Creating Resilience

State of Play: Five Things Occupiers Should Know About the Current Investor Mindset

By: Matt Werner & Spencer Levy

June 4, 2024 5 Minute Read

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The Implications of Challenges in the Capital Markets for Landlords and Occupiers

Continuing challenges in the capital markets—caused by high inflation and interest rates—are putting pressure on commercial real estate investors and changing decision-making in unexpected ways.

This article analyzes large real estate investors’ motivations, business models and behaviors, which will help occupiers navigate the current real estate cycle.

Understanding Institutional Investors: Sources of Capital and Why They Invest in Commercial Real Estate

For occupiers, navigating an uncertain real estate cycle requires understanding who the commercial real estate investor is, why they invest and their goals. Commercial real estate investors typically fall into one of six categories: institutional investor, foreign investor, real estate investment trust (REIT), developer, bank (REO) and private investor. Dry powder, or unallocated, investment-ready capital, for commercial real estate reached over $400B in 2023. Investors employ various strategies for allocating this capital, with opportunistic or value-added strategies topping the list.

Figure 1: Global Real Estate Dry Powder by Strategy (US$ Billions)

 
Source: Pregin, CBRE Research, August 2023.

Capital for commercial real estate investments comes from investors worldwide—In Q4 2023, Canada, Singapore and Japan were the largest countries of origin for U.S. commercial real estate investment.

Figure 2: Source of U.S. Real Estate Investment Volume (US$ Billions)

 
Source: CBRE Research, MSCI Real Assets, Q4 2023.

To maximize ROI, property owners focus on goals that vary by asset, but may include:

  • Rent and occupancy
  • Operational efficiency
  • Cash flow
  • Value and profit
  • Portfolio optimization
  • Growth

Macroeconomic Trends Are Impacting Property Values, Creating Risks and Opportunities for Occupiers

What does this mean for occupiers? High interest rates designed to lower inflation have reduced property values and, therefore, has changed the decision-making process for landlords—this creates risk and opportunity for occupiers. Other challenges—financial institution balance sheet issues, increased supply chain and construction risk due to global natural catastrophes, valuation impacts from lower office occupancy rates, and increases in commercial property and casualty insurance—will continue to add uncertainty in the foreseeable future. Additional factors at play include heightened services inflation from wage growth, unemployment tied to geopolitical events and the cost of capital in the form of short-term interest rates. While not all these factors directly impact the real estate cycle, they do impact investors’ decision making.

Figure 3: Price Index, Y-o-Y Change (%)

 
Source: The Federal Reserve, U.S. Bureau of Labor Statistics & CBRE Econometric Advisors.

Asset-level Investment Decision-making is Driven by Appreciation and NOI

Commercial real estate asset values increase through appreciation and income growth (NOI). Income growth depends on market fundamentals, while appreciation depends on capital flows. To measure income growth, investors look at capitalization (or cap) rates, which provide a snapshot of return on investment at the time of sale. Higher cap rates often provide investors with higher returns but typically carry more risk.

Figure 4: Historical and Forecast Cap Rates (10-Year Treasury)

Image of line graph

Source: CBRE Econometric Advisors, Q3 2023.

Appreciation and income growth are measured through the NCREIF Property Index (NPI), a historical measurement of property level returns across multiple property types comprising average income and average appreciation return.1

1 Source: National Council of Real Estate Investment Fiduciaries.

Figure 5: NCREIF Property Index

 
Source: CBRE Research, NCREIF, Q2 2023.
*For year ending Q2 2023. All returns are reported on an unlevered basis.

Lack of Market Information is Delaying Decisions: Investor Behavior and the Real Estate Cycle

Income and appreciation growth, the two methods investors use to build value, operate on cycles. While a simplified explanation of a complex process, it provides a sense of how investors time the market.

Figure 6: The Real Estate Cycle

 
 

Commercial real estate investors require information and an active market to make informed decisions. Prior to the acquisition or disposition of an asset, a unanimous vote is required by the voting members of an investment committee. Over the past few years, reduced investor confidence and rising capital costs have driven a reset in asset values. A drop in transaction activity has sharply reduced market data, especially for office properties, adding to investors’ hesitancy in deploying capital.

Figure 7: The Investment Committee

 
 

Figure 8a: Percentage Point Contribution Y-o-Y Office Value Changes (%)

Image of bar graph

Source: CBRE Econometric Advisors.

Figure 8b: Peak-to-Trough Capital Value Changes (%)

Image of bar graph

Source: CBRE Econometric Advisors.

Figure 9a: Year-to-Date Asset Returns Through Q3 2023 (%)

 
Source: Macrobond *NCREIF reflects the performance of the NPI from Q2 2022 to Q3 2023.
*NAREIT U.S. REIT performance reflects change in the total return index from January 2023 to October 2023. NCREIF/.GREFI.
*Reflects data up to 2023 Q2.

Figure 9b: Returns in Local Currency (%)

 
Source: Macrobond *NCREIF reflects the performance of the NPI from Q2 2022 to Q3 2023.
*NAREIT U.S. REIT performance reflects change in the total return index from January 2023 to October 2023. NCREIF/.GREFI.
*Reflects data up to 2023 Q2.

Market Dynamics Differ Across Asset Classes, More So Than in Past Cycles; Multifamily Trends May Impact Labor Availability

Market conditions are very different for office, industrial and retail properties. This distinguishes the current real estate cycle from most previous ones. Employers should pay particular attention to multifamily trends as these factors may impact talent availability in current and future locations.

Figure 10: Real Estate Markets in the Black: A Landlord Perspective on Various Asset Classes

 

Office: While office-using employment varies widely by U.S. metro area, most markets have seen an increase in office vacancy rates over the past five years.

Figure 11: Office-Using Employment by Metro (2023 Annual Change)

 
Note: Office-using employment includes jobs designated by the Bureau of Labor Statistics as Professional & Business Services and Financial Activities.
Source: U.S. Bureau of Labor Statistics, CBRE Research, Q4 2023.

Industrial: Partly due to the manufacturing boom and constrained capital availability, construction costs for industrial buildings remain elevated. Most industrial markets experienced decreased space availability from 2019 to 2023.

Retail: The availability of retail space has declined in most U.S. markets, driven by resilient consumer spending and a paucity of retail development over the past decade.

For more, check out The Weekly Take podcast.

Content in this article was presented during the CBRE Institute Global Forum in March 2024.

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