This year has been a tumultuous one for commercial real estate. While hotels and leisure properties have flourished, the office sector may be facing an existential crisis. In spite of current troubles facing the industry, the Urban Land Institute’s (ULI) Real Estate Economic Forecast — a semiannual report updated this past May — paints a somewhat brighter picture moving forward, with positive but slow growth over the next two years and average inflation by 2025.
“As pricing stabilizes or becomes more obvious, the pricing discovery will improve and there will be an increase in transactions.”
The report is based on the median forecasts from 41 economists and analysts at 37 major real estate investment, advisory and research firms. This past June, ULI senior vice president Anita Kramer, one of the authors of the report, spoke with Scotsman Guide. She offered further insights on the estimates for how the commercial real estate sector will fare from now until the end of 2025.
Where do you stand on whether we will have a recession in the near future?
The Urban Land Institute hasn’t taken a position on that. So, I’m going to reflect on what I have heard from real estate experts. I think there is still a sense that if there is a recession, it might be more of a technical recession, meaning the numbers of the gross domestic product might be negative, but the recession won’t hit all the sectors of the economy and it will be shallow. Experts are saying this because job growth remains so strong and inflation is slowly being tamed. In general, the forecast from our survey participants indicates low growth in 2023, low growth continuing but strengthening in 2024, and above- average growth by 2025. If we do slip into recession in the earlier years, it will be moderate and short-lived.
The ULI forecast calls for commercial real estate transaction volume to decline to about $425 billion this year, less than half of the record-setting activity of 2021. You then see transactions rebounding in 2024 and reaching $695 billion in 2025. What will spur this future growth?
The transaction volume is being impacted by various factors, including higher interest rates and the lack of readily available credit. The lenders are being more cautious and the borrowers are facing higher costs at a time when the valuations of their properties are still being discovered. The RCA CPPI National All-Property Index shows that prices dropped by 11.2% from a year ago in May. The ULI forecast shows that prices for all property types are expected to decline by 8% this year. Now, most sectors are still above the pre-pandemic pricing point, but the downtown office sector is not.
So, as pricing stabilizes or becomes more obvious, the pricing discovery will improve and there will be an increase in transactions. Interest rates are holding steady right now but are most likely going to continue to rise, and that will result in more uncertainty about prices. As those issues sort themselves out, you can expect to see an increase in transaction volume.
Your forecast shows total direct investment returns for the office sector dropping by 10% this year before a return to positive territory in 2025. What will account for the future recovery?
These are institutional-quality properties. While some institutional owners hold Class B and C properties, the overarching view of their portfolios would be that they hold higher-quality and newer properties. But I would also look at it another way: The office sector experienced a substantial valuation decline in 2022 and 2023, so modest increases in 2024 and 2025 will not get the office sector out of the valuation hole that has developed in recent years.
What surprised you the most about the results of the forecast?
I think a lot of people will be surprised by how strong the retail sector is right now. The report focuses on community and neighborhood shopping centers, not malls. That is very important to remember. The vacancy rates (at the community and neighborhood centers) are below their long-time average and they are expected to remain unchanged. Rental rate growth is also greater than average for the past 20 years. So, I just think that there is not a widespread awareness that these community shopping centers are great opportunities for investment. They are doing very well.
What is the main point from the report you would like people to know?
I want people to understand that the fundamentals for commercial real estate are still quite strong and that this year, the market sectors are adjusting to new norms, such as price discovery, the stabilization of interest rates and then bringing inflation under control. All of that is happening in 2023. But the fundamentals of the industry, including the need for commercial real estate, remain strong. ●
