“You have to look at the overarching, longer trends and make decisions about what sectors and what investment strategies you’re going to focus on based on that long-term view of basic supply and demand, with more focus on the demand side of the equation, particularly if you’re a long-term holder of real estate.”
Property Type Outlook
With commercial real estate capital markets so disrupted by the recent increases in interest rates, property owners and investors have turned their attention to property market fundamentals as the best way to generate returns. That means focusing more on the competitive supply of new properties and especially tenant demand for space. This change in focus helps account for the dip in investor demand for industrial, which is finally receiving much-needed deliveries that are muting rent gains. And it certainly explains the plunge in investor demand for office buildings, where tenant space demands continue to spiral down.
Yet the biggest feel-good property story this year is the retail sector comeback, which is probably better explained by a collective reassessment of the sector than by any dramatic recent shifts in supply and demand dynamics. It seems clear that the retail sector was underappreciated. Now the industry is coming to realize that the nation will keep shopping for most of its goods and many services in shopping centers indefinitely, even if e-commerce continues to take market share away from in-store retailers.
The more positive attitude toward the retail sector was evident in our interviews this year and confirmed by the results of the Emerging Trends industry survey. The overall retail score jumped more than 14 percent [42 basis points (bps)], by far the largest one-year gain in any property sector in over a decade since the GFC. In this remarkable and broad-based turnaround, every retail segment improved, led by an astonishing 44 percent (84 bps) gain in the rating of regional malls, followed by 20 percent increases in outlet and power centers.
Retail is still a long way from being the industry favorite, however. What’s on top? Not industrial. After 16 straight years at either the first or second position among the major property types, industrial/distribution fell to the number three position. Still, the decline was not dramatic at just 1.5 percent.
Housing is now the preferred property type, with multifamily housing just edging out single-family housing in the two top positions. Multifamily managed to earn a slightly higher rating this year despite rising vacancies in some high-growth markets as the massive pipeline of new product came to market. But single-family housing had a much bigger gain, second only to retail, as the historically low number of homes available in the resale market presented better opportunities for homebuilders, despite the increase in mortgage interest rates.Hotels were about flat this year as economy hotels regained favor, but luxury, upscale, and midscale hotels all declined moderately.
The office sector continues to get no love from survey respondents. Its rating of 2.60 was the lowest of any major sector since 2011, after falling another 4.4 percent (12 bps) this year. Central city offices were the lowest rated of any property segment by a wide margin, displacing regional malls, which had long dwelled at the bottom of the heap. Suburban offices were a bit better but still received the second-lowest rating, and both CBD and suburban offices dropped further this year.
Hotels were about flat this year as economy hotels regained favor, but luxury, upscale, and midscale hotels all declined moderately.
In sum, the all-sector investment prospects average rose slightly from 3.26 to 3.37—the second highest since 2016, though still below the 3.43 registered in 2022. The ratings of three major property types increased (single-family housing, multifamily housing, and retail), while two declined (office and industrial), and one was about flat (hotels). Despite the overall small gain in investment prospects, development prospects fell marginally again to their lowest rating since before the pandemic.
With the declining fortunes of the office sector, the spread between the top and bottom sectors widened again this year to tie its highest level in the past two decades.
Among the property subsectors, data centers remain the most preferred type, followed by moderate-income/workforce apartments. However, life science facilities fell the most of any segment (9.1 percent), the victim of significant supply additions while demand cooled. Overall, the ratings of many niche segments outpaced the traditional major property types as more niche sectors are becoming accepted institutional investment options.
