2024 Real Estate Predictions

We started polling our team leaders last year about what they're seeing and what they expect for the future of real estate markets. Here's what we (collectively) think will define real estate markets in 2024...

#1 The CRE sector will prove to be better than expected in 2024

Real-Estate Doom Loop Threatens America’s Banks (WSJ)

The Slow-Motion Crisis in Commercial Real Estate (Bloomberg)

Kevin O’Leary Says a Coming Real Estate Collapse Will Lead to ‘Chaos’ (Yahoo Finance)

Recent headlines suggest that CRE is in for a GFC/early 1990s-like crisis.

Although some losers will emerge over the next year (see below), their failures will not implode commercial real estate markets.

Prediction: Losers emerge but the CRE system will see "green shoots" in 2024.

#2 Economists will be wrong (again)

Most economists called for a recession in 2023...

Kudos to four economists who bucked the trend:

• Goldman Sachs chief economist Jan Hatzius was more confident that the U.S. wouldn't enter a recession than Goldman's CEO.
• Claudia Sahm took on Larry Summers, insisting that inflation could be tamed.
• Campbell Harvey , the guy who originally realized that inverted yield curves almost always precede recessions, said 'this time is different' (for 2023).
• And Mark Zandi at 穆迪分析 consistently had a more bullish take on 2023.

Economists are now generally calling for slower (but positive) employment growth in 2024. When in doubt, steer clear of the herd...

Prediction: Employment growth will turn negative at some point in 2024.

#3 Apartment problems will exceed office problems

A year ago we predicted that "cracks in the multifamily armor" would emerge in 2023. Many of these cracks will explode in 2024, leading to a wave of multifamily defaults and restructures that will meaningfully overshadow office losses.

How could this be?

• Multifamily is generally more leveraged than office properties.
• Multifamily was priced to perfection 18 months ago.
• A greater share of the multifamily stock traded near the recent peak.
• The multifamily sector is 2x larger than the office sector.
• Most office properties (especially on a value basis) will be able to mitigate cap rate expansion via NOI growth.

Office will have more than its fair share of problems, but it seems to be priced-to-worst (or nearly so) while multifamily expectations remain relatively bullish.

Prediction: More mortgage losses from multifamily properties than office properties.

#4 There will be fewer real estate jobs

Prediction: Meaningful decline in real estate employment between now and year-end 2024, on a path to match the last cycle's severe contraction.

#5 Brokerage revenue will disappoint, led by CBRE

Over the last two years, brokerages have gone from blistering transaction volumes and fees to an almost complete stop. Transactions are down 50-60%, and brokers are on the front line.

We think it's hard to declare winners and losers based on nominal revenues. E.g., Walker & Dunlop's revenue has fallen meaningfully, but the move is in line with the firm's strategy of focusing purely on multifamily capital markets. Is W&D a loser? Not necessarily. We wouldn't be surprised to see W&D outperform as multifamily markets rebound more aggressively than some of the other big sectors.

On the other hand, we wouldn't label the larger, more diverse brokerages "winners." They should experience more stable revenues across a cycle, which is generally priced into their multiples.

We went back 18 months to see what analysts' revenue expectations were before higher rates and fewer transactions defined the market outlook.

On balance, actual 2023 revenues are on track to come in 12% below analysts' estimates from 18 months ago with significant variation among firms.

Interestingly, those same analysts' 2024 projections are comparably lower in every case (e.g., down 9% in 2023 and 9% in 2024 for JLL, down 19% in 2023 and 21% in 2024 for C&W, etc.) except for one firm: CBRE.

CBRE was relatively bullish about a rebound in early 2024 until last quarter, and we think these expectations have perhaps anchored analysts' expectations. Why is this a problem? Senior executives are paid to hit EBITDA. If revenue lags, CBRE will almost certainly implement more cost-cutting measures.

Prediction: CBRE won't hit analysts' revenue targets for 2024 and will implement more cost-cutting.

#6 Apartment syndicators will face the music

Nearly $70 billion of multifamily properties were purchased around the Covid valuation peak. A disproportionate share of these deals were purchased by 16 firms.

Syndicators led the way with a common playbook: Older assets, mild renovation plans, max leverage, floating rates, short-term maturities, and very aggressive pricing (i.e., <4% cap rates).

Tides Equities, GVA, Rise48, and ZMR purchased more than half of their portfolios near the peak, and we think they're going to struggle to recapitalize $5B of aggressive debt.

Note: Independence Realty Trust followed the syndicators' playbook with one big exception... 90% of Independence's debt is fixed with long-term maturities, so it will likely be able to grow out of negative leverage and won't face comparable near-term maturities.

Prediction: Sparks will start to fly in early/mid-2024 as at least $1B of debt on Tides/GVA/Rise48/ZMR properties will need to be restructured, sold at a loss, or foreclosed on.

#7 Loan sales will be more of a hot topic than loan defaults

This downturn is very different from the early 1990s and GFC. Banks are in no mood for foreclosures.

With billions of questionable debt on its balance sheet, what is a bank or debt fund with billions of bad loans to do? Hire a broker to sell the loans and let the loans be someone else's problem.

We think this fee business could be a boon for some brokers. E.g., Newmark noted $26B of loan sale activity from only two FDIC transactions in its 3Q23 quarterly report; Newmark didn't disclose its fee, but 25 bps would equate to about $130M of fee revenue (or about 5% of Newmark's annual revenue).

Prediction: Loan sale activity will double over the next 12 months.

#8 Life science will officially lose its luster

PWC's Emerging Trends survey is "must read" material for CRE professionals. Of the 26 property types in the annual survey, life science was #2 on the list two years ago, #4 on the list last year, and middle of the pack for 2024.

