Commercial real estate: A new cycle in Europe, the Middle East and America?

Amid challenging macro conditions, how have commercial real estate markets in the US, Europe and Middle East fared? In this webinar, a panel of experts discussed the most important market trends and highlighted the issues for the year ahead.

Highlights from Q1 2023 Global Commercial Property Monitor

Despite regional variances, the overall commercial property market sentiment index has improved since the last quarter of 2022, explains Tarrant Parsons, Senior Economist at RICS. The Middle East region was the strongest performer and the only world region in positive territory in this index, with Saudi Arabia and UAE leading the way.

Tarrant states that European markets remain generally cautious, with investment activity still downbeat amid the ongoing tightening in monetary policy. However, positive expectations for rental growth in most segments except retail and secondary office space show that occupier conditions are somewhat more resilient than the investment side of the market.

North America’s Q1 Global Commercial Property Monitor (GCPM) results reveal a slight divergence between Canada and the US, explains Tarrant. While the picture seems to have stabilised in Canada, sentiment towards the US market continues to deteriorate. However, conditions remain varied at the sector level, with occupier and investor demand appearing more resilient for industrials while weakening significantly across offices.

Mixed signals

There is lot of conflicting data in the market, for example, capital decline but strong occupier markets, says Simon Durkin, Head of European Research and Strategy at BlackRock Real Assets. He believes the policy of central banks raising interest rates in response to rising inflation will affect occupier markets at some stage, most likely after the impact on the real economy.

Jens Böhnlein MRICS is Global Head of Asset Management and Sustainability / Managing Director at Commerz Real AG. He comments that despite stress in certain sections of the market in continental Europe, there is still rental growth in some areas, particularly in prime office and prime retail sectors. In places where strong economies or close synergies exist and commuting distances are short, 15-minute cities have in essence been created, he says.

In the US, the weakest link is office vacancies and office rent as occupiers revaluate space requirements, says Dee Dee Sklar, Board Member of Nuveen Churchill Private Capital Income Fund. A problem in the US real estate market, says Dee Dee, is that 70% of real estate financing resides in banks below the top 25. The bulk of real estate finance is in much smaller banks across the country and those markets have been curtailed since around the third quarter of 2022. Banks and insurance companies are only providing financing to their best clients. Bright spots were provided by multifamily and affordable housing, she added.

Looking at global real estate markets, Dee Dee believes long-term investors are going to be the solution. For example, Blackstone are raising the largest real estate fund ever, targeting logistics and data centres. Such investors have pensions needing to be paid out over long time horizons. They can be patient if they feel confident about sponsors achieving the returns needed to meet their pension obligations to their members, she says.

The Middle East market

In the Middle East, countries like UAE and Saudi Arabia have seen positive growth in both, occupier and investor demand, says Faisal Durrani, Head of Middle East Research, Knight Frank. In Saudi, the government’s transformative programme, Vision 2030, has seen more than USD 1.1 trillion committed to real estate and infrastructure investment. This is creating significant domestic economic activity and is reducing reliance on global economic growth and inflation, he says. Initiatives to attract global multinationals to headquarter in Riyadh is resulting near full occupancy level, and in King Abdullah financial district prime property is fully leased or fully committed.

Transforming cities beyond office spaces

While there is a real push for prime office areas, the second and third tier locations are likely to struggle, says Jens Böhnlein. He highlights the importance of transforming city centres by offering amenities beyond just office spaces, providing a reason for people to be there beyond just working. He believes that developing vibrant areas is crucial in attracting both multinational companies and younger talent. ESG and carbon neutrality will also need to be considered and the future of prime real estate will require both a desirable location and sustainable practices, he says.

In the past 12 months, there has been a notable contrast between vibrant cities such as Paris, Madrid and Stockholm attracting people back into the centres and those that have been less successful, says Simon. He also highlights the contrast between different areas within a city, comparing the somewhat subdued City of London to the capital‘s bustling West End. The future of cities is going to be far more mixed use, he believes.

Experiential retail, for example, has been key in helping the retail sector recover in Saudi Arabia. While shopping malls are still very popular, when you segment by age, the majority of Generation Z prefer shopping online, explains Faisal. What we are seeing, he says, is the rise of developments that are classed as lifestyle retail developments where the focus is on food and beverage outlets as well as entertainment, such as cinemas.

In markets such as the UAE, where expats make up around 90% of the population, there is a strong social dynamic in the workplace, leading to most employees returning to the office, states Faisal. Nevertheless, international corporations are increasingly providing flexible work arrangements and remote work options, he says. Additionally, cities in the Middle East tend to be smaller compared to those in Europe or North America, resulting in less commuting for the populace, he adds.

Alternative career options in real estate involving remote working technology are emerging. But for industries such as banking, accounting, and real estate firms, being physically present in the office is still crucial for problem-solving, team collaboration, and learning new skills, says Dee Dee.

ESG, stranded assets and natural disasters

When the global financial crisis ended, people asked what would happen to the malls. Post-pandemic, similar questions are being raised about the future of older buildings, some of which may make way for more green, residential or mixed use, suggests Dee Dee. She also cites the very high percentage of buildings needing energy efficiency improvements that cannot be repurposed cost effectively. These include New York and other cities such as San Francisco, Boston and Chicago. One part of the solution that is not new, yet increasingly being adopted in the US is the use of C-PACE (Commercial Property Assessed Clean Energy) financing.

Simon anticipates a rise in stranded assets, which he says is not limited to ESG factors alone. Reduced occupier demand is contributing to steeper depreciation curves. Demand is also being more narrowly focused on sub-markets offering amenities as well conventional office space, he says.

How are commercial real estate markets in Europe, the Middle East and the US shaping up in the face of the evolving economic environment? We present the results of the latest RICS Global Commercial Property Monitor and discuss with leading participants in the sector their insights on the opportunities for the rest of the year as well as the potential risks to the property market.