Julie Whelan (00:00):
Hello, I'm Julie Whelan. And on behalf of the CBRE global research team, we welcome all of you to the 2022 Global Mid-Year Real Estate Market outlook. The global landscape is so different than it was at the beginning of the year. Geopolitical issues have escalated and COVID variants continue to be a concern. Inflation and interest rates are leaving the world wondering where the global economy is going, and the risks associated with the inaction around environmental and social issues is just too great to put aside. Not all the news is negative though. The woman's football team in England, the Lionesses, are the champions of Europe. This excitement is a shining example of the progress that a group of powerful women are bringing to the global stage. With all that is going on in the world, organizations are more focused than ever on the health and safety and wellness of their employees, the environmental sustainability of their operations and the social equity of their policies.
Julie Whelan (01:08):
As real estate professionals, we are integral partners to the organizations that occupy and invest in real estate. So their focus must be our focus. We are in an era where real estate professionals are tasked with more than just the structure of the built environment, but also how the built environment impacts our communities, our people, and our planet. At the same time, we recognize we're entering a period of growing economic uncertainty. So caution and educated decisions are also the key to our successes. Today, my colleagues from CBRE global research will help with that education, sharing their views about what we can expect throughout the remainder of 2022. We will spend time on the outlook for the global economy, office, industrial and retail, multifamily, and finally capital markets. We thank you all for the questions that were submitted in advance. We have reviewed all of them and hope to cover most of the topics in our discussion today. We have quite a bit to cover. So let's get started. First, I welcome Richard Barkham, our Global Head of Research and Global Chief Economist to the screen. Welcome, Richard.
Richard Barkham (02:20):
Hi Julie.
Julie Whelan (02:21):
So Richard, there are mixed messages about the direction of the global economy. Consumer confidence is low, business confidence is falling and inflation continues to surprise on the upside, but on the other hand, consumers are still spending and U.S. Job growth continues to outpace the supply of workers, but clearly the concerns around the risks are growing and they're real. Can you help us frame out what the story is today?
Richard Barkham (02:47):
Yes, I can. And I think we're heading to recession or at least a very serious slow down. It's important to note despite all the volatility that you've mentioned, we are not there yet. But I think the pressure on the consumer and on business from rising energy prices, high food prices, and most importantly, rising interest rates is going to see demand ebbing away by Q4 of this year and into, the first half of 2023. I would say Europe looks the most vulnerable at this stage. And the war in Ukraine has caused a extremely nasty spike in natural gas price, and that's put a lot of pressure on the economies of Europe. But also I would say that in the United States, the Federal Reserve is about to push interest rates to levels that we have not seen for 14 years, and that will, we've had some slow down in the United States, but there is more to come over the next 12 months or so. So I think we are headed for recession.
Julie Whelan (04:00):
So you talk about recession. And I know from my perspective, the global financial crisis was the last recession that really resonates with me in part because of how severe it was. How severe can we expect this recession to be
Richard Barkham (04:12):
Okay, well, I don't want to sugarcoat the message but I think there are factors in play, quite a few of them that might lead us to the conclusion that we're going to face a moderate recession. On the one hand corporate balance sheets are reasonably strong and despite the fact that demand will ebb away, I think because of the war for talent companies will want to hold onto their labor. So I, we may not see widespread spike in unemployment. I would say also that consumers even now, have still quite a lot of savings and cash accumulated from the pandemic period. And they can use that. They can draw that down in tough times. So consumer spending might not dip quite as hard as it might, otherwise have done. And I think with regard to inflation we are not going to some multiyear wage price spiral that we saw in the 1970s that people have talked about.
Richard Barkham (05:22):
This is a very nasty inflation spike, but I think we've reached the peak of inflation. I think it's going to ease over the next 6, 12, 18 months. And by the middle of 2023, that will allow the fed and the other central banks around the world to start cutting interest rates so demand can revive. If we look at Asia, which is a really big part of the global economy we see actually China is already in recession, I would argue. And what that means is China is stimulating quite hard, its economy and China should pick up towards the end of this year and into next year. That will be good for demand levels in Asia and good for the global economy. So, I do think there is a route there to a moderate recession. Having said all of that, there are some big downside risks out there as well.
Richard Barkham (06:19):
And I think the war in Ukraine is the biggest downside risk. That could escalate in ways that are not predictable, but certainly the impact on global energy prices, even though it's been acute so far, could escalate and that would have a serious impact on Europe. But I also think that rising interest rates--and we're in the upswing of a rate cycle--can be quite unpredictable and can bring about financial crises. And I'm particularly worried about emerging markets right now. Emerging markets are struggling with oil prices with food costs and they themselves hold around 4 trillion of dollar-denominated debt. So they may struggle to pay the interest date on that debt. We might see some defaults and that could feed through the financial system. So there are big downside risks there, but on balance, we're looking at a moderate recession, I think, that will last through the first half of 2023. And then we'll see things pick up again.