We think the general industry opinion of life science continues to be inflated, and the next 12 months will be especially painful for these projects.

Prediction: Life science vacancy continues to climb and will be in the bottom 25% of property types in PWC's next Emerging Trends survey.

#9 Data centers will surge but raise eyebrows

Speaking of PWC's survey, data centers scored the highest marks from respondents for investment and development prospects in 2024. We expect a wave of activity to shine a light on data centers, along with their extraordinary need for power.

Example: Digital Realty's properties use enough energy to power 1,000,000 U.S. homes annually.

This dynamic sets the stage for two big challenges in 2024:

1. ESG hawks will increasingly complain about data centers' power requirements.
2. Cities and municipalities need to provide access to massive amounts of power to satisfy the surge of data usage. We think this challenge will come into view in 2024 as many cities struggle to provide sufficient power.

Prediction: Tensions will rise about ESG concerns and/or a lack of electric capacity needed to satisfy data center demand.

#10 Open-end fund managers will be recapitalized

We predicted that 2023 would see $30B+ of gated equity pull up at the exits of open-ended funds and non-listed REITs. As of a month ago, redemption queues totaled about $36B.

We think these redemption queues will fall in 2024 as managers seek ways to keep their investors happy while steering their funds through choppy real estate waters.

One creative solution: GP-led secondaries

StepStone, a leading institutional investment advisor, recently released a white paper covering the rapid expansion of capital available to fund managers:

"Higher interest rates are likely to lead to a bull market for GP-led real estate secondaries. GP-led secondaries allow GPs to complete worthwhile value add programs and potentially meaningfully improve returns, thus enabling them to live up to the latest market cry: Stay Alive until ‘25!"

This capital typically targets smaller, niche operators, but it's a relatively unique time for open-end funds and non-listed REITs. On one hand they're facing seismic stress from investors wanting out while on the other the larger platforms generate very significant fee revenues.

Example: Blackstone's core plus fund (BPP) manages nearly $69 billion with a reported 1% fee. i.e., nearly $700 million in annual fees. Blackstone's fund is larger than most and likely offers discounts to some investors, but this resource (major fee generation) is something that smaller funds and platforms would likely trade to shore up capital outflows.

We could see at least one or two firms moving relatively quickly to promote going on the offensive during a good time to deploy capital, rather than struggling through redemption queues for several years.

Prediction: At least one large real estate investment manager will mitigate redemption queues by trading GP interests for fresh capital.

#11 Japanese investors will be a top U.S. investor again

International capital migrates across the globe like schools of fish. i.e., impossible to predict over the long term but easy to spot in the short term.

Canada and Singapore have been the biggest buyers of U.S. real estate in recent years, and, while that may not change, Japanese investors seem to be doubling down on U.S. real estate and racing up the list of largest U.S. investors.

After decades of relatively slow growth in Japan and stinging memories of the bust that followed the 1980s commercial real estate boom, Japan's economy is on much more solid footing, and property prices are down.

Prediction: Japanese investors will be a top 5 buyer in 2024 and a common source of recapitalization equity for real estate funds/companies.

#12 More platform plays and spinouts

Here's a quick thought experiment:

Assume you are a highly skilled real estate sponsor. You work for a platform that raised $100 million a few years ago, and you spent the last three years putting that money to work. Your firm knew you were valuable, so they agreed to give you 20% of the upside in your deals (your "promote").

Here's what likely happened to that promote over the last 18 months...

What would you do if you were in that situation? Stay behind to try to save your $700K or leave, start over, and play for the $10-16M at a new shop? We think we'll see many deal captain-types leave established shops in 2024 to plant new flags.

Another thought experiment:

Assume you are the platform that hired the deal captain above. Your firm is entitled to 80% of the promote outlined above. Do you hang around and fund your overhead with no light at the end of the promote tunnel?

Predictions: Many seasoned sponsors will start new firms in 2024, and several big operators will recapitalize their operations with institutional capital.

#13 CRE executives talk a lot more about AI

You probably had never heard of ChatGPT a year ago. Now it (and endless talk about artificial intelligence) is a normal part of daily conversation.

Real estate tends to lag broad technology trends, but AI is already starting to penetrate executive conversations.

During the largest REITs' investor days this year, the words "data" and "analytics" came up about 200 times. We think we'll see a 50% increase in how much this topic is discussed during investor days in 2024.

However, with a few exceptions, AI seems to be a lot more talk and a lot less action in real estate. We think this will continue to be true in 2024, but a few leaders will emerge.

Prediction: Mentions of AI will spike by at least 50%, but 2-3 real estate firms will emerge as clear leaders when it comes to leveraging data, analytics, LLMs, and automated processes to make better real estate decisions.

#14 Business schools will continue to focus more on "business" and less on "school"

Business schools are in crisis. Their primary offering (MBAs) aren't as valuable as they once were, and most students know it. Thus declining applications...

Today's realities of business school supply/demand have shattered the traditional model, and the attainment of credentials and networks far supersedes attracting new students and donors.

...which is why business schools are increasingly selling their brand to students seeking loose affiliation with universities.

Example: Did you know that HBS generates nearly 2x more revenue from selling credentialing (think LinkedIn badges) than from MBA tuition?

HBS generates $970 million of annual revenue, employs nearly 1800 people, and pays them $240K a year in salary/benefits (on average). Bottom line: Harvard Business School is a much bigger business than it is a business school.

Other MBA programs aren't falling as fast, but their challenge seems more existential because they can't sell the HBS-light credentials. They are desperate for students who will pay big tuition numbers, which pulls down the bar for talent and exacerbates the core problem: MBAs are designed for mediocrity, and student achievement isn't a top priority.

Prediction: The number of MBA applications will fall, and acceptance rates will increase.