Can Investors Spot Opportunities Among Changing Winds?

TSP’s Zac Goodman Expects Real Estate Developers To Remain Cautiously Optimistic Despite Rising Inflation and Interest Rates

I’m reading a lot of negative news, seeing a lack of confidence and general dissatisfaction with the world at the moment.

Perhaps a look back to 1984, the year that George Orwell forecast would presage a bleak totalitarian future, will help us put things into perspective.

In 1984, the UK employment rate was 66%, compared with 75.5% today. UK gross domestic product was £461.5 billion compared to £3.13 trillion today. UK infant mortality was 10 per 1,000 births compared to 3 per 1,000 today.

Despite three economic bubbles forming and bursting between 1984 and today, the late 1980s recession, the early 2000s dotcom bubble and the global financial crisis, temporarily destroying wealth for millions of people, things have kept getting better and better.

After more than a decade of effectively zero interest rates since 2008, it’s a new world that we’re living in now. Real estate investors are grappling with both inflation and high interest rates on the delivery side, as well as changing occupier demands on the other.

But, in real estate, change also means huge opportunity.

In January, UK business confidence was reported to have dropped to its lowest since the financial crisis. Despite this, I expect real estate developers to remain cautiously optimistic in the near-term. Let’s go back to 2022 to understand the source of our challenges but also the seeds for this year’s opportunities.

What has really shaken the real estate outlook in this difficult market is capital values taking a hit, predominantly due to rates, but also a result of crumbling confidence, which feels like it started around the time of the Ukraine invasion in February 2022. Long-term impact on yields is over hyped, it always is, but there is no pure correlation that you’ll find historically.

Last year was also the year when it became clear that working from home has become part of our lives and there is no discernible trend between those that promote it and those that do not. My best guess is that office occupancy plateaus at 70% of pre-pandemic levels and stays there. Smaller business still want space, larger business too. But the latter want less space, better located and much higher specification.

Rents have surprisingly remained strong and in some cases increased, where the product offered the right location and the right occupant experience.

Here’s the opportunity and the reason why I remain optimistic about the outlook for real estate.

Over the last 12 months, sustainability has gone mainstream in commercial real estate. Every day in 2022 I’ve seen a company either hire a sustainability officer, become a B Corp or achieve one form of sustainability accreditation or another.

This is great, but it’s becoming a confusing world of virtue signalling and badge wearing.

At some point the shoe will drop and we will all have to produce proper auditable data that’s verifiable. This can be either an opportunity or a challenge for commercial real estate developers and investors. The key is clear targets, measurement and reporting.

Another 2022 trend impacting our market confidence today is productivity discovery – that’s right, not price discovery.

There’s a cold wind blowing in, and we will all have to do more with less for a while. Business and therefore real estate will learn very quickly next year what we can achieve without. That can be people, real estate, technology.

Every business will be different and will tackle cost reduction differently. I think that those that manage to retain good people will be the most successful.

With interest rates still high, it will be the right type of property that will continue to outperform inflation. Spaces are now being designed for flexibility and productivity, rather than just a place to go and sit for eight hours. There is some real thought going into how people will use offices as a tool, empowering them to work flexibly.

Think high spec flex offices, prestige retail and other operating uses that have longevity over novelty. Don’t think “market carry – this will come back like before”. That’s just hit and hope.

This year, success will lie in the emphasis on operational and true market fit or add-value opportunities.

You don’t want to be the developer or investor leaving when the environment is challenging and turning up when the party starts again. Think long term: things are only getting better from here.

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By ZAC GOODMAN

From original article published on CoStar