Julie Whelan (07:23):
Okay. So the world is a big place, and you mentioned a little bit about Asia, but how do you see the scenario playing out between the different regions?
Richard Barkham (07:32):
Well, I think Europe looks to be the most vulnerable as I've pointed out. You've got the rising energy prices and natural gas prices. I mean, that's not just an impact on consumers heating their homes. It's important to realize that those energy prices, those gas prices, that gas feeds Northern European manufacturing business and so the impact there on the Northern European export machine is pretty acute, I think. So that looks a problem. The United States seems to have the most acute inflation problem right now not just through rising prices, but also because labor demand is well ahead of labor supply. But equally I think at the moment in the United States, we're seeing supply chains easing up, we're seeing inventories building up. And I think we're about to see inflation easing there.
Richard Barkham (08:34):
as retailers begin to cut prices in order to shift the backlog of inventories that they have. Asia is actually quite mixed. As I've said, China is in recession already, but it's stimulating. But a lot of the big economies in Asia, they export to China. So they've had a hit from the slow down in China. And they're about to take a hit, I think, from the slow down in demand in Europe. On the other hand, as I've said, China is picking up and I think one bright spot for Asia I think is just auto demand. Even though we might be going into a slow down in the United States, there is a backlog of demand, pent up demand for, for U.S. Autos and in Europe, maybe 4 million autos in the United States. And of course, what that means is that that keeps up demand for semiconductors and APAC is a really big semiconductor-producing region. So, China stimulating semiconductor cycle is still pretty strong in APAC might offset some of the current and future downside from the export hit. So you know, I think we see a moderate recession, probably Europe worse at the moment, APAC and the United States may be faring a little bit.
Julie Whelan (10:06):
Okay. Thank you for that perspective, Richard. So we have a lot of our sector specialists teed up today to speak about the implications of all of this for real estate. So for your final question from your bird's eye view, how is this outlook going to impact our real estate markets?
Richard Barkham (10:21):
Well, all recessions lead to rising unemployment and rising unemployment will feed through, into rising vacancy. Some sectors will be worse hit than others, but rental growth will also ease back quite considerably because vacancy is on the increase. That's the bird's eye view. I think this life sciences data centers and industrial, the sectors that are powered by the digital economy, they're likely to fare better than some of the more traditional sectors. So that's the birds eye view on real estate.
Julie Whelan (11:00):
Excellent. Well, thank you for that insight on the global economy, Richard. So in summary, it seems that we do have some turbulence ahead, but there's plenty of reason to believe that we are in route to a soft landing. So let me welcome now, Ada Choi our Head of Office Research for Asia Pacific and Jessica Morin, our Head of Office Research for the United States to talk about the office outlook. Welcome Ada and Jessica. Good morning. So I'm gonna pose this first question to both of you. The global office market has been in the hot seat, as we all know so well for the two past two plus years, and its very existence has been called into question. So from your perspective, what is the state of the market today in major markets around the world?
Jessica Morin (11:51):
So in the U.S., The worst really seems to be behind us. Over the past three quarters, we have seen that move-ins have actually exceeded move out. Vacancies are starting to stabilize, although they reached a nearly 30-year high and asking rents are starting to moderately rise. And same thing across major markets. We've seen vacancies are stabilizing or decreasing except with a few exceptions like in Berlin and Barcelona. Now on the return to office side, in both regions, the U.S. And Europe, it has been slow, but we do expect occupancy levels to really start to pick up in the fall once employers really make it more clear what their expectations are for their employees. But with that said, the majority of employers, both in the U.S. And in Europe do support hybrid work. So we do expect employees to be in the office less and that will have an overall net negative impact on demand.
Jessica Morin (12:50):
But by our estimates, that's about 9%-15%. We do see that the reduction in demand is going to be offset by the change in how we are actually using space and design will accommodate that. So for example, we're gonna have less individual desk space and we're gonna have a lot more shared open space for collaboration. So in the long run we expect that job growth will continue. We'll see a moderation in new supply and that in combination will balance out any kind of reduction in demand in the near term or in the longer run.
Ada Choi (13:29):
I think Jessica, if you compare Asia Pacific, we are coming out from this crisis earlier. I look at the net absorption in 2021. In fact, it has increased 40% last year in APAC. It's a very strong rebound. However, for this year we are expecting this demand momentum to be normalizing. Of course, APAC is a huge is quite a big region. So the supply and vacancy for the rentals vary significantly. If we look at mainland China, particularly Shanghai, it was largely affected by the restrictions and city lockdowns in Q2. So the numbers did not look well, but for the other markets that have limited supply, rents are escalating. This includes Singapore, Seoul and Sydney, and we noticed that occupiers have to plan ahead to secure the space. Meanwhile some of the occupiers can enjoy more optionality and rental discounts. The rental cycle will last longer in mainland China, Hong Kong, Tokyo, and some of the Southeast Asian markets.
