and tertiary markets.

Life sciences

Although investor interest in life sciences-related real estate was increasing before 2020, the global pandemic has resulted in an unprecedented level of interest in this sector. 2021 saw the strongest life sciences market in US history, with investments in life sciences-related real estate reaching USD21.4 billion, representing a 62% increase over the previous year and a 111% increase since 2018. CBRE reports that venture capital funding of life sciences in the US has grown by 328% in the last five years, and predicts that investment in US life sciences real estate is likely to increase by at least 10% in 2022.

Savills reports that 2020 saw GBP19.9 billion of life sciences-related capital raised by companies headquartered in the UK (a 23% increase over 2019), and that venture capital funding of life sciences companies over the last five years has risen sharply across Europe.

Because of the importance of a deep and local talent pool and proximity to leading medical and educational institutions, life sciences real estate is concentrated in a relatively small number of markets. In the US, the leading life sciences markets are Boston/Cambridge, the San Francisco Bay area, San Diego, Raleigh-Durham, New York/New Jersey, the greater DC/Baltimore area, Los Angeles, Denver/Boulder, Philadelphia and Seattle/Bellevue. Outside of the US, Savills reports that funding for life sciences is greatest in China, the UK, Germany, Switzerland and Canada. With record funding levels, tight vacancies and rising rents, life sciences real estate seems poised to continue to be an attractive asset class, especially for large investors who can absorb the significant costs associated with these assets and invest with scale.

Proptech

Proptech continues to grow in influence and importance in the global commercial real estate markets. According to the Center for Real Estate Technology & Investment’s 2021 Real Estate Tech Venture Funding Report, private investment in proptech rose to USD32 billion in 2021, a 28% increase from 2020. A Verdantix report indicated that, from January through November of 2021, proptech funds invested USD9.3 billion across six areas:

• construction management;
• commercial property management;
• residential property management;
• retail management;
• operational management; and
• workplace management.

Proptech funding is expected to continue to grow in 2022. For example, Fifth Wall, the world’s largest venture capital firm dedicated to proptech, recently closed on EUR140 million in commitments for its debut European Real Estate Technology Fund. According to PERE, the oversubscribed fund has commitments from PGIM, Azora Capital, BNP Paribas and Ivanhoe Cambridge. PERE also reports that, on the other side of the world, Australia’s Taronga Ventures has received AUD170 million in commitments for its first proptech fund, with investors that include Ivanhoe Cambridge and APG Asset Management. In the US, Wilshire Lan Capital recently announced that it has raised USD40 million for its first vehicle, with investors that include Morgan Properties, J.P. Morgan Asset Management and Nile Capital Partners.

A number of the world’s largest real estate investment companies, including Blackstone and Brookfield Asset Management, are investing in proptech companies. In addition to this unprecedented fund raising, the importance of proptech to the commercial real estate industry is evidenced by the fact that, according to a 2021 study by JLL, approximately 8,000 companies across the globe currently offer tech-based solutions for the built environment.

Blockchain

2021 saw the continued increase in use of blockchain technology in commercial real estate transactions. Examples include the tokenisation of real estate assets, where non-fungible tokens (NFTs) facilitate the “fractionalisation” of real estate ownership interests using blockchain-based smart contracts. Tokenisation has proliferated on an international scale, with digital asset trading platforms launching in more than 15 countries across the Americas, Europe, the Gulf region and Asia. Other areas include the use of cryptocurrencies to fund transactions, the adoption of artificial intelligence to document deals and perform due diligence, and the recent interest in decentralised autonomous organisations (DOAs) – entities managed by rules encoded on the blockchain rather than by a hierarchical corporate management structure – in certain US marketplaces. Taken together, these technologies have the potential to materially impact the way that commercial real estate transactions are handled.

Once adopted for a particular investment, blockchain and digital asset platforms confer enhanced transparency, efficiency, security and liquidity for transaction counterparties while unlocking new value, increasing deal speed, reducing cost, automating property management processes, and providing access to a larger – and more diverse – pool of participants. As noted recently by GlobeSt.com, “A new market for tokenised real estate assets is taking shape, fueled by the growing adoption of cryptocurrencies and the emergence of digital asset trading platforms that are offering young investors micro-shares of properties that have been tokenised on blockchain.” Although regulators have begun enacting laws and issuing executive orders to limit certain practices, it seems inevitable that blockchain technology will have a growing impact on the commercial real estate industry in the coming years.

ESG

The last few years have seen a dramatic increase in the importance of ESG in commercial real estate ownership and investment. In a 2021 Global Investor Survey by CBRE, 60% of respondents stated that they have already adopted ESG criteria as part of their investment strategies, with the Americas, EMEA and Asia-Pacific all reporting an increased focus on ESG compared to previous years. In a survey of 85 publicly traded US REITs conducted by NAREIT, 95% of respondents (by market cap) reported that their investors had requested information about ESG.

In the private markets, large investors such as Norges Bank, LaSalle Investment Management, PGIM and BlackRock, as well as many pension funds and endowments, are increasingly requiring the funds and companies in which they invest to have a well-articulated and well-executed ESG strategy. In what is being described as a landmark moment for climate change accountability in the US, the US Securities and Exchange Commission recently issued proposed regulations that would require publicly listed companies, including public REITs, to report on the climate-related risks associated with their business activities.

Conclusion

Like every other sector, commercial real estate was significantly impacted by the COVID-19 pandemic. It is still too early to tell what long-term impacts the pandemic may have on commercial real estate, especially the office and retail sectors. However, the solid fundamentals that existed for many asset classes before the pandemic, coupled with low interest rates and supportive governmental policies in many countries, combined to allow for a dramatic recovery for many asset classes. Although the war in Ukraine, increasing inflation and potential COVID-19 variants present potential concerns, the prospects for commercial real estate are good for most asset classes in many of the world’s major markets and, as a global asset class, it is likely to continue to attract significant investment capital from investors around the globe.