WMRE: Can you talk about how the U.S. economy—from increased interest rates and high inflation—is going to impact the CRE space heading into the new year?

John Chang: The outlook is really complex this year. I can't think back in the 20 something years I've been doing this where it was, at an end of a year, so complicated, and the ball can bounce a variety of different ways. But right now, what it looks like is inflation is coming back in. It's still high, it's 7.1 percent, but it is starting to come back down. A lot of that has to do with supply chains, and the thing that makes it particularly complex is we're trying to guess what the Federal Reserve is going to do.

Now, based on their statements, we believe that they're going to start to level off the overnight rates. We're expecting a 25-basis-point increase at their next meeting on February 1 and then let it rest for a while. And so if that is what happens, then that is going to be very helpful. If there is some sort of challenge—like right now, China is dealing with severe COVID issues and that foils their supply chains and it starts to shorten up the supply of goods, we could see inflation start to move back up—then the Fed could take different action. So, so much of the outlook for ’23 depends on what the Federal Reserve does. But right now, we're really hoping that they they let it rest.

WMRE: Is there any advice that you have for CRE investors for 2023?

John Chang: It’s going to be a very complex year. It’s going to be very choppy, from a transactional standpoint. There's going to be a lot of disconnect between buyers and sellers. But my recommendation to investors, if they plan on selling a property, they need to move to market. They need to get to the market rate and move that property. If they want to sell, they can't chase the market because they're going to chase it down. And where they're going to end up is below where they would be if they moved to market right away.

From a buyer standpoint, don't get caught up in the number today. Look at where you see that asset in five years. Over the longer term, this could be a very good year to make those acquisitions. Because when the interest rates stabilize, there is a tremendous amount of capital waiting on the sidelines and it's going to come back in in a wave.

WMRE: One of the key findings from Deloitte’s 2023 Real Estate Outlook that I thought was interesting was about how owners and investors are targeting the office space. Can you talk about this?

John D’Angelo: Our survey—it's global. So, if you look at the 450 respondents we had, they're pretty much equally spread across EMEA (Europe, Middle East and Africa), North America, and APAC (Asia-Pacific). So, if you blend all that together, downtown office came up as the top for risk-adjusted returns, but for the U.S., it was fifth and suburban office was way down the list.

I think the way you square that circle with office and how it's popping up is: anecdotally, a bunch of cities, particularly in Europe and APAC, saw a more robust return to office when we surveyed than was the case in the U.S. You figure there's inevitably going to be more returning to the office and figuring that there was already some pricing built into a central business district office that made it attractive. I think that's how you got optimism about it as a place to invest globally.

And in the U.S., it’s certainly less so. I think what we're seeing is a little bit of a catch up after the office environment saw not very much physical occupancy for a year and a half. So, I guess you blend all that together and investors are looking at opportunities for something that's already been repriced. Our view is return to office continues to evolve. It's not just going to be exactly like it was. Employers of choice are thinking responding, sensing, resetting their return-to-office policies. And I think that's going to continue into ’23.

WMRE: Deloitte’s report also noted the importance of environmental, social, and governance priorities in 2023. Can you discuss that?

John D’Angelo: If there's ever a lull in conversation, it's a layup to bring up ESG with real estate companies and liven up the conversation—and I don't mean to be glib about it. Whether it's driven by what looks like regulatory and reporting pressures, investor pressures or broader stakeholder pressures, there's a level of intensity about environmental and social topics in the built environment that I've never seen before. And I think that's certainly borne out in our survey results.

The Inflation Reduction Act certainly is helping a lot with incentives. So there [is some interest] driven by occupiers of that space who need to understand the performance of the built environment as they're making site selection choices, and then investors [are thinking] about what's the environmental performance? And how do the management teams that they're investing in think about it, underwrite it and drive performance? Do those people understand how to keep an asset relevant?

WMRE: What is one top-line opportunity you see in commercial real estate next year, especially for the first six months or so?

Rebecca Rockey: If you are prepared for distress, then you will have opportunities to be first in line as delinquencies and defaults pick up. During recessions, this is inevitable. It doesn’t mean we get to [Great Financial Crisis] levels of defaults but we will see opportunities arise in distress next year.

If you are targeting a more conservative investment profile, some sellers of high-quality assets may also be facing certain circumstances that will require or encourage them to sell, even if they would prefer to hold. Fund manager or sellers facing loan maturity, end of fund life or even redemption requests may decide to meet the market and sell at relatively attractive going-in yields (at least in comparison to where yields were just six to nine months ago). This will provide active investors with some interesting options as we head into next year. We also expect to see the pool of active buyers diversify a bit, as large institutional investment managers and non-traded REITs take to the sidelines while allowing for smaller managers and private wealth investors to compete for deals as pricing and yields shift.

WMRE: What is a particular challenge CRE investors will need to keep in mind?