Julie Whelan (14:39):
Great. Thank you for those insights. It's always important to look market to market because real estate is still a very local discussion. So here in the U.S., We have seen enhanced trends and we hear a lot of anecdotes around the flight to quality. So Jessica, I'm interested to hear if you have data that supports those anecdotes and then Ada would be really interested to understand if you're seeing the same trends in Asia Pacific.
Jessica Morin (15:05):
Yeah, so we do have the data to support flight to quality. So in the second quarter in the U.S., we looked at 2,700 lease transactions across 12 of the largest U.S. Office markets from 2019 to the first half of this year. And we classified the building or the lease that took place as either top tier, which is that A/A+ space, or lower tier. And so what we saw is that base rents across all quality tiers increased this year. However, for lower-tier space, we saw that concessions in the forms of tenant improvement, allowances and free rent increased quite a bit in that lower-tier space. And so that had an net overall effect that brought effective rent down by 3.4% last year. And by 1.1% this year. Alternatively on the top-tier space, landlords have actually been able to roll back concessions because of strong demand for very high quality space.
Jessica Morin (16:04):
So we actually saw effective rents increase by 3.8% last year and by 6.7% so far this year. So the flight to quality is very real. We're seeing it in our data and this growing preference for sustainable features and buildings as well has really changed what we consider obsolete office. And it's gonna cast a wider net over the type of office space that we just don't expect to lease in this kind of climate. So that has really driven the conversations around office conversions and demolition to make way for multifamily, industrial and life sciences. And we're really starting to hear those conversations ramp up and it's not just conversations, it's planned projects that are underway or have been completed in the last couple of years as well. So we're seeing that really concentrated on the East Coast in Boston and suburban Maryland we've seen underway and planned projects for office-to-life sciences. In New Jersey there's a number of multifamily and industrial coming up from obsolete office. And then on the West Coast, we are seeing some examples in San Francisco peninsula in Orange County and in Phoenix of office-to-multifamily.
Julie Whelan (17:23):
Fascinating.
Ada Choi (17:25):
I think Julie and Jessica, in terms of this trend about flight to quality, Asia Pacific is not that different. And also in this region in many cases when it comes to relocation, flight to quality is associated with the workplace transformation initiatives. So the occupiers can use the new space for more flexible hybrid working style as well. I think another reason for this flight to quality is the ESG desire. So some of the relocation is to the greener buildings and we notice that many of them are new buildings as well. Well, I think there is a lot of discussion, whether those relocations involve downsizing and we notice this is true, but most of these moves are basically cost- or space-neutral as a trend we are seeing in Tokyo, in Taipei and several Australian markets. However, I think going forward there may be some resistance to this relocation because of the sharp escalation of federal cost. So this could potentially lower occupier intention to relocate as it is difficult to guess the budget. We know that some of the landlords are increasing incentives on tenant improvement or the fit-out period, or even provide the turnkey solutions. So it will be easier for them to attract the tenants.
Julie Whelan (18:57):
Very interesting. So it's clear that tenants want better space, they're willing to pay for it. And the rest of the market is really gonna get converted into highest and best use, which makes sense. There's a reshuffle going on. So as if the pandemic weren't enough to challenge office, we have what Richard talked about, which is a global economic slowdown and looming recession. So how does that outlook change your outlook for office in the near term?
Jessica Morin (19:24):
So a recession will begin demand for office space and it's going to further delay the U.S. Office recovery companies are going to look for where they can cut expenses. So I'd expect continued right-sizing and possibly an increase in short-term renewals. With that said, we have started seeing this play out. There's been a few tech companies that have been in the headlines for hiring freezes and layoffs. And these same companies have also pressed pause on planned office expansions and even their current underway build-out in cities like New York, San Francisco and Washington D.C. But aside from those few examples of companies, I do think we'll still continue to see leasing activity over the next several quarters, but occupiers are just going to move even more cautiously.
Ada Choi (20:18):
Well, I think for Asia Pacific, Richard has already mentioned there are two major effects. First of all, the Western MSCs are likely to be more cautious about the business investments or expansions in this region. And for Asian companies who rely on exports to the west, they will also be affected. However, we also notice that there is pent-up demand for several markets when who are relatively late when it comes to coming back to the office. India, for example, we have seen a very strong rebound in terms of the demand. Philippines is another example. I think Richard has also mentioned that we are optimistic about a recovery in China. So it's quite a counter cyclical kind of movement China, Hong Kong. We are going to see the recovery in 2023, and that's why we are expecting the demand to improve. In fact, in 2023 in that region, and it is expected that the Chinese government is going to prioritize the supports of the economic growth and provide some stimulus, for example, cutting the tax be more nice to the tech companies. So this will also help us as an office market to see the improvement in the demand for the later half or next year.
