‘The playbook is changing’: keeping a nascent real estate recovery on track

A “nascent” recovery for commercial real estate could yet be derailed by geopolitics, economic challenges and distress in the funding markets, according to the team at MSCI Research. In a blog post, executive directors Will Robson and Tom Leahy said a correction had been helped by rising rates and yield shifts, but added that structural factors such as changing office demand are still reshaping the market. “The move into a more sure-footed recovery will depend on several factors that may see some segments of the market race ahead while others lag for a potentially extended period, presenting both opportunities and risk for investors,” they said. “If investors didn’t have enough to worry about with market-based risks, geopolitical and economic uncertainties persist, and the spectre of climate risk has not gone away,” Robson and Leahy added. Some investors will pivot their portfolios toward emerging property types, the pair said, while others will see a chance to get exposure to more traditional sectors at cyclical lows. “In any event, it is likely that investors will not have significant yield compression at their backs and will need to drive returns through active management and selection,” MSCI’s team said. “Market turning points are characterised by elevated dispersion in asset returns and, in such an environment, understanding the key factors driving performance through attribution will be vital.” An uneven revival Investors are more selective over where they want exposure and their route to market, Robson and Leahy said. Blackstone’s purchase of data centre operator AirTrunk typifies the blurring of lines between traditional commercial property and infrastructure, while residential and industrial assets remain in favour. Offices and retail have become “dirty words for many investors” owing to “huge value destruction”, MSCI said. “That revaluation is starting to tempt back some players, though, and there are pockets of outperformance in both markets,” the firm added. “It is highly unlikely that aggregate deal volumes will return to their long-term average for these property types in the near future, however.” Fundraising is tough and distress levels have continued to grow, the pair noted. “This may aid the recovery by providing opportunities for well-capitalised players to acquire assets at a discount,” they added. “Unsurprisingly, data shows that the best-performing fund vintages tend to be those formed in the immediate aftermath of a market correction.” Price declines and higher interest rates have cast doubts over the ability of some borrowers to repay or refinance loans. “Concerns about borrowers and their lenders are global,” the authors said. “In Europe, property prices and values have undergone substantial corrections since mid-2022, meaning that many properties sitting on investors’ books will likely be worth less than they were originally acquired for, especially those bought close to the peak of the market in 2021. When asset values do not meet or exceed loan obligations, prospects for refinancing become grim.” Picking winners Picking the right assets is as important as ever, MSCI’s team said. “Every property is unique and, unlike in public equities, investors cannot buy the market,” they said. “As such, investors must carefully balance top-down allocation strategies – determining exposure across geographies and property types – with the granular, bottom-up asset-selection and asset-management decisions.” They continued: “The interplay between these two approaches has grown increasingly complex as the real estate market becomes more dynamic, influenced by macroeconomic shifts, technological disruption and evolving tenant demands. Understanding the drivers of performance – whether stemming from strategic allocation or asset selection – is paramount for investors seeking to optimise returns.” Asset management will also be critical in a new investment cycle, Robson and Leahy said. “The challenge for investors is clear,” they added. “With market conditions evolving, the playbook for delivering returns is changing.”