Law firm DLA Piper recently released its 2022 Year-End Real Estate Trends Report. One of the more interesting findings? Transactional volume handled by DLA Piper’s real estate group soared in the first half of 2022, nearly doubling the volume that the firm handled in the first half of 2021.
But in the second half of last year, the volume handled by the firm’s real estate group dropped dramatically, slowing to a pace more consistent with pre-pandemic levels.
What does this slowdown mean for 2023? We spoke with Boston-based Barbara Trachtenberg, partner of DLA Piper and co-vice chair of the firm’s real estate practice, about the trends report and what the commercial real estate industry might face this year.
Here is some of what she had to say.
We see in DLA Piper’s trends report that the transaction volume handled by your practice’s attorneys dropped in the second half of 2022. Do you think deal activity will continue to slow throughout 2023?
Barbara Trachtenberg: I was at the Real Estate Roundtable meeting in D.C. last week. This week we had our London real estate summit. People are generally thinking that at least the first quarter and maybe the first half of 2023 is going to be relatively slow for commercial real estate transaction volume, similar to what we saw in the second half of 2022.
But no one is sitting around saying, ‘This is going to be so bad.’ No one thinks that transaction volume will be stale forever. People are optimistic that after one or two more quarters the pace of transactions will pick up. They are confident about 2023. It’s not that nothing is happening. But 2021 and the first half of 2022 saw such a high volume of transactions that today feels slow by comparison. It’s not really that slow. It just seems slow after what we saw during the last year-and-a-half.
What caused the slowdown in transaction activity in the second half of last year?
Trachtenberg: The rising interest rates created some pricing issues, especially in the second quarter of last year. People were looking at purchase agreements that were enacted earlier in the year. Then, when they went to do their due diligence later in the year, they saw that the deals weren’t going to sketch out. Suddenly the cost of debt went up.
What’s interesting is that we saw buyers asking for concessions because of the rise in interest rates. But we didn’t see as much of that in quarters three and four. It makes me think that the interest rate increases have worked their way into underwriting by now. But, yes, some people are taking a pause because of the interest rates. Many of the people we are seeing in the market now are all-cash buyers.
Are investors and buyers looking for certainty today when it comes to interest rates?
Trachtenberg: People want to make sure that the cap rate they are using, the assumptions that they are using, are actually going to play out. Stability in interest rates helps create stability in the market.
The higher interest rates have had an impact. They contributed to the surge of multifamily business that we saw in 2022. You can factor inflation and interest rate increases into multifamily leases because they turn over quickly. At the same time, higher interest rates discourage people from buying homes. That is what is driving multifamily.
Where you surprised at all by how busy multifamily was last year?
Trachtenberg: I was surprised that of all the transactions we were involved in last year, 40% of them were multifamily. I would have thought it was less. I knew we were doing less industrial, but I also knew that we were doing more deals in the data center and life sciences space. So, yes, it was surprising to see that so much of what we worked on last year was in multifamily.
You mentioned that your company was involved in fewer industrial transactions last year. Do you think that the demand for industrial space is slowing, at least a bit?
Trachtenberg: It will slow down this year. You see the headlines about what is happening in distribution and logistics. Industrial had been hot for so long. Demand for industrial space went up in 2019. It went up in 2020 and 2021. It makes sense during a pandemic when people are spending more time at home and are not as willing to get out, that they will rely more on people bringing things to them. The demand for industrial space couldn’t stay as high as it was. That can’t last forever. But the industrial market won’t do what the office sector did. It will slow a bit, but it will continue to remain a strong sector.
Speaking of office, do you see some hope for increased demand for office space this year?
Trachtenberg: It depends on what kind of investor you are. There will be opportunities in office. For people who are well-capitalized and who are willing to take risks, there will be opportunities. They might want to buy office properties that might currently be having some leasing issues but are otherwise good assets. If they have the time and capital to invest in them, those investments could pay off in the future.
Is the office market strong in the suburbs or in urban areas today?
Trachtenberg: We do a state-of-the-market survey of our clients every year. We have asked that question for the last few years about whether the office sector will be more robust in urban or suburban areas. We took that question out this year. The notion that we heard early in the pandemic that people if they were going back to the office would want to be closer to home and not go back into the city hasn’t played out. I am sitting here in London right now. It is so busy. People are back in the office in London. It’s just a matter of time before we end up the same way.
Now, companies might not be using as much office space as they did pre-pandemic. People are going to shrink their footprints. I really do think, too, that there will be some office space that will struggle. In the long term, though, office space will still be a strong play.
You mentioned earlier that the life sciences and medical office markets were strong last year. What are some of the factors behind that?
Trachtenberg: One of the things we as America realized during the pandemic was that we need to be controlling more of our pharmaceutical and medical uses. I do think there has been an increased focus on not just developing new vaccines and technique and pharma in America, but also on manufacturing it here. There is a lot more PPE, too, getting manufactured here in the United States.
Even with all the economic uncertainty that the United States is facing today, do investors still consider commercial real estate a good home for their dollars?
Trachtenberg: Commercial real estate, especially in the United States, has always been a good hedge against inflation. People still have a lot of dry powder that they are ready to deploy. They are just being more careful about how they deploy it. But I do think commercial real estate continues to be a very good opportunity for investors.
Was there anything else in DLA Piper’s trends report that you thought was interesting?
Trachtenberg: If you turned on the news during the pandemic, you would have thought that everyone was moving to the Sunbelt and that there was no one left in the Midwest and Northeast. But when it came down to it, the deals that we worked on last year took place in the places where you would have seen the most deals pre-pandemic, places like Boston, New York, Los Angeles and Chicago. These are the places where deals have been happening, the gateway cities. I do think that while maybe people are now looking at other markets, when it comes down to putting money on the line, they are still choosing to be in those gateway cities.