Julie Whelan (21:39):
Great, thank you, Ada and Jessica. So it seems the pandemic absolutely accelerated change for the office market. And it seems that those assets that get the right mix of location and design and amenities are really well positioned towards the future of office. Even if that future might take a bit longer to arrive in some places given the economic climate. So I thank you for both of your comments. Now let's shift gears to industrial and logistics and retail. I welcome James Breeze, our Head of Industrial Research for the U.S., and Tasos Vezyridis, our Head of Retail and Logistics Research for UK and Europe, to talk about these two asset classes that have growing dependence on each other. Welcome, James and Tasos. James, industrial and logistics has been on a surge that many are envious of, and that surge only seemed to have gained strength during the pandemic. I'm gonna once again ask you, is this sustainable even amidst the outlook that Richard talked about?
James Breeze (22:39):
Hi Julie. Yes, the industrial and logistics sector has been experiencing record fundamentals over the past 24 months. And that includes record leasing activity, net absorption, rental rate, growth and development. The industrial real estate market is not recession-proof, but the sector is somewhat insulated from an economic downturn. There's still long-term changes to consumer behavior, supply-chain strategies and sustainability governance that need to be accounted for in the distribution strategies of retailers, wholesalers and outsource 3PLs. Some examples include the continued growth of e-Commerce, the need to protect inventory levels, the need to diversify supply sourcing, and that includes increasing domestic manufacturing the need to expand into growing population areas throughout the Sunbelt and even the need to find facilities with lower carbon footprints. So it would take a significant drop in retail sales for there to be a large decline in overall demand. And right now it just doesn't look like that's gonna happen. So that means that historically low vacancy rates are very likely here to stay despite some massive development in the U.S. We can expect to see double-digit rent growth for the foreseeable future in North America. Last year when CBRE projected there would be annual rent growth per lease comparables of 10% in the U.S., it raised eyebrows. And today it's 18%. We're seeing similar rent growth in Canada and accelerated rent growth in APAC and Europe.
Julie Whelan (24:19):
Okay. So we will keep an eye on those retail sales numbers, but things still seem rosy, but there are a lot of headlines about major occupiers giving back space. What's your take on that?
James Breeze (24:30):
Well there's definitely been exaggerated headlines about the industrial market out there recently. Whether it be the end of e-Commerce, the massive overstock of goods or major E-retailers giving up space. A lot of it's been inaccurate, which is frustrating. While we aren't speaking about specific occupiers, it is important to note that there is not one company that had market share of lease transaction volume over 5% the past 18 months and not one occupier with a market share of over 3% in 2022. Demand for industrial real estate comes from a diverse tenant sense. If one company decides to pause expansion, it really has no effect on industrial fundamentals. If there are headwinds for the occupier sector, it's in a, from a supply or a size-range perspective we're starting to see a pullback in demand for what we call light-industrial users. These are companies that lease space under 25,000 square feet. They tend to be small businesses, and they're being affected by the rising costs much more than larger companies are so leasing in 2022 is off about 21% for spaces under 25,000 square feet. And I think we'll probably continue to see that the rest of the year.
Julie Whelan (25:50):
Okay, thank you for that. So Tasos James painted quite a bullish picture and in Asia Pacific this year marks the 12th consecutive year of rental growth. And the demand for modern logistics space is very healthy and vacancy is low in that region. So from your perspective in Europe, are you seeing the same trends that James and our Asia Pacific colleagues are seeing?
Tasos Vezyridis (26:14):
Thanks, Julie. Yes. Trends in Europe for logistics property are probably similar to the U.S. On the demand side, we have seen a slowdown of expansion of some e-Commerce players. However, the decline in demand from pure-play retailers has been offset by other sectors, such as third party logistics, also servicing the online channel, traditional bricks-and-mortar retailers, with or without an online channel, and manufacturers. Now, the reorganization optimization of supply chains has been a high priority for all occupiers and trends such as nearshoring, diversification of sourcing and increases in safety stocks are driving demand in Europe at the moment. Now regarding e-commerce, we still expect e-commerce to continue to grow in both established and less established European markets because of the strong or growing presence of what we call e-commerce drivers. These are things such as the digital skills of the population, mobile internet usage and the use of credit or debit cards and the use of digital wallets.
