U.S Commercial Real Estate Outlook 2023: Navigating Challenges and Embracing Transformation

​Discover the key trends shaping the commercial real estate landscape in 2023, including the impact of high interest rates, a moderate recession, evolving work dynamics, ESG considerations, and decarbonization efforts. Stay informed to make strategic real estate decisions.

Highlights:

1. Overview
2. Capital Market
3. Industrial & Logistics
4. Data Centers
5. Life Science

​A Challenging Year Ahead Overview 

As we step into 2023, the commercial real estate industry faces a unique set of challenges and opportunities. In this overview, we delve into the major trends that will shape the landscape and offer insights to help you navigate the evolving market.

From the impact of high interest rates and a moderate recession to the transformative effects of ESG considerations and the digital economy, we explore how these factors will influence real estate demand and investment decisions.

1. Impact of High Interest Rates and Recession: Despite a slight easing of inflation, high interest rates persist, making 2023 a challenging year for commercial real estate. The Federal Reserve will continue raising rates until inflation shows a significant reduction toward its 2% target. As a result, weakening fundamentals and a higher cost of capital are expected to lower asset values across various sectors.
2. Moderate Recession Outlook: While a recession looms, it is anticipated to be relatively shallow. Healthy corporate finances and the reluctance to lay off skilled labor in a tight market will mitigate the depth of the downturn. Although consumer confidence remains subdued, average household debt is comparably low compared to previous recessions. Unemployment is unlikely to breach the 6% mark, indicating a moderate downturn.
3. Embracing Change: ESG and Digital Economy: Amid economic headwinds, the pace of change in the real estate industry will not slow down. Environmental, Social, and Governance (ESG) considerations and the growth of the digital economy will continue to drive real estate demand. Companies and the office sector must adapt to the benefits of hybrid working models. Cities will need to accommodate evolving commuting patterns and reduced office space requirements.
4. Retail Resurgence and Resilient Sectors: The retail sector is experiencing a resurgence, attracting significant investor interest after a period of transformation. Data centers and industrial real estate are expected to be the most resilient sectors. The multifamily sector stands to benefit from the housing shortage. The hotel sector will continue its recovery from pandemic restrictions, while life sciences activity may temporarily ease due to limited venture capital availability.
5. Decarbonization Efforts: In response to environmental concerns, governments, occupiers, and investors are pushing for significant decarbonization efforts across all sectors and locations. Meeting sustainability targets will become a priority for real estate players, impacting investment decisions and shaping the industry's future.

Conclusion: As you plan your real estate strategy in 2023, it is crucial to consider the prevailing trends that will define the year. High interest rates, a moderate recession, evolving work dynamics, ESG considerations, and decarbonization efforts are just some of the factors demanding attention. Stay informed, monitor market developments, and seek professional advice to make informed and strategic decisions aligned with the changing real estate landscape.

​Contact us for personalized insights into how these trends may impact your specific real estate strategy.

​Investment Activity and Asset Values Expected to Drop

​The commercial real estate investment activity that started slowing down in the second half of 2022 is predicted to continue in the first half of 2023. With increasing capital costs and a drop in lender appetite, obtaining financing may prove to be challenging. However, CBRE predicts that capital will still be available for high-quality deals, such as multifamily, industrial, and grocery-anchored retail, particularly with established and creditworthy borrowers. Additionally, the market is expected to benefit from the record amounts of equity capital that continue to target real estate investment, despite the likelihood of a moderate recession in the coming year.
 
As interest rates rise, real estate asset values tend to fall, tightening financial conditions and hindering both economic activity and real estate demand. CBRE forecasts that cap rates may expand by another 25 to 50 bps next year, translating to roughly another 5% to 7% decline in values. However, multifamily and industrial properties will remain the most favored by investors due to their relatively strong fundamentals and positive long-term demand outlooks. Meanwhile, grocery-anchored retail centers, which have experienced a decade of restrained development, are expected to weather any downturn.
 
While higher capital costs may deter some buyers, large equity players who can quickly deploy their capital will still find opportunities. However, CBRE warns that these investors will likely have only a short window of opportunity. Following the Great Recession, the bottoming out of pricing only lasted around six to nine months before cap rates began to compress. Given expectations for a relatively moderate recession, the window of opportunity may be even shorter this time.
 
CBRE predicts a 15% year-over-year drop in U.S. commercial real estate investment volume in 2023. However, it is still expected to exceed the pre-pandemic record annual total in 2019. Investment activity is anticipated to bottom out in the first quarter and then gradually improve, assuming a moderate recession, lower inflation, a drop in long-term U.S. Treasury yields, and the end of rapid-fire interest rate hikes.
 
In summary, CBRE highlights multifamily, industrial, and grocery-anchored retail properties as the most attractive to investors due to demands. Meanwhile costs may prove to be a deterrent for some buyers, but large equity players who can efficiently deploy their capital will still find opportunities. The window of opportunity, however, may be relatively short, lasting only around six to nine months based on past trends. Investment activity is predicted to drop in 2023, but a clearer economic outlook should emerge by Q2, reducing uncertainty and bolstering investor sentiment. 

Industrial & Logistics: Supply Chain Diversification and Location Optimization are Key

​In 2023, companies will strive to diversify their product sourcing to mitigate potential disruptions to their global supply chains. The ongoing war in Ukraine, inclement weather, labor issues at U.S. ports, and China's port shutdowns all pose potential risks. As a result, companies will adopt a "China Plus One" approach, adding other countries to their supply chains or shifting manufacturing to other Asian countries. There is also a trend towards onshoring and nearshoring to Mexico.
 