Rebecca Rockey: A wave of maturing debt is coming to the market at a time when financial market conditions are tightening, and lenders are pulling back. And there is more to come. The median interest rate on loans rolling next year is 3.9 percent. We already have 3.5 percent to 4 percent 10-year Treasury rates and the BBB bond rate is over 6 percent. Higher debt costs are going to affect all asset classes as repricing ensues, but I would be most focused on assets in challenged sectors, such as highly vacant office buildings. 

In addition, the era of significant cap rate compression has transitioned into an era I would characterize as “income-focused.” Without capital value appreciation driving so much of total return, the fundamentals really come into focus. Investors who can dial-in strong rent growth and occupancy assumptions, and who can execute on their business plans will be best positioned moving forward.

This is a challenging environment because growth assumptions are downshifting all as investors are facing negative leverage conditions for the highest-quality assets. Investors can stomach a few years of negative leverage, but only if they believe that they can grow their way out of it on the income and rent growth side. Underwriting has become increasingly difficult given both the moderating growth environment and the increased macroeconomic uncertainty, so there needs to be a lot of conviction in any deal that makes it to the finish line.

WMRE: Which asset class do you anticipate being hit the hardest by this environment that we're in, and which one do you think will feel the impact a little bit less?

Richard Barkham: The greatest uncertainty at the moment, obviously, is about the office market. [Office has] a situation where usage might be back to 60 percent—in the better space, maybe more than that. In America, the return to the office has been extremely slow, but in any case, at the moment, vacancy in the office sector is high. And so that's a sector that we might see capital value drops, particularly in maybe the B and C grades.

But of course, against that, you've got industrial continuing to have the tailwinds from good consumer demand and shift to e-commerce. Multifamily also probably rents will slow down, and vacancy is going up, but it's only going up a little. Multifamily will be hit by rising unemployment and slowing job prospects. But America is chronically short of housing, maybe four to 5 million units short. So that puts a floor on multifamily. And then other sectors that are associated with digital economy, data centers, are likely to continue to do strongly but they’re running into headwinds because of the power issue.

Life sciences—again, the fundamentals are quite good. There is a lot of drug discovery work going on. I think we had a little mini boom over the last couple of years due to venture capital availability, and venture capital has eased up. So maybe life sciences will cool for a little bit. Retail [will be] probably somewhere in the middle. We haven't built any retail for the last 15 years, so it's not as if we've got a ton of space. In fact, we're recording that occupiers can't move because there's not enough space of the quality that they want. But I don't see rents accelerating away in the retail sector. It's just that fundamentals are reasonably good, particularly in suburban areas, particularly grocery-anchored and open-air [centers]. Retail seems to be reasonably well supported and reasonably well priced.

WMRE: What do you foresee in terms of transaction volume?

Richard Barkham: We’ve just run our investor intention survey. They're showing continued desire to deploy capital in real estate with, not surprisingly, multifamily and industrial ahead of the queue. But—monetary tightening is monetary tightening. Overall, volumes will be down in 2022, in 2023, but not too far from the average of the 2014 to 2019 period. So ’21 was a pretty strong year, ’22 was a strong year benefiting from all the stimulus, [and] ’23 will be much more subdued, but there will still be activity.

And we've also done for the first time a lender survey and we do see appetite by lenders to deploy capital in real estate. Again, it mirrors the investor interest in industrial and multifamily. One of the crunch points will be the attitude of banks to the office sector in 2023 because that sector may need refinancing. It's not a whole-scale refinancing, but there is some refinancing required. Will the banks be willing to extend that finance or will it require more equity to come in, and will that equity be around? Will people take to the idea that actually people are misreading the situation in the office sector because the return to work has been slow? So it could go either way, but at the moment it looks challenging for office.

WMRE: How does the current macroeconomic environment in the U.S. today set up the commercial real estate industry for 2023?

Thomas LaSalvia: We're in a precarious position for commercial real estate. Our baseline forecast remains without a recession for 2023, but it definitely wouldn't take much on the supply side—some kind of oil shock or some other geopolitical tension boiling over that really causes increase in supply prices in addition to a drop in consumer spending—to push us over that line. So right now, not quite expecting that. We're expecting household incomes to hold up relatively well. We're expecting the labor market to hold up relatively well and consumer spending.

All of that matters so much for commercial real estate because at the end of the day, it's households, their budgets, it's how much they're willing to spend. And we know that dramatically affects, certainly retail, but also, especially over the last couple of years, industrial because of e-commerce. So, with that overtone in mind, we are expecting a full-scale deceleration in performance for CRE, but not a decline in performance.

With multifamily, for example, rent growth over last year, 2022, will be around 8 percent. That's still very high historically. We're expecting that that positive shock within the multifamily space to come to an end. And we're already seeing a lot of signs of that just in the quarter three data and in our preliminary quarter four data, even a further deceleration, to drop back towards longer-term averages, 3 percent to 4 percent annualized. And that's what we're anticipating for the first quarter and into the second quarter.

WMRE: What else do you think will be top of mind for CRE investors heading into next year?