Tasos Vezyridis (27:12):
All these are boosting demand for e-commerce. Sustainability. Sustainability is also a much higher priority for occupiers compared to a couple of years ago. In our latest European logistics occupier survey, most of the occupiers suggested that they are willing to pay a premium for green buildings, especially when the premium is being offset by savings and operational costs. Now let's move to the supply side. On the supply side in almost all markets supply is struggling to keep up with demand. Vacancy rates are at historical low levels and are already preventing from additional listing activity. The average vacancy rate for major European markets is currently less than 2.8%. Now tight supply is being driven by different factors, such as land availability, planning constraints, construction costs, and a tight labor market. These are factors that we do not expect to change in the short term, so tight supply conditions will continue. Again, in our latest survey, European occupiers stated that due to lack of space availability, they are increasingly exploring alternative locations outside of traditional logistics hubs, for example, locations in France's Atlantic coast, Southern parts of Italy. So to summarize, demand is still strong, supply is tight, and therefore the imbalance between supply and demand is pushing rents up in pretty much all European markets. This is a high-level overview of European logistics.
Julie Whelan (28:32):
Great, thanks Tasso. So I'm happy to raise my hand to set up a logistics hub in the Southern part of Italy. I can do that. So you also do a lot of research on retail, and I know in the us, we have experienced surprisingly positive demand in retail through the pandemic. Some are almost saying there's a bit of a retail revival underway. What's your perspective on retail around the world as your final question?
Tasos Vezyridis (28:56):
Physical retail has been through a lot of challenges the last few years due to the growth of internet sales and the impact of COVID. However, physical retail markets are recovering as the impact of COVID is fading. Footfall and retail sales have bounced back because they have been supported by saving balances, tourism recovery, and the return of office workers. E-Commerce growth has also moderated, penetration rates have declined following the lift of COVID measures. So overall we have seen a good recovery the last few months across the globe, and there has been a shift to physical retail and a retail revival predominantly in the U.S., But other regions are also following. However, there are also challenges: inflation, the tightening of monetary policy, geopolitical risks, and the prospect of a recession are now the main concerns of consumers, occupiers and investors. Inflation is squeezing disposable income.
Tasos Vezyridis (29:50):
I guess we all feel that. And consumer confidence is sliding across the globe. Now, the impact on retail sales has been muted so far because it have been supported by healthy saving balances. Although these are now eroding. In China, specifically, sales are also affected by COVID restrictions. Now, looking forward, we anticipate slower sales growth pretty much across the globe. Also occupiers are expected to be challenged by increasing operational costs. Now, that being said, not all is doom and gloom. Our latest research shows that retailers clearly see the value of the physical retail store, suggesting it is more effective than the online channel on a number of metrics such as consumer engagement and cross-selling products. Physical stores are also believe to boost online sales in the local area. So overall things are better for retail than they have been the last few years, but let's be honest here. There are also challenges ahead of us.
Julie Whelan (30:46):
Well, thank you, James and Tasos for the context you have shared on retail and industrial. It's really fascinating to hear how consumer behaviors are evolving to shape these assets that are poised to move forward with strength due to their fundamentals. So we're gonna continue to focus on demographic trends and move on to multifamily. I welcome Jen Siebrits, our Head of Research for the U.K., And Matt Vance, our Head of Multifamily Research for the U.S. Welcome Jen and Matt.
Matt Vance (31:18):
Hi Julie.
Julie Whelan (31:20):
Hello. So multifamily has been a resilient asset class since the pandemic. On one hand, inflation and wage growth suggests that could continue. But as Richard mentioned, consumer confidence is low, which might suggest something else. So what's your perspective?
Matt Vance (31:39):
Well, Julie apartment rents are generally determined around occupancy and housing demand in the U.S. Remains exceptionally high. It has brought occupancy rates to historic levels. And so it's not surprising that we're seeing exceptional rent growth as well. I would say the good news is that the average renter in a professionally managed apartment property is not yet cost burdened. That average tenant pays right around 27% of their income toward rent and that's pretty good. It's below that 30% typical threshold considered to be cost burdened. So there is room for additional rent growth and as you point out especially with additional wage growth. I should probably acknowledge quickly that for lower-income households they're, especially in high-cost cities, they face much more significant affordability issues.
Matt Vance (32:43):
But it is great that we're seeing more and more emphasis from the FHA, Fannie and Freddie and investment funds and strategies being established to tackle this problem and have more focused investment into workforce housing. And we need more of it. But as I said, there is still room for growth. Now on the other hand, vacancy rates did begin to increase last quarter and it was really the result of both supply and demand. Developers have responded to these incredibly strong fundamentals. They've added a lot of new supply to the pipeline and at the same time we saw unseasonably weak demand. And some of that slow down in demand is the delayed effect of what we saw last year, which was a truly record year for housing demand in the U.S.
Matt Vance (33:33):
And it's very likely having pulled forward some of the demand that we would've normally seen this year and maybe even next year. But also I have to believe that some of that slowdown in demand is being driven by exactly what you mentioned in your question. And that is that falling consumer confidence. It's causing households to make more conservative financial decisions. And housing is just one of those. So if I were gonna sum this up for you in a sentence, it's that the U.S. Multifamily sector will continue performing above trend for a while longer, but that vacancy rates will continue their drift back up toward more normal levels this year and next, and that we can expect rent growth to decelerate as a result.
