Key Trends To Watch As Real Estate Levels Out
After almost three years of severe dislocation, real estate markets are showing robust signs of reaching the bottom — and that is presenting significant, though selective, buying opportunities for institutional managers. Several leading indicators suggest recovery in the capital markets, real estate supply-demand forces are turning positive, and broader economic trends are powering growth in specific segments.
“At Goldman Sachs Asset Management, we have seen a meaningful increase in investor interest in the real estate space again, after about 30 months of market change” said Jim Garman, Global Head of Real Estate in an article in Pensions and Investments. “There’s a recognition from many clients that valuations are starting to bottom out in several sectors and that this might be a good time to re-enter the market.”
Leading indicators
A number of indicators are pointing to a recovery in the capital markets, Garman said. First, liquidity has returned to the market with commercial mortgage-backed securities issuance rising over 180% this year, and real estate transaction volumes up 14% year on year in the third quarter, even though that’s still much lower than the peak. Second, The NFI-ODCE index — the NCREIF Fund Index - Open End Diversified Core Equity index, which tracks institutional core private real estate returns — is starting to stabilize. “We’ve also seen the public REIT stocks improve quite materially in the past five months, and we’re seeing the early signs of core buyers returning to the private market.”
In addition to improving liquidity, the supply-demand fundamentals are positive. Rental housing demand has been resilient despite the market turmoil, underpinned by a strong job market in the U.S., he said, pointing out that U.S. multifamily housing absorption in the first half of 2024 was one of the strongest it has been in about 10 years. Garman’s team is also closely watching new construction starts for logistics and housing assets, which are down more than 50% from their peak.
“Overall, the market is in a much better condition today than it was, say, a year or two years ago. The prospects for strong income growth in our target segments look attractive,” Garman said.
Keep a watchful eye
That’s not to say there aren’t headwinds. Three market and operational aspects to watch closely are dislocation, dispersion and the asset manager’s ability to navigate the real estate market.
“We don’t think this will be a V-shaped recovery as there will be ongoing capital markets dislocation,” Garman said. Looking ahead, “a significant amount of leverage is still to be worked through in the system. It’s well known that more than $3 trillion of debt maturities will come due over the next four to five years in the U.S. and Europe. That will create some attractive opportunities to invest but will take time to get resolved,” he said.
Secondly, “We think there will be a wide dispersion in the performance of different assets going forward, probably more than we’ve seen in previous economic cycles,” Garman said. “Powerful trends are driving the real economy which we think will shape the future of real estate. There will be quite a difference in performance between the right assets in the right sectors with the right quality versus those that don’t have those features.” While values are down on average 20-25%, that dislocation most impacted the secondary and tertiary office market, where values are down much more and may have further to fall. The industrial sector fared far better due to ongoing demand.
Finally, Garman said, “This is a real estate market for investors who can operate at the intersection of capital markets dislocation and the big trends driving the future of the real economy, and who can create value through operational excellence.” In an environment of higher inflation and higher interest rates“we expect income growth to be a larger component of total return, so the need to drive returns through operational excellence, as opposed to through cap rate compression, is much more relevant,” he said.
Underlying drivers
Goldman Sachs Asset Management, which has been investing in real estate for over 30 years, identifies attractive sectors in real estate through the lens of mega trends that are driving the real economy, notably, technology, demographics and sustainability.
“Technology themes are going to continue to have an extraordinary influence on the types of real estate that people want to carry out their activities in, and where they want to do that.” Increasingly, ever more digital societies are driving demand for logistics and industrial real estate through the growth in e-commerce, advanced manufacturing and automation, while cloud computing and artificial intelligence are driving demand for datacenters. Garman also notes the ongoing disruptive effects of new technology on real estate, with the office market upended by the work-from-home theme enabled by the shift to video-enabled meetings and other technology tools.
On the demographics front, as the U.S. population has grown, it has aged, Garman pointed out. By 2030, people aged 65 and over will reach about 73 million — over 20% of the population, per the U.S. Census Bureau. That’s up from about 56 million, or roughly 17% in 2020. This baby boomer cohort is driving demand for access to healthcare, located in medical outpatient buildings, and more senior housing.
On the other end of the spectrum, the Gen Z and millennial populations are pursuing both single-family and multifamily rental properties, Garman said. Strong educational demand is also behind the need for quality student housing facilities. “The living sector, broadly defined, is a target sector for us in the US and Europe as well as Japan”, he said.
Sustainability will also continue to drive new opportunities in real estate. “There is strong demand from certain parts of the occupier population, the investing community and from regulators to make buildings more energy efficient and more sustainable, particularly in Europe,” Garman said. “We have real evidence now, through our investing activities in the region, that buildings that are next-generation sustainable can command premium rents and a lower cost of capital.”
Bridging the gap
The long-term structural shift away from bank lending in real estate — a shift that began with the global financial crisis and opened up the private market to real estate credit lenders — has accelerated though the current market cycle and will likely persist, Garman said. Goldman Sachs Asset Management, which has been a private real estate credit fund manager for 15 years, continues to see compelling opportunities in this space.
“Given that over $3 trillion of real estate debt will need to get refinanced over the next four to five years across the U.S. and Europe, that will present opportunities for private real estate credit funds,” he said. “We carefully watch credit quality. We aim to provide borrowers with large-scale loans through direct origination on high-quality real estate with customized solutions.”
Meeting objectives
“We think that real estate is a must-own asset class in a diversified portfolio that includes alternatives,” Garman said.
Real estate allocations can help investors meet different portfolio objectives, he said. The asset class can deliver current income, often in a tax-advantaged way for private investors. It can provide enhanced returns through more opportunistic strategies, as well as diversification and inflation protection. “We find that different clients are looking to solve for different problems. Our job as a manager is to provide our clients with solutions that fit their portfolio needs. It’s not a one-size-fits-all approach.”
Goldman Sachs Asset Management manages strategies across core-plus equity, opportunistic equity and credit, as well as secondaries, he noted.
The firm’s real estate team factors dual attributes into its client approach: delivering investment performance and ensuring a strong client experience. “What that means in practice is having an investment process that allows us to transform complexity into tangible value. We harness the extensive data, insights and access that we garner from across our platform, and then combine that with our operating expertise and execution capabilities to deliver strong performance,” he said. “And the client experience is all about partnership. We co-invest alongside our clients, and we view it as a long-term partnership.”
