The commercial real estate market has seen plenty of change since the COVID pandemic started grabbing headlines in 2020. Just look at all those empty offices, buzzing warehouse spaces and suddenly packed indoor mini-golf centers and high-tech bowling alleys.
What are the biggest trends in today’s post-COVID commercial real estate industry? Midwest Real Estate News spoke with Jonathan Keith, managing director with the New York office of Deloitte & Touche, about the company’s 2023 Commercial Real Estate M&A Outlook and the challenges that the commercial real estate industry faces in the coming months. Here is some of what he had to say.
Was there anything in the M&A Outlook that surprised you?
Jonathan Keith: I wouldn’t say there was anything surprising. Real estate touches everyone’s lives. We all see some of the real estate trends manifesting in our daily lives. More people are going back to shopping at brick-and-mortar retail today. We see multifamily rental prices rising. We see that some companies are implementing back-to-work policies in the office sector. We see these trends playing out in our everyday lives. It’s not surprising when we see those trends reflected in the results of our M&A Outlook.
Speaking of one of those trends: Are you seeing more companies encouraging their employees to return to the office?
Keith: There is a little push to get folks back to the office. Will the office look the way it did pre-COVID? Probably not. I think back to my experience. When I started working, I was commuting five days a week to the office while wearing a suit and tie. My sense is that we will not go back to that. The question is, will employees return to the office two or three days a week or four days a week? How do companies grapple with that in terms of the amount of space they need?
Companies have some decisions to make. There is a value to getting people back to the office and working together again in person. But there are also some cost savings by having people work remotely. I don’t foresee a full return to where we were before COVID. How this will shake out, I don’t know. Right now, companies are taking small steps but are not returning fully to the days before the pandemic.
We’ve seen that multifamily rents are still rising, but not as quickly as they once were. Do you have a feel for whether rent growth will continue to slow in the multifamily sector?
Keith: That’s difficult to predict. A lot of it is market-driven. Markets behave differently across the United States. The apartment rental market in the Manhattan area is much different than in the Rust Belt in the Midwest or in the Southeast. From a general perspective, it is tough to say whether multifamily rents will go up or down or stabilize. It’s about looking at a particular market and the demographics around it.
I know industrial sales have slowed, but demand for industrial space remains high. Is industrial still the darling of the commercial real estate sector in your opinion?
Keith: We see industrial and some of the alternative real estate types, such as data centers and offices retrofitted for medical services, to be the strongest commercial classes. Warehouses remain very strong performers. We have seen a drop in M&A activity in the industrial space, though, through the end of 2022. M&A activity has been even slower in the first quarter of 2023. That’s because of higher interest rates and uncertainty around rates and where the economy is heading. Both of those play into the gaps between buyer and seller expectations.
The uncertainty around the economy has led to a continued decrease in deal volume and deal value through the first quarter of 2023.
Are investors sitting on the sidelines, even when it comes to strong sectors such as industrial?
Keith: We had such a long period of lower interest. Now, investors are looking for a stabilization of rates. They are looking for the new normal. Maybe the new normal rate will be 5% versus where it might have been before May of 2022.
One side fears that interest rates will go up. One side says that maybe they will come down. That gap is there. People are waiting to sell until interest rates stabilize. They are also waiting for some stabilization with the economy. People are waiting for the country to return to more of a moderate growth economy.
One of the things you mention that investors can do today to protect themselves is to rebalance their portfolios. Can you talk about that?
Keith: Investors need to adjust their portfolios to include some of the asset classes that are stronger today, assets like industrial, multifamily or some of the alternative assets like data centers. There is also an option to repurpose existing facilities, though that comes at a cost. If you are long on offices, can you repurpose some of that space into industrial or retail? We’ve all seen old banks turned into restaurants. You can repurpose certain assets to more desirable real estate sectors.
A lot of times, when you have heavy M&A activity, a group can focus on purchase, purchase, purchase. When the market slows, it’s a good time to work on your portfolio. What are the things you can improve on? Take the same sort of professionals who have done the M&A work and have them manage the portfolio and optimize that. In a new market, there are things you can do to optimize and get ahead of the trends of the market.
What are some of the key trends in Deloitte’s latest M&A report?
Keith: The two big takeaways are that industrial remains strong and that office is on the flipside of that. We will continue to see growth and opportunity in the industrial sector. On the flipside, office is still seeing a large amount of uncertainty. Is there too much office space out there? The risk is that a change is taking place in office usage among companies. That can have a significant impact on the owners of that real estate.
The other interesting thing concerns retail. The thought during COVID was that people were not going to return to malls. There was the sense that malls were dying. People can use the Amazons of the world to order items from their computers. But that is changing. People do want to go out and shop. We are seeing a desire for experiential retail. People want experiences. There has been a rebirth of retail from that perspective. Everyone that we wouldn’t need that old bookstore because we have Amazon. But now trends are working the other way. There is a desire and appetite among consumers to go out and shop in brick-and-mortar locations again.