Julie Whelan (34:24):
Okay. Thanks for that, Matt. So Jen, we hear global investors are targeting Europe now for multifamily properties. What is behind that trend? And do you think it's gonna be lasting?
Jen Siebrits (34:35):
Yeah. So Julie, look, compared to North America, multifamily housing as an investment-grade asset class is a relatively new concept. I mean, living in private rental homes isn't a new concept in Europe, but instead of being provided by the state or individual landlords, more is being provided by large-scale private and institution investors. And of course, many of these investors cut their teeth in the U.S. And are bringing their expertise to Europe. In many places there's a first mover advantage to be had with the ability to gain significant market share, particularly in the higher-end space, which is still achieving premium rent. It's not just that the size of the rent market is growing. This is being driven by longer-run social and demographic factors, which are delaying entry into home ownership, right? Things like getting married later and having children later and more younger children among younger people in higher education who have got large student debt accumulated, and also factored in is high and rising house prices. This has led to affordability barriers to home ownership. And this demand has led to robust rental growth and low vacancies. In the U.K. We currently have the highest levels of occupancy since we started collecting the data.
Julie Whelan (35:49):
Very interesting, Jen, so this last question for this section goes to both of you and we know the world is a connected place and Jessica and Ada talked about the rise of hybrid. So how does the rise of hybrid and in turn more remote or home-working, what does that mean for downtown and conversely suburban multifamily market health?
Matt Vance (36:11):
Well, I would say in the U.S. early in the pandemic we saw much bigger, much more negative impacts in downtowns and expensive coastal cities, but that's all over now. The suburbs went largely unaffected, but now renters have stormed back into their urban, their live-work-play downtown apartments. But I would say that there is, I think, something worth commenting on here that's playing out in both urban and suburban settings, and that is developers in the U.S. Have recognized the need that their residents have for more space to accommodate remote working. And Jen, I see you nodding, I think this is playing out everywhere really, but for some context in the U.S., the average apartment, and by the way, these developers are approaching this in two major ways. Number one, they are increasing the average size of the apartments being developed. Since the pandemic, the average size of newly built apartments has increased, or is 9.6% larger than the units built in the 10 years leading up to it. That's 90 square feet for incorporating workspaces. The other way that they're approaching this is by incorporating workspaces directly into the shared common areas of these properties and really giving their tenants the ability to leave their apartment and feel almost like they're going to work, even if it's just down the hall or up or down a few floors.
Jen Siebrits (37:50):
Yeah. I mean, similar to you in the U.S., Matt, I mean, large cities like London were really hard hit by remote working practice, but we found housing demand has returned really swiftly. I mean, interestingly, we've seen a pick up in demand for centrally located small apartments, pied a terre, where families have left London, rural locations, and now need somewhere to stay for the few days a week that they work in the office. I also agree with you, Matt, about the demand for workspaces, you know, within apartments or within the overall scheme, this has become an essential requirement. And of course, another issue that's high up on the agenda is sustainability. Developers in Europe are starting to consider how upcoming regulations might have an impact on the overall design of their schemes.
Julie Whelan (38:34):
All right, Jen and Matt. Well, thank you so much. Maybe hybrid work is a reason for me to get a pied a terre. I think that's a great excuse that I can give my husband. So the world is a connected place. And the changes that we're seeing in consumer behavior are really impacting all asset classes is what we're learning. And that is probably among the most evident in multifamily. So now last but not least, I welcome our capital markets panel to the screen. Darin Mellott, our Head of Capital Markets Research in the U.S., Henry Chin, our Head of Asia Pacific Research and Global Investor Thought Leadership, and Neil Blake, our Global Head of Forecasting & EMEA Chief Economist. Welcome, Darin, Henry and Neil. So to all of you, we are at the end of a decade-long surge in property values where cap rates have compressed across the world. Are we about to see cap rates move in the other direction? Could you speak each from your perspective regions?
Henry Chin (39:33):
Good morning, Julie, and it is very interesting. Capital markets is always very sensitive to the overall economy and is always the first one to reflect the market conditions. But in Asia Pacific, we have not recorded any significant cap rate decompression in the first half of this year, but we are expecting to see cap rates move out in the second half. But given the diversity of Asia Pacific economies, the magnitude of cap rate movements also varies. Despite the strong market conditions, the rising interest rate involvement and the negative carry do put cap rates under severe pressure in Australia, in New Zealand and Korea. We are expecting to see cap rates to move out in those three markets first in a range of 50 to 75 bps. Cap rates will also move out in mainland China because of its weak fundamentals, but the magnitude will be within 25 bps. And the cap rate spread remains so healthy in Japan, despite the strong weight of capital targeting Japan and the lower interest rate involvement in Japan, we still do not expect to see cap compression any further. The cap rate is going to remain stable. The final point I want to make is what we have noticed is that the private capital remain extremely active, particularly in Singapore and in Hong Kong. So they are talking a trophy core asset by those private capital and some institutional capital can be easily priced out during the bidding processes.
