Predicting the future is often an exercise in crystal ball gazing. When prognosticating what lies ahead for real estate, the best we can do is forecast using available data. With accurate historical data and the right tools, it is possible to conduct trend analyses on how the market might react to changing variables. The past few years have made this challenging, as whatever assumptions we previously made about the future of real estate were flipped on their head. Bottom line? The slate has been wiped clean, and we must work off an entirely new set of assumptions.

Before commencing, it is worth adding a small disclaimer. In this article, we are not offering any investment advice. We are only making observations and educated guesses based on the current state of the market.

A Minor Recession

Many experts, including those at JP Morgan Chase, predict a small recession for the coming year. Inflation has risen to the point where the Fed has had to boost interest rates to try and curb spending. Interest rate increases are intended to cool an overheated market and lower demand for goods and services, including large ticket items and mortgages on new homes. The cumulative impact of this can have recessionary consequences.

Fortunately, most experts are predicting that if there is a recession, it will be shallow and short-lived. The latest interest rate hike by the Federal Reserve was in early May of 2023, and rates now stand between 5% and 5.25%. As explained by Fed chair Jerome Powell, the reason for these increases is apparent: the Fed’s primary focus is to bring down inflation which hit a 40-year high in the wake of the pandemic. The Fed has also hinted that this rate hike may be the last, which bodes well for economic recovery, restores confidence, and provides the ingredients required to set markets back in an upward direction by the fall. Though this is good news, we still need to reconcile ourselves to the reality that what we have just gone through will permanently shift traditional working patterns, impacting the real estate landscape.

Shifting Habits

One of the most significant changes that has unfolded during the past three years has been a pronounced shift in traditional working patterns; more specifically, the rise and normalization of remote work. The degree to which companies have adopted this varies from hybrid work (i.e., a combination of in-office and remote work) to fully remote. Recent reports suggest remote (or at least hybrid) work is here to stay, but some large corporations are now pushing back and mandating a total return to the office. Where this ends up is still anyone’s guess.

The concern about such trends is evident from a commercial real estate perspective. Even a fractional change in work patterns from traditional to hybrid or remote will reduce the demand for office space, impacting the value of those assets. Hybrid work, reduced commuting, new pedestrian traffic patterns in city cores, and new shopping habits all combine to change the value proposition of multiple categories of commercial real estate.

It is essential to be mindful of the magnitude and impacts of these changes when conducting various methods of valuation of potential commercial real estate investments. Using historical sales data and comparable property sales that are over a year old will likely yield an inaccurate picture of a property’s value, given how quickly the underlying dynamics of commercial real estate have changed.

In-person retail shopping, which was significantly affected by the weight of the pandemic, is returning to normal levels as more and more people feel comfortable returning to location-based shopping rather than solely or predominantly relying on online ordering and deliveries. This is combined with pressures to add more contactless and hybrid shopping options, with various app, AR, and even VR solutions being explored with varying enthusiasm. Thus, in the long term, technological innovation will dictate the longer-term outlook of this sector.

Some more resilient, stable, and predictable kinds of commercial real estate can be found in industrial properties and data centers. Global geopolitical issues are increasing interest in domestic manufacturing, making such properties valuable. Data centers are evergreen, as internet usage and the demand for server space will continue growing. The shifting dynamics of retail are best evidenced by companies like Amazon and their ecosystem of manufacturing, warehousing, and delivery partners. Will we see an increase in industrial and warehouse real estate demand?

The hospitality sector, including hotels and other travel-focused real estate, continues recovering from pandemic restrictions, as people’s pent-up demand to leave their homes has resulted in a surge in demand. That said, other variables that might impact the long-term outlook will also be affected by the rise in the online marketplace for short and long-term rentals from companies like Airbnb and Vrbo. Still, in the short term, demand is up, and the sector is returning to pre-Pandemic levels.

Environmental Concerns

Many factors contribute to increased environmental consciousness in many realms, including at the corporate level. For many large organizations, being a good and responsible corporate citizen is mission-critical and crucial to brand building. This priority expresses itself in many ways, including at the social level. Implementing measures to mitigate events like pronounced extreme weather events, nuclear accidents, and rail disasters that cause environmental damage plays a crucial role in fostering a brand’s image through social responsibility, particularly for big enterprises that are acutely aware of these risks. Events such as these highlight the ongoing need to protect the environment.

Combating environmental degradation is a complex issue that can take organizations in multiple directions, but one area continuing to gain traction is decarbonization. Investors will be challenged to balance making their buildings greener to attract tenants against the future demand for office space. For such efforts to take hold, property owners must invest substantially in making their assets more environmentally friendly and reducing their carbon footprints.

Room for Growth

While traditional retail is on the upswing, such growth may plateau. E-commerce only accounts for around 20% of user buying habits. This relatively limited market share is partly due to the need for more infrastructure to fully maximize the efficiency of the overall promise of what e-commerce can deliver. Amazon is one of the few companies with a rapid shipping infrastructure. Still, the scale of their growth has created a predictable social backlash, as consumers are becoming aware of Amazon’s quasi-monopolistic grip on e-commerce. As much as consumers would like to support the brands to which they have traditionally been loyal, most of these retailers don’t have the infrastructure necessary to compete with Amazon’s efficiency. As the space becomes more competitive, there will be an impact on the retail real estate landscape.  