Thomas LaSalvia: We're going to hear an awful lot about housing affordability over this next year. That's not new in anybody's mind, but it's certainly from the White House, from Congress, from local governments—housing supply, public-private partnerships are all going to be headline topics. And I think in the new year, particularly intriguing to watch will be the insurance markets.

We've already heard of some insurers pulling out of high wildfire risk areas like in California or in hurricane areas along the Gulf. It's going to be huge to follow the insurers. What's happening with premiums, and who's willing to stay in which markets? It will give us a sense of longer-term projections for how the real estate is going to behave in certain markets.

WMRE: How do you think rising interest rates and inflation will affect investor interest in commercial real estate next year?

Ryan Severino: Clearly we've seen a dampening effect. And I think that the real question is how far the Fed goes. I'm hoping, because we're seeing signs that inflation is slowing down, faster than economists would have thought. Hopefully that gives the Fed cover to really not push too far beyond that. Because I think if they get up into sort of the five-ish [percent] range, there's still a path to slow the economy down without causing too much collateral damage. And again, we're already seeing inflation slowing down without interest rates being at that level. So, I'm still hopeful that there is that path forward, that they can do that. But admittedly, that path is narrowing and it will really depend on how aggressive the Fed is willing to be.

WMRE: And when inflation and interest rates are at these levels, is there a sector that is impacted the most?

Ryan Severino: When you look at the demand side, commercial real estate has actually held up pretty well under the circumstances. I think the one exception to that from a property level point of view has been office. Number one, a lot of that has to do with factors that are just very specific to office. And number two, there are pockets of strength that have held up really well—trophy caliber assets, the really high quality assets. And that was an existing issue before the pandemic and the downturn. It's just been exacerbated over the last few years.

So, I think in terms of when you look at the space overall, it's held up pretty well. And I think that's an informative statement because we haven't really seen an environment like this in about 40 years. Commercial real estate was really just becoming more of an accepted asset class if you go back to that point in time. If anything, if you look at how well the asset class performed coming out of that, I think it portends pretty good things ahead for anybody who isn't too myopic and doesn't panic too much about the environment that we're currently in.

WMRE: What kind of impact does higher inflation have on REIT stocks, as we head into 2023?

Kevin Brown: When I've investigated the impact of inflation, there really seems to be almost no statistical correlation between REIT performance and inflation [over the past 20 years]. And the reasons are that, yes, rents do typically go up with inflation. It's not one for one, but we have seen a number of real estate sectors improve with inflationary growth.

However, that's not true across the entire board. Over time, that will eventually be true. But many of the REITs have long-term leases, like, say, office companies or mall companies, where you sign leases that are 10 to 15 years in length. And those have set terms, in terms of how they escalate over time. And so you'll be able to push through inflationary increases. When those leases come due, the market rents will be higher based on inflation. Inflation will drive market rents higher and you'll reset the rents to the market rent. But to flow that through your entire portfolio could take over a decade. So [in] some sectors, you can see immediate revenue growth, like hotels, for example, your leases turn over every single night, so you can very quickly push through rental increases. So, it's a bit mixed there.

But then you have some things that counter that, where you're paying higher labor costs. And so some sectors, the labor costs are small, but other sectors, labor costs are a significant expense and you're paying higher wages as inflation goes up. You're paying higher electricity and utility costs. So that’s something that keeps the positive impact to REITs somewhat down. And then you also have construction costs are going up. And many of these companies, sectors, they rely on development projects to support their valuations, to actively add value through their development pipeline. And as construction costs go up, the cost of projects go up, but not necessarily your net operating income that you're going to generate is going to go up. So your development yield falls. You're just creating less value as construction costs go up. So that kind of eats into it as well. So the overall impact is, for the most part, kind of nets out to be neutral.

WMRE: Is there a sector you’re particularly optimistic about in 2023?

Kevin Brown: Healthcare is probably the sector I am most optimistic about, just because senior housing in particular, it's still recovering. And the demand story is just demographics. It's something that you can pretty much count on continuing to be very strong for the next decade as baby boomers age into the target demographic of these facilities. And the construction starts, they dropped to almost zero during the height of the pandemic, and they're below historical average. It takes two or three years to build on these facilities, and so if we're seeing demand growth of 4 or 5 percent, that's going to continue to ramp up to as much as 7 percent to 8 percent by 2026 as the baby boomers age into these facilities. But supply growth for at least the next three years is going to be around 2 percent. This is a sector that is able to push through higher rate growth faster from inflation. So I think we're just going to see very strong bottom line numbers for senior housing.

WMRE: What do you see on the horizon—maybe areas of opportunities and potential challenges—for the first six months of the year that investors should pay attention to?

Milind Mehere: When I think about the next six months, I think what you’re seeing is the stock market is going to be continue to be extremely volatile. And while inflation seem to be coming down a little bit, there is there's going to be, again, huge swings in the market and I think the safe haven for investors is to explore some of these private market funds, including vehicles like, REFLX  and BREIT. So that's really what I would think about, as I think about the next six months.