Darin Mellott (41:09):
And Julie in the U.S. We've seen cap rates begin to decompress. Now, I think it's important to emphasize it's difficult to paint with broad strokes right now. Everything's very deal-dependent. Everything depends on the market, property type that we're talking about, the asset, it's risk profile, et cetera, but generally speaking, we've seen cap rates move out 50 to 75 basis points some more, some a bit less. So for example, prime multifamilies probably closer to 40 basis points. Industrial retail, closer to 75. Office, most impacted. That's gonna be closer to a hundred basis points, but seeing how expectations to reset relatively quickly and long-term interest rates are off of their peaks. Right now, we see a relatively stable outlook for cap rates. But as Richard mentioned, we have an evolving macro picture and so there is some potential for additional expansion there.
Neil Blake (42:06):
The situation in Europe is a bit more like the United States than it is like APAC. We're definitely seeing cap rates starting to move out, but yeah, the picture's actually, you know, we've had some increases, we've had some markets still the same, some are in between. It's not a coherent pattern by geography either. By sector, it's quite interesting. The biggest increase in cap rates have actually been logistics which have actually had a very few good years before that. And the slowest have actually been multifamily housing, maybe not surprised there. And retail, I mean, we heard about retail from Tasos before, how it's having a little bit of a comeback and there are some retail cap rates, which would be going down and not just at the prime end, secondary assets as well. So overall we're seeing, cap rates got by up to 50 basis points at the prime end. There's more coming but we are lagging behind the United States.
Julie Whelan (43:06):
Okay. Very interesting. So spots of value creation, but a pretty consistent story around the world that cap rates are moving out. So Darin, you talk to our Debt & Structured Finance teams quite a bit. How much has the cost of debt risen and what impact is that having on the real estate market?
Darin Mellott (43:23):
The cost of capital has increased materially since the start of the year. So we've seen fixed rate loans going from the low threes to the high fours and low fives. Floating rate spreads have blown out to about 350, that's over a SOFR about 225, and that doesn't include a cap. In terms of lender preference, there's a clear preference for multifamily, industrial some grocery-anchored retail, healthcare, life sciences even some data centers. Other properties are gonna be more difficult to finance. And we've also seen LTVs impacted. So we've seen LTVs come in from the mid-sixties to 50 to 55% range, roughly give or take a few percentage points depending on the asset. But to answer your question, we've seen a shift in pricing and volumes have been impacted. Those financial conditions have tightened and we expect to see continued reverberations from those tightening financial conditions in the form of relatively subdued volumes. Important to note, those volumes are still going to be healthy from a historical perspective. Right now we expect volumes in 2022 to be down 5%-10% from 2021. But again, mentioning that perspective, that's still going to be 47% over the five-year pre-pandemic average.
Julie Whelan (44:43):
Wow. So that perspective is so important because so often we view short term historical data and jump to conclusions that are easy to miss if we're not looking at the long-term ones. So since the beginning of the pandemic, there has been an expectation that distress is coming to the real estate market. It's been a constant question that we have received recently, New York University and Columbia released a staggering study suggesting that $500 billion in real estate value is poised to be lost in the market. Are we now, or are we going to finally see distress in the real estate market?
Henry Chin (45:19):
Yeah. Hi Julie, this is a fantastic question. We are hoping to see the distress for the over the past 10 years, but, unfortunately we haven't seen much of a widespread distress across Asia Pacific. One big reason is that there are plenty of liquidity in the market and that mainland China probably is the only market we are finding to see distress opportunities. If you look at the past few years over-leveraged developers disposed non-core commercial assets in order to pay off real debt, and the trend is set to continue. But what we are seeing in the news with the headwinds we are seeing in the China residential market and the headwinds we are seeing in the macroeconomic situations, distress opportunities will appear in China, but in a more controlled manner.
Darin Mellott (46:05):
Julie, we haven't seen distress in the U.S. However as macro conditions worsen, one area of particular concern is with several billion dollars of floating-rate loans that are gonna require refinancing in the near term. So that bears worth watching.
Neil Blake (46:20):
Yeah, there's no obvious sign of distress in European property markets at the moment. Sure, cap rates are going up. Values might be under pressure, but it's after several very, very good years. If you do want to punch around to see where there might be problems, it's probably the supply of debt, and it's harder to get debt for the secondary investment. It's harder to get debt for development. It's really, the lender has actually been risk-averse in the face of impending or possible recession. You also gotta remember as well that now might not be the time to look for this. There might be problems refinancing down the road, but just let's remember that Europe by and large is in a recovery from the pandemic mode as far as occupying markets go. You know, vacancy rates are still relatively low. They're recovering. People are paying their rent and as long as that keeps going you don't get distress. And let's remember we're expecting a relatively mild recession, not another GFC.