This means there’s room for significant investment in growing domestic logistics facilities. We will likely see more of everything from transportation to the warehouses necessary to store products nearby their destinations. Some experts even predict this is the start of a ten-year trend, so the future of this sector remains bright.

Mixed-Use Properties

Over the past decade, the traditional shopping mall has become more of an antiquated relic from a bygone era, and the pandemic may be the catalyst delivering the final death knell to the sector’s ongoing sustainability, at least in the traditional ways in which we perceive those assets to be used. Anchor stores that used to provide the foundation of a mall’s success are increasingly folding and pulling out of large malls, often leaving these facilities in chaos, if not disrepair. As many of today’s regional shopping malls stand as this generation’s equivalent of a drive-in movie theater, what was once a symbol of progress and prosperity is now more symbolic of an era that once was.

With these changes comes a fascinating shift in malls in select cities, where regional governments encourage redevelopment of these properties and pronounced shifts in their use. Various experiments are being conducted, including options such as converting malls into mixed-use housing and commercial spaces, shelter for the unhoused, or experiential retail.

Such properties are currently a difficult sell – large properties with immense amounts of deferred maintenance usually are. Still, if repurposing efforts gain traction and become successful, it might reignite interest in this sector. Given the magnitude of change required, the time horizon for such a transformation remains unclear. Though no single trend has yet emerged as a clear frontrunner, it will undoubtedly become a space to watch while making that critical, highest, best-use determination.

Considering Trends

A variety of trends are picking up across the country, often in barometer regions that tend to be the leaders in change across the country.

Across regions, the trends that gain momentum often act as a barometer for viability in other areas. Some of these trends include:

• Re-Zoning. Various municipalities, particularly in urban areas looking for increased density and expansion, are considering re-zoning from commercial to residential or mixed-use properties. Converting properties from purely commercial to mixed-use – where zoning can be changed to accommodate it – will likely be a notable trend in the coming years.
• Going Green. As previously stated, there will likely be a push toward decarbonization, particularly in the construction and operation of facilities. In the past, much of this has been offset with carbon credits, but new mechanisms must be considered and implemented as credits eventually come due. 
• Risky Global Investments. Various geopolitical problems will likely challenge investing in international commercial real estate. The ongoing war in Ukraine, political tensions in China, and political unrest across the board have led to uncertainty in many markets. It will be difficult to predict what direction political winds will blow, so maintaining familiarity with how these impact investment opportunities will be essential.
• Tax Credits. Since property taxes are generally the single most significant expense in commercial real estate, investors should look to see what kinds of tax credits they can use if they shift their focus. Many tax credits are currently offered for specific categories of real estate investment. Typical areas of interest include credits for low-income housing, qualified opportunity zones, and historic and brownfield credits.

• Long Lease Confidence. After enduring the uncertainty of the pandemic, many commercial property owners are starting to regain confidence and seeking to enter lengthy leases with anchor tenants. This is predicated on several factors, including interest rates, inflation, and demand. However, given the unpredictability of market movements, locking in long-term tenants could change the trajectory of a market perceived to be in a state of decline.
• Collapsing Office Space. While office spaces may return in the future, that return will likely occur over a longer time horizon. While the demand for office space is down, it will likely worsen before getting better. The business world is still adapting to various social and real pressures to increase productivity and cut costs. Despite the push to return to the office, significant resistance makes it unlikely this year.

Overall, commercial real estate offers a mixed bag. Only 40% of investors expect revenue to increase this year (down by half from 80% last year). Given this variability of factors, that uncertainty and an unresolved outlook for the future will leave commercial real estate as a somewhat speculative investment. Given the circumstances, some investors will strike gold, finding the right properties for the right uses at the right times. Others might make riskier choices, which may be less fruitful.

A Year of Opportunity

If there is one thing we can proclaim with certainty, it is that 2023 is a year of both significant opportunity and pronounced risk. Investors with a greater ability to absorb risk will have more options, some of which will win big and others that won't—as with any investment, predicting what falls into what category will be difficult. The more risk-averse investors will likely find relatively little regarding reliable investments that have not already been picked over. Given these circumstances, thorough due diligence will be more critical than ever.

By its very nature, commercial real estate investment has always been marked by contrasts, with ups, downs, cyclical trends, and various investments of varying quality available across the board. Focusing on one’s investment efforts, removing confounding and irrelevant data, and tracking the potential returns of any investment will remain as important as ever.

The Importance of Data and Insights

With the rise in machine learning and data-driven decision-making, the way investment decisions will be made is fundamentally changing. Traditional investors may find themselves forced to alter their approach to investing. Decisions will no longer be made simply by gut feeling or following familiar patterns of the past. Technological advancements in fields such as artificial intelligence will assist in making decisions and change how decisions are made.

One thing is certain—data is critical for evaluating investments across the board. Forecasting costs as accurately as possible will be a requirement to make narrow-margin investments work out.

Savvy investors should consider itamlink to help manage, and even forecast, property taxes. By importing data from various sources, (mainly through APIs,) errors and human mistakes will be minimized. Forecasting always has an element of uncertainty, but the more historical and current data you have available from unbiased sources, the more accurate you can be in your decision-making and the more confidently you can invest.

If you need automated and detailed tax management and expense forecasting, consider booking an itamlink demo today. Additionally, if you have any questions about the health of your property tax operation, we are more than happy to chat with you.