The shift in imports away from congested West Coast ports will benefit markets in Savannah, Charleston, Houston, and Baltimore, while onshoring of manufacturing will benefit Phoenix, major Texas markets, Atlanta, Cincinnati, Greenville-Spartanburg, and Northern Florida. Occupiers' location decisions will be driven by factors such as supply chain costs, high-quality infrastructure, and strong labor dynamics. Louisville, Memphis, Indianapolis, and Kansas City stand to benefit from the shift.
 
In 2022, there was a record 661 million sq. ft. of industrial space under construction, nearly double the amount since 2020. However, falling groundbreakings and construction financing challenges will lead to a decrease in completions by 2024 and a shortage of first-generation space. Despite this, industrial leasing activity is still expected to be solid in 2023, led by 3PLs who are outsourcing to deal with inventory, labor shortages, and rising transportation costs. However, in markets with an excess of construction deliveries, concessions such as free rent and higher tenant improvement allowances may be required.
 
In summary, U.S. Real Estate Market Outlook for Industrial & Logistics in 2023 will require supply chain diversification and location optimization to mitigate potential disruptions. Risk-management firms need to look at opportunities that'll come up following the supply chain diversification, such as expansion close to the new sources and shifts in imports among the ports.

​Data Centers: Power and Land Availability Constraints Expected to Slow Future Supply

​The expanding need for data centers is being driven by the transformation of digital infrastructure resulting from the shift towards hybrid cloud environments as a way of adapting to a post-pandemic world. Despite the growth witnessed in the industry, the future supply is likely to slow due to land and power constraints. The problem is particularly evident in major markets like Northern Virginia and Silicon Valley, where the demand for wholesale colocation inventory has more than tripled to 3.71 gigawatts (GW) since 2015. Although there were 1,600 megawatts (MW) under construction in major markets in H1 2022, a lack of space and power is likely to constrain further development in primary markets in the coming year.
 
The hypervisors are the dominant users, but enterprise demand has also increased in the data center market. Rent is, therefore, expected to increase with space availability and power having the most significant influence on asking rates in 2023. Hyperscale demand will continue to grow, with developers expanding their offerings in secondary markets with more affordable land, better power supply, and tax incentives, such as Omaha and Salt Lake City.
 
Data center operators face pressure from various stakeholders, including the government, financial markets, and corporate clients, to make their facilities more sustainable. The growing scrutiny over the large amounts of water needed to cool data centers is raising questions surrounding water resources. Consequently, large technology corporations in water-stressed areas are expected to adopt new technology to minimize water usage in 2023.
 
Site selection is expected to be influenced significantly by environmental considerations, with markets like Montreal and Hillsboro, Oregon, benefiting from an abundance of clean energy. Conversely, markets like Phoenix and Las Vegas will face challenges because of tighter resource restrictions. Consequently, data center providers and users will seek to find ways to minimize their carbon emissions in 2023.
 
In summary, U.S. Real Estate Market Outlook for Data Centers in 2023 will likely experience a slowdown in future supply, with power and land availability being the primary constraints in primary markets like Northern Virginia and Silicon Valley. The activity will, therefore, shift to secondary markets, where there is more power capacity and affordable land. Data center operators and users will also focus on finding ways to reduce carbon emissions and promote sustainability.

​Life Sciences: Normalization Expected with New Construction in Key Markets

​The life sciences sector in the U.S. has experienced rapid growth in recent years. However, in 2023, the market is expected to moderate due to the economic slowdown. Nevertheless, the life sciences real estate market should remain relatively resilient, with new construction set to increase supply in the most sought-after lab/R&D markets of Boston-Cambridge, the San Francisco Bay Area, and San Diego. Other markets will experience more stable supply and demand trends as the long-term expansion of the life sciences sector continues.
 
Despite the economic challenges, the life sciences industry has a history of resilience during economic downturns and is expected to exhibit milder declines than most other sectors in 2023. Several megatrends, including the rising demand from an aging population, higher healthcare costs, and the need for more effective and cost-efficient therapies, all support the relative stability of life sciences employment. Moreover, rapid advances in high technology and artificial intelligence are driving transformative medical advancements.
 
The industry's response to each phase of the business cycle also creates stability in the market. During favorable cycles, smaller companies with innovative research remain independent, but during less favorable cycles, they become more open to partnerships and mergers and acquisitions with larger-cap firms. As the industry entered the current cycle, the largest pharmaceutical and biotechnology companies accumulated historic cash balances and have now started using this capital through partnerships, acquisitions, and other activities to stabilize smaller companies showing promise.
 
The ongoing reduction in venture capital funding and dearth of equity financing is causing many life sciences companies to slow their expansion. The annual venture capital investment in the life sciences arena has decreased by 27% since its peak in Q4 2021. However, the government has expressed commitment to bioscience investment, with proposed funding from the National Institutes of Health expected to increase significantly in fiscal year 2023. Additionally, the Biden administration is investing $2 billion to expand the U.S. biotech and biomanufacturing sectors. Such government policies are expected to alleviate the impact of a lack of private capital funding.
 
The life sciences real estate market slowdown and pullback in private capital that has lessened current demand for commercial real estate are expected to continue in 2023. Many occupiers and investors wait on the sidelines until there is greater clarity on the trajectory of interest rates and the economy. However, with a historic amount of new life sciences laboratory/R&D construction underway, mostly in the premier clusters of Boston-Cambridge, the San Francisco Bay Area, and San Diego, smaller, emerging markets are also expected to experience favorable demand for multi-tenanted lab/R&D space.
 
In conclusion, the U.S. Real Estate Market Outlook 2023 for Life Sciences presents challenges and opportunities. Although the market is expected to moderate due to the economic slowdown, the life sciences industry has a history of resilience during economic downturns. Emerging markets and government policies, such as bioscience investment, continue to offer opportunities for growth. The industry's response to each phase of the business cycle, in addition to new construction, will also provide stability to the market. 

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