Julie Whelan (47:19):
Great, thanks for those comments. So Henry with your front-row seat to investor sentiment, how is the outlook right now impacting investor sentiment?
Henry Chin (47:28):
I think on the back of a rising interest rate environment, what we are seeing, investors across the globe are acting cautiously, when it comes to new acquisitions. However, it does not necessarily mean that investors are putting their investment on hold because plenty of dry powder is sitting on the sidelines, looking for the good opportunities. As a result at CBRE we do believe that there are three distinct vintage strategies that could apply globally. The first is to identify the value between public and private markets. We advise investors should look into REITs which potentially trade below their Net Asset Value and other listed vehicles that seem to be undervalued. We do believe opportunities should be U.S., U.K. And Australia. The second, to look at the debt investment strategies. I think debt investment strategies become so attractive, particularly during the time of uncertainty and the rising interest rate environment. And the focus should be senior to junior loans for the U.S., U.K. And Australia, particularly if you are the core or value-added investors. If you're an opportunistic investor, distressed opportunity is going to happen in mainland China, as we mentioned earlier. The third is to target the best-quality asset globally. We do believe the best-quality asset could potentially be trading at a 5%-10% discount to its book value. However, look in the past: this buying window of opportunity has been relatively short; therefore do be prepared for this opportunity.
Julie Whelan (49:07):
Thank you for that investment strategy education, Henry, very valuable. So final question for all of you to answer in just a few seconds, we wanna leave the audience with optimism. So from a geographic and asset class frame, where are the opportunities, following what Henry said for investors today.
Henry Chin (49:25):
In Asia, send us everyone logistic and offices are the focus. I want to highlight offices because return to the office is so real in Asia Pacific, but we also are seeing increasing level of interest into new economies, such as the cold storage, data center, multifamily and life-sciences-related investments, because APAC is likely behind the U.S. And Europe. But we also start seeing clients to look at retail selectively because of attractive pricing and also reopening the borders. And we love shopping.
Darin Mellott (50:01):
In terms of inflation hedges, I think multifamily and industrial fundamentals are gonna keep those property types quite attractive. Again, speaking to strong fundamentals, I think there will be opportunities across property types in Sunbelt. But depending on the type of capital, I think there are gonna be some interesting opportunities in the next year perhaps even generational opportunities in the gateway markets amid less competition in the near term. Also I think it's worth mentioning current financial and economic conditions aside, when things change, there are always opportunities. And to that end there’s going to be opportunities to enhance value and frankly, the need to protect asset values as ESG criteria is further integrated into the investment landscape. And that's also worth keeping in mind, Julie.
Neil Blake (50:52):
Well, Julie, Europe's got the same secular favorites that a lot of other people have mentioned logistics in particular, also data centers, life sciences and things like that. A particular shout, I think for multifamily housing, I think as Jen's mentioned it's an emerging section from Europe and it's seen as a potential inflation hedge, basically doubly attractive, so they're ones to watch. In offices, there's quite a wide range of experience going on. Henry's mentioned the flight to quality. That's certainly part of it. Also in Europe, we've got impending ESG legislation and prime is seen as somewhat ESG-proof. That new build, they're usually fully certified. So that's nothing to worry about immediately for the investor. And add to that, we are actually looking forward to a pause in completions for a couple of years. A lot of projects were put on hold during the pandemic.
Neil Blake (51:44):
They've been further delayed cause of high construction costs, so that actually could help to maintain the demand-supply balance of the market. But don't forget prime comes at a cost. Cap rates might be going up. You can still argue that it's cheap, but for some investors so often it's quite expensive. And there's a whole lot of secondary offices out there as well to think about. Might be good reason, but for the well-located, I stress, the well-located secondary office, which is secondary cause it doesn't meet ESG standards. There's a value-add opportunity there. It needs CapEx, meaning without spending there’s gonna be a shortage of well-located offices sometime in the future. And when you've got that kind of challenge, there's always that possibility of mispricing. So I think some investors will be taking quite a lot of particular attention to that at the moment. So it's not all prime. Sometimes opportunities does where ESG creates as well as it destroys.
Julie Whelan (52:36):
Great. Well, thank you Darin, Henry and Neil for closing out our session today and showing us the route towards opportunity in this environment. And thanks to my colleagues for their education and insight and thanks to our audience for joining this call. We've learned that we have both reason to be cautious and optimistic as we finish the back half of 2022. As you navigate the remainder of this year and beyond, we welcome you to reach out to the CBRE professionals on this call to answer any questions you may have. We also welcome you to visit the cbre.com Research and Insights page to learn more about the topics we discussed today. Wishing you all health and wellness. Have a wonderful day.
