2024 Drivers of Change

Positioning for an upturn

At a glance:

  • With inflation reducing and general elections ahead, interest rate cuts are expected to spark new economic growth.
  • Cultural shifts, like hybrid work and online shopping, keep impacting real estate fundamentals across property types.
  • Well-positioned buyers see opportunity ahead, and it’s a question of “when” not “if.” 

Players position to take advantage of property investment upturn 

Across the world’s advanced economies, inflation is currently on a downwards trajectory, and economists and investors are now debating when the first interest rate cuts will happen.

The financial markets are pricing in central bank interest rate cuts in the first half of this year for Canada, the Eurozone, UK and USA, however financial pundits, certain central bank leaders and politicians are openly debating the impact of moving too early or too late. We believe the Bank of Canada may be the first to cut given the recent GDP figures suggest that sluggish growth is now becoming a far more pressing issue than inflation. However, the Fed, ECB and Bank of England are unlikely to be far behind, as supporting the economy becomes the main priority for policymakers in 2024. The politics of upcoming general elections throughout the world may make cutting rates early in the year coincide with world leaders promises of better economic conditions.

While world leaders are making promises, what are economic experts saying?

Oxford Economics is forecasting 10-year government bond yields for the leading western economies to steadily decline over the next two years, which will ease pressure on real estate cap rates by making them appear relatively attractive. Indeed, government bond yields are already declining and some market commentators argue the lagging nature of inflation metrics are masking a greater than anticipated reduction in inflation.

Quarterly GDP Growth Annualized | Forecast from Q4 2023 onwards

Real estate fundamentals impacted by both lifestyle shifts and new debt market parameters

The sharp rise in interest rates and the rapid decline of liquidity and lending in the last two years has contributed to price corrections across real estate markets around the world, with all the main sectors impacted to some degree. This has sparked a crisis of confidence for parts of the office and regional shopping center markets. Concerns have grown over the popularity of flexible working, work-life balance and safety in our large cities and what this will mean for demand for urban offices. For retail, online has been snaring a growing share of retail sales online even before 2020. Then the pandemic increased the number of people who shopped online dramatically. Even though many people gradually drifted back to offices and shopping malls in 2022/2023, numbers are still down compared to pre-Covid and it is apparent that a sea change in attitudes has occurred. In many office markets, there is now a trend towards smaller but higher finished and amenitized offices near transport hubs in key city centers.

"We’ve expected 2024 to be the turning point, and as we look ahead at recovery and growth, we also look for impact. Cities and communities are facing big challenges: office utilization, housing affordability and supply, climate resilience, safety, and infrastructure. Economic recovery is top of mind, yet it is closely connected to our social and environmental well-being, and both public and private sector leaders will need to step toward solutions and strategies together."

- Mark Rose, CEO & Chair, Avison Young

That interest rates are set to fall in the coming year will alleviate pressure on underwriting real estate investments, but for some heavily leveraged buyers the projected rate cuts will probably be too little too late. Policy interest rates have risen by 450 bps in the Eurozone, 475 bps in Canada, 515 bps in the UK and 525 bps in the US since Q4 2021. The rapid increase means some real estate owners will find certain assets are no longer economic when the debt comes up for refinance in 2024, and they will need to sell or surrender properties. Figures from the Mortgage Bankers Association show US$117 billion of mortgages on US office buildings will come up for refinancing in 2024. The majority of that sum will be successfully refinanced, extended in negotiated transactions or repaid, but there will be some forced sales and assets being handed over to lenders.

Central banks are expected to cut rates because the economy is forecast to slow in 2024, particularly during the first half. There is a question whether we were in recession in 2023 and have avoided a more significant downturn.  A further economic slowdown could reduce occupier demand for real estate further, and in some instances put downwards pressure on rents. Therefore, prices for secondary quality assets in the investment market, particularly buildings in the more troubled parts of the office and retail markets, will face further short-term price falls. 

New York City skyline with commercial office, retail and multifamily properties

Unique investment opportunities are clearly emerging

We see 2024 as a year of improvement, but with the first half as a time real estate markets will be sending some contradictory signals. In response to a slowing economy, we believe rents and values will fall in some occupier markets, attracting negative headlines. This will impact decision making for class A assets and further devalue the demand for secondary assets. Higher interest rates for longer, slowing demand and the potential for recessionary signals will further impact pricing and fundamentals. With that said, the “bad news” is mostly out and is playing into the hands of the biggest and best capitalized companies. Prime assets in sought after markets and portfolio acquisitions are in the sights of top institutional players.  Our markets have hit the low point in the cycle and the question is “when”, not “if” it makes the next move- which is recovery. Out of the difficult cycle we are experiencing, opportunities are presenting themselves. Money is made at the lows and periods of distress. Opportunistic buyers will have the attention of sellers on potential deals. 

How bullish or bearish an investor feels in the first six months of 2024 will depend greatly on what stock they are holding, and those with prime, well-located assets are unlikely to be panicked or sell at bargain prices. However, for older, large floor plate offices in tier two markets, or secondary quality shopping malls, buyers will be in a stronger position to negotiate down the price. The largest private equity players are writing off billions in value and at the same time raising new billions from various investors to take advantage of the very assets that have been written down.

In retail, real estate prices have now been under pressure for many years and bargain hunters will be examining its sub-sectors for instances of prices having over-corrected. In contrast, in the residential market, despite the price falls in 2023, seller confidence may quickly return as supply has not surged during the downturn.

Oxford Economics is predicting GDP growth will be subdued in H1 2024, but strengthen in H2, then gain momentum in 2025 in Canada, the Eurozone, UK and USA. In our opinion, a combination of falling interest rates and the approach of a new economic cycle will draw real estate investors back into the market to make acquisitions; initially targeting prime assets in core markets, with industrial, multi-residential, data center and storage stock drawing strong interest. The early months of the year will largely involve market research, price discovery and negotiations, but from late spring we believe deals will begin signing, pushing up transaction volumes. We are forecasting cap rates to peak for prime assets in the coming months, then gradually fall during H2. For secondary assets and tier two markets, we see the peak for cap rates coming later in the year, when we believe developers will be looking for older assets that need to be refurbished or redeveloped to bring them into line with new ESG regulations and meet the growing demand for green buildings from tenants.

Overall, 2024 looks set to be a turning point year in our opinion, as investors position themselves for improving economic conditions in the second half, followed by stronger GDP growth in 2025.

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