First-mover advantage beginning to materialize for real estate

Clarity across markets has been in short supply amid stickier than expected inflation, rising interest rates and recession risk.

Central banks’ progress in stemming inflation became evident toward the end of 2023. This has led to the sentiment among investors that interest rates are likely at their peak. But given the resilience of many economies globally, interest rates are expected to stay elevated well into 2024. Stable interest rates will bring more predictability to debt costs, helping to stabilize pricing , increase loan originations and catalyze liquidity.

Debt markets have become a significant focus for real estate investors; credit strategies offer diversification benefits and perform well in high-interest-rate environments. New sources of debt are arising to complement funding options in markets and sectors where lenders are more cautious, and debt funds have added significant lending capacity, particularly since the Global Financial Crisis. JLL projects $3.1 trillion of real estate assets globally have debt maturing by the end of 2025. Investors should look at opportunities to deploy across the capital stack and risk spectrum, including through mezzanine financing, rescue capital or other structures to gain exposure to new property sectors and geographies. 

While capital raising for real estate funds has declined compared to pre-pandemic levels, there is substantial dry powder on the sidelines, reaching $402 billion by October 2023. As risk and return expectations shift, investors have become increasingly demanding of higher returns, and capital deployment is targeted at higher-yielding strategies and taking first-mover advantage in markets where capital values appear to be bottoming out. Real estate investors should be prioritizing sectors and geographies where rental growth forecasts can be underwritten with the greatest confidence.

Despite recent denominator-effect concerns and allocation pressures favoring fixed-income strategies, the long-term attractiveness of commercial real estate (CRE) as an asset class remains intact, and early signs the denominator effect is abating have emerged. CRE offers better inflation protection with lower volatility, lower correlation to other asset classes, stable income and diversification benefits. We expect strategic asset allocations into real estate, especially in the long run, to remain stable and, for many investors, trend higher.

Looking at sector investment dynamics in real estate, portfolio strategies had already been shifting during the decade leading up to the pandemic-era, and the market is in the early stages of a significant reallocation of capital. Diversification will take different forms in markets around the world, and even those sectors which are currently “out of favor” still have a place in global, diversified portfolios. The living sector now attracts the largest share of capital globally, followed by logistics. While other sectors, including offices, have recently seen net outflows, we are expecting these sectors to recover, with a focus on quality assets. Deployment will be a hurdle for new strategies, given varied degrees of barriers to entry, competition and crowding-in strategies, reinforcing investors’ need for agility and real-time market connectivity.

Growth in the asset class will extend beyond major sectors. Longer-term opportunities will emerge with technological and societal shifts, evolving business models and growth in dynamic industries, such as life sciences and data centers. With many cities and companies shifting to cleaner energy solutions, there will be growing demand for supporting infrastructure, manufacturing and distribution facilities. Advanced manufacturing presents another opportunity and will see an increase in demand for research & development, production and logistics assets.

As a clearer picture of the future emerges, investors should evaluate their existing holdings and explore opportunities for income and capital value growth across the full spectrum of real estate assets, geographies and deployment strategies.