On October 27, 2022, PwC and the Urban Land Institute (ULI) released their “Emerging Trends in Real Estate 2023 Report.” According to PwC leaders, the annual report looks forward to the year ahead, unlike most reports that look back at the last quarter or year. The report was compiled from surveys and interviews of over 2,000 real estate executives, investors, developers and market experts. The theme that emerged more than any other from the interviews with industry leaders seemed to be one of cautious optimism that we will ride out any near term slump and be well positioned for another period of sustained growth and strong returns.
“The outlook for the next year, 2023, is actually a little lower than it was going into the pandemic, or nearing the pandemic,” said Andy Warren, PwC’s director of Real Estate Research. Two years ago, Warren said, return to office was the most highly debated topic in Emerging Trends. And, while many corporations are still in a “fact-finding mode,” it is fairly clear that the office is still important and so is remote work. “We’ve kind of hit the middle,” Warren said. “Employees like the flexibility, but they also like to be in the office. They like to collaborate with their co-workers, get inspiration and get things done.”
With the worst days of the pandemic appearing to be behind the country, one of the report’s themes centers on a return to normalcy. “U.S. commercial property markets actually embarked on a remarkable run, with some of the strongest returns, rent growth, and price appreciation rates ever recorded,” the report says, despite fears early in the pandemic that commercial real estate would be devastated.
Markets to Watch
Over the past 20 years, Emerging Trends has surveyed its members and asked them to evaluate the investment and development prospects of what has grown to be a list of 80 real estate markets across the United States. The survey results from the viewpoints of a diverse group of real estate professionals. The long-term impact on local markets has been hard to pin down, since hot spots and infected areas have spiked and waned since the pandemic started in early 2020. However, looking at the markets moving up in the overall real estate prospects rankings, the suburban markets in the Sun Belt tracked in the survey have gained the most over the past year.
Super Sun Belt
These markets are large and diverse but still affordable, forming powerhouse economies that attract a wide range of businesses. Despite their large population bases, most are among the fastest growing markets in the United States. Moreover, their economic performance has been solid through thick and thin. Though every market lost jobs during the pandemic recession, recovery has been much quicker and more complete in the Super Sun Belt markets. These metro areas collectively have the highest average rating of any subgroup, as it did last year.
It’s not heat and humidity that investors and developers seek in the Sun Belt markets, of course, but strong market prospects. And forecasts for population and especially economic growth show that they are looking in the right places. Population and gross metro product (GMP) are both expected to grow faster in these markets than just about anywhere else in the nation. Accordingly, these markets have maintained their dominance at the top of the Emerging Trends ratings as can be seen in the chart below.
- Nashville
- Dallas/Fort Worth
- Atlanta
- Austin
- Tampa/St. Petersburg
- Raleigh/Durham
- Miami
- Boston
- Phoenix
- Charlotte
Nashville, for the second year in a row was the top-rated metro area, while the Dallas/Fort Worth area jumped five spots from a year ago to become the number two-ranked market. The Atlanta metro area also scored higher this year, jumping to the number three-ranked spot from number eight last year.
Reinforced in this year’s Emerging Trends is the dominance of the markets in the warmer Sun Belt regions. They top the “Markets to Watch” standings, while the number of markets in the cold-weather climates in the Northeast and Midwest decline in ranking. Quality of life and affordability play a big role in where people choose to live, and many of the markets that received lower scores this year have inadequate infrastructure for their population size and growth.
Property Type Outlook
Once again, industrial/distribution leads the pack, ranking first for both investment and development prospects, as it has for ten straight years dating back to the Great Recession. Multifamily housing continued to be in a strong second place position. However, beyond the major property types, 2023 may be known as the year “niche” property types came into their own. Two of the highest rated niche subtypes are life-science facilities and medical office. These sectors generally command greater returns than the traditional product types due to higher cap rates. But investors also value the strong demographic tailwinds supporting these niche sectors at a time of expectations of cyclical market challenges.
Life Sciences
The life-sciences industry is flourishing amid record levels of venture capital funding, continued investments in research and development (R&D), and burgeoning investment in local ecosystems that will bolster long-term industry expansion in core clusters and emerging markets alike.
While the COVID-19 pandemic may have shined a brighter light on the opportunity to invest in this niche sector, the industry has been gaining momentum prior to 2020. The convergence of science and technology has been the ultimate growth driver in this industry for the last decade, leading to quicker development of breakthrough drugs and innovative therapies. The added volume of funding served only to accelerate activity faster than what occurred before the pandemic.
Developments underway or being converted totaled 26.8 million square feet at midyear 2022, over 40 percent of which has been pre-leased. When planned and proposed projects are included, the volume swells to 70 million square feet. Speculative development has never been quite this active within the life-sciences industry. Due to rapid tenant growth, investors and developers had to move quickly to capture demand, especially given speed-to-market needs of growing companies. A majority of leasing activity was driven by expansions and new leases, accounting for 62 percent of leasing volume since the onset of the pandemic, reflecting overall industry growth trends. The most mature market clusters are generating the greatest level of demand and investment activity, but expansion into emerging markets is starting to take firmer hold. As institutions, universities, and local communities invest in the development in innovation communities, talent pipelines and incubator space for growing startups, more markets will capture the growth of the life-sciences industry.
Medical Office
The future looks bright for medical office. The U.S. health care system supports an insured population of more than 300 million people and represents over 18 percent of U.S. gross domestic product. A large part of the medical real estate that supports the industry is represented by medical office buildings (MOBs). Occupied by medical tenants, MOBs are facilities where services and procedures are performed on an outpatient basis. Many of these buildings are located out in the community in convenient areas for patients to drive to. They might be occupied by practitioners of various types of specialties, ranging from urgent care to dialysis center to ambulatory surgery centers and of course, regular physician offices.
At the end of 2021, there were over 36,000 MOBs in the United States comprising more than 1.6 billion square feet of space. This amounts to roughly $498 billion in market value. On a square footage basis, over half of the sector is owned by users of the real estate (hospitals, provider, and physician groups). The remainder is owned by REITSs and private investors. This represents a substantial amount of opportunity for investors to take on more ownership.
Looking ahead, many factors will continue to push demand for medical office space on an upward trajectory – the aging population and the growing number of insured people needing care, the increasing move by health systems and hospitals to locate services in more convenient, community-based areas, and advancements in health care technology and care delivery that require the space to support it. With reliable performance and very little speculative construction, combined with the availability of industry-specific data, medical office has been maturing into an attractive and stable commercial real estate class.
Summary
As one CEO of an investment management firm stated, “The short-term risks are real, and I’m not making light of any of them. But if you have the long view, I don’t think it’s time to panic.” For the most part, commercial real estate professionals interviewed in the survery remain reasonably upbeat about longer-term prospects.
It makes sense that real estate experts would take the long view given the nature of real estate assets: buildings take a long time to conceive and develop. Even simply acquiring one typically takes more time (and effort) than buying just about any other type of financial asset, and they are usually held for longer duration. Still the willingness of so many people in the industry to look beyond some of the cyclical headwinds is striking. Says the head of advisory services for a commercial real estate firm, “The recession – if we have one – will obviously impact some markets worse than others, but it’s just like anything else. We’ll look back in 10 years, and the prices that seem astronomical today will seem like a bargain 10 years from now.”
