2024 Summer Issue of Urban Land - 53

percent-still well above the Fed's 2 percent
target.
" We believe that we're actually going
to be in a structurally higher inflation
environment for quite some time, " says
Paula Campbell Roberts, managing
director, chief investment strategist for
global wealth at KKR. " There are structural
forces that I think keep us in this
train where we're just going to have
much more inflation volatility. " Those
forces include investment in energy
transition, geopolitical competition, persistent
labor shortages, and AI that is
driving demand for both people and
power.
Another inflationary force to add
to that list is the federal deficit, notes
Rosen. The United States is running
a deficit of roughly $1.7 trillion, and
governments throughout history have
inflated their way out of too much deficit.
Rosen's base forecast is inflation at
3.5 percent, which is likely to affect the
Fed's willingness to reduce interest rates,
thus setting the stage for interest rates
staying higher for longer. Rosen also
was quick to remind industry participants
that current interest rates of 4.5
percent are still " reasonable " by historical
standards.
Transaction volume poised
for improvement
Although still weak, transaction volume
is expected to begin climbing from a
low of $378 billion, recorded in 2023,
according to MSCI Real Assets. The ULI
forecast predicts that transactions will
gradually notch higher to $610 billion in
2026.
Even in a higher rate environment,
the improvement in transaction volume
is achievable, though volume might not
rise as steeply in 2025 as the forecast
predicts, notes Roberts. One of the big
factors that muted transaction activity
last year was uncertainty. " That part
of the puzzle, at least, is solved, " she
says. " No one believes we're headed
higher from here. " The question remains,
however, as to when, or if, rate cuts will
occur, as well as the ongoing price discovery
happening in the market.
Price discovery and a reset in property
values are expected to help thaw
activity in the transaction market. " We
haven't had a market clearing price yet
for the excess commercial real estate
that's out there, " notes Mark Grinis,
Americas real estate, hospitality & construction
leader at EY. Based on the
MSCI Commercial Property Price Index,
the ULI Forecast projects that valuations
will hit bottom in 2024, falling another
5.0 percent this year before reversing
course with value gains of 2.0 percent in
2025 and a bigger bump of 4.0 percent
in 2026.
Yet this picture of " gloom and doom "
in commercial real estate is exaggerated,
says Grinis. According to Trepp, CMBS
delinquencies are at 4.7 percent overall,
which is half what they were during
the Great Financial Crisis. With roughly
$800 billion in maturities coming to the
market, most of them probably will be
paid off or extended. " There's going to
be distress; I just would be hesitant to
say it's a flood, but there will be opportunities, "
he says.
Many investors are hoping to capitalize
on the opportunities ahead. " I look at
this investment environment [as being]
like the early '90s. It's going to be the
best single vintage of investments in
2024 and 2025 as price expectations
are reset and the market resets, " Rosen
says. The challenge, even with the lower
prices, is the negative leverage. " But I do
think this is going to be a great investment
environment, and the volumes will
go up as people capitulate, and they
capitulate through selling, or they may
capitulate through a foreclosure or other
things, " he notes.
Retail fundamentals shine
Retail has made an impressive turnaround
from a down-and-out sector to
one that has taken a lead position for its
strong fundamentals. That success story
is largely due to limited new construction,
and to owners that have successfully
backfilled vacancies with a more
diverse variety of tenants ranging from
medical office to entertainment.
Retail properties are anticipated to
yield the highest returns over the threeyear
forecast period, averaging 4.6 percent
annually. Although industrial and
apartments are experiencing some nearterm
softening due to an influx of new
supply, both are projected to continue
to post positive returns. Industrial and
apartment properties are forecast to
have average annual returns of 3.3 percent
and 3.2 percent, respectively. Not
surprisingly, economists predict ongoing
difficulties for the office sector, with an
expected average annual return of less
than 1.9 percent until 2026.
Office is continuing to struggle with
hybrid work models that have pushed
vacancies in some metros in excess of
20 percent. The ULI Forecast predicts
that vacancies will rise another 150
basis points during the next two years,
before a slight improvement in 2026.
In addition, office rents are projected
to contract by an average of 1.1 percent
annually during the next three years.
" There's a survey out there that says
by 2026 everyone is going to be back
in the office, " Grinis says. " As much as
we would like to think that would be
nice, as real estate folks, that's not going
to happen. " The reality is that 80-plus
percent of people want the flexibility
of being able to work remotely, at least
part of the time, and surveys have
shown that a high number-45 percent-have
said they are willing to quit
if they don't get it, he says. So, he adds,
the solution for office is probably going
to require time for supply and demand
to fall back into equilibrium.
It is difficult to paint the entire commercial
real estate industry with a single
brush. Investors are finding opportunities
by taking more of a micro-view of different
property sectors and geographic
markets. In multifamily, for example,
there's a lot of talk about oversupply
and depressed rent growth in many
markets. On the other side of the coin,
there are examples such as Boston,
which is still producing 10 to 15 percent
increases in rent.
" This will be a transition year overall
for real estate, but I don't think that
means sit on the sidelines, " Roberts says.
" You don't want to wait until everyone
gets the joke about the opportunities in
real estate. " It's important to have local
market expertise and be able to pivot
to different asset classes and markets
where there are opportunities to acquire
an asset at a discount to replacement
cost, she adds. UL
BETH MATTSON-TEIG is a Minneapolis-based writer.
SUMMER 202 4
URBAN LAND
53
ULI MEETING COVERAGE
2024 Summer Issue of Urban Land

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