Midyear Global Real Estate Market Outlook 2023

Julie Whelan:
Hello, I'm Julie Whelan, and on behalf of the CBRE Global Research Team, we welcome all of you to the 2023 Midyear Global Real Estate Market Outlook. As we started 2023, uncertainty was looming in our global economy and our commercial real estate markets were already feeling the effects. Consensus was the global markets would be operating in a weak economic environment as central banks continued to fight inflation. Now, we find ourselves at midyear. So much uncertainty remains, but we have more answers than we did six months ago, which of course means a new set of questions: Inflation is trending in the right direction, but will there even be a recession? Will it have a global impact? Commercial real estate capital markets have slowed, but fundamentals have remained strong in so many sectors. Which ones could surprise on the upside? Office, particularly in the U.S., has been on the front lines battling both structural and especially this year's cyclical forces. When will it see the bottom?

Today I'm joined by my colleagues from CBRE Global Research to help answer these questions and more about what we can expect throughout the remainder of 2023 and into 2024. We'll spend time on the outlook for the global economy and capital markets, and then I'll moderate a high-level conversation with our sector experts on expectations for office, industrial and retail, multifamily and hotels and, finally, data centers. As a reminder, please share any questions that you have via chat, and we will do our best to answer them after this session. We have a lot to cover. So let's get started. Let's start with the state of the economy. To discuss how the rest of 2023 will unfold, I'm joined by our leader who always has his pulse on the market, Richard Barkham, Head of Global Research and Global Chief Economist. Welcome, Richard.

Richard Barkham:
Hi, Julie.

Julie Whelan:
Richard, at the start of the year, your exact words for the U.S. economy were, “We expect a recession in 2023, but we are not overly pessimistic.” Do you still agree with that statement? And what are your views globally on that?

Richard Barkham:
I would still agree with that statement, Julie, and I would say the situation in the global economy has improved over the last six months, particularly in the United States and Asia. But I would also caution that we're still at peak interest rates and we'll be there for the next six months. So the downside or a nasty downside, or the possibility of that has not fully receded. Let's remember we started the year with three pretty intense headwinds on the global economy. China, the world's second-largest economy was in lockdown. Europe was faced, faced a winter with a tenfold increase in energy prices and, led by the Federal Reserve in the United States, central banks around the world were raising interest rates to deal with inflation, which had substantially surprised on the upside. So why do I say things have improved? Well, China, obviously out of lockdown and growing, energy prices fallen precipitously in Europe, to long-term levels. So nothing out of the ordinary there. And I think we're making substantial progress on headline inflation, and there is increasing indication that core inflation is turning down. So, there's much talk of the U.S. achieving a soft landing. That's not quite in our scenario, but the path to a soft landing in the United States is certainly wider than it was.

Julie Whelan:
Well, I read in early July that the G-10 collectively had raised interest rates a total of 950 basis points across 28 rate hikes. So glad to hear that core inflation is coming down because they have certainly been working to do that. So you talk about a soft landing, but you also alluded to the fact that our house view is different. It still calls for a mild recession, so not entirely avoiding a recession altogether. Why is that? Why are we being cautious?

Richard Barkham:
Well, in short, and I've more or less said it already, we are not yet through the rate cycle. And if I had to unpack that, I would say that first and foremost, we have not seen these levels of interest rates for 22 years, and the U.S. and the global economy has changed a lot over that time. In particular, there's more debt. So there is still a degree of uncertainty about the timing and extent of the impact of interest rates, and we do think that there will be more negative impacts on growth to come, despite the fact that we've seen resilience in the U.S. economy, quite remarkable resilience. I think secondly, as we pass through the, what we economists called the transitory phase of inflation or pandemic legacy inflation, we're still left quite surprisingly with uber-tight labor markets both in the United States, in the UK and Europe, and in Asia.

Richard Barkham:
And just to take a case in point in the United States, for instance, wage growth is stable at 4.4%. It doesn't sound very high, but it's not really consistent with 2% inflation. So I think we need to see more rebalancing with lower labor demand and perhaps increased labor supply. In other words, a little bit more labor weakening, labor market weakening, higher unemployment, and I think we might need some periods of negative economic growth in order to achieve that. And my final point would be that on this issue of recession, the headwinds that I mentioned to start with haven't completely died away. Europe is already had a mild recession, growth returned in Q2, but it may slip back into recession. The German economy, which is a driver of Europe is quite weak right now.

Richard Barkham:
And of course there are risks in Asia as well around China growth, from its very sluggish housing market in tier two and tier three cities. But having said all of that and cautioned that we might still experience a mild recession, I would say, you know, the, the operative word there is mild. It is not a very extended period of negative growth, more like a period of standing still, that we have in our house view, albeit it's not quite a soft landing.

Julie Whelan:
So standing still that seems to me like treading water or when do you think we'll stop and we'll actually be on a solid upward growth track again?

Richard Barkham:
You can never precisely date these things, but we think that the U.S. will experience mild negative growth in Q4 of 2023, and then Q1of 2024. So this weak patch will stretch into 2024. And the U.S. is a major driver of the global economy, so that will exert a slowdown on all of the advanced economies and the emerging markets as well, albeit with different timings. However, we do think, and we're already beginning to see it during Q1, the conditions for getting down to 2% inflation will come into place, and that will allow central banks led by the Fed to start to cut growth. And that will bring about the conditions where growth can revive in Q2, making 2024 a weak, but positive, year for the global economy.

Julie Whelan:
Okay. So this baseline around our economic outlook is extremely helpful, but we're here to talk about implications for commercial real estate and we have many colleagues in the wings waiting to help us do that. But to start us off, what is your high-level view of implications for our sector?

Richard Barkham:
Well, let's talk about capital markets. Capital markets usually leads the economy by about six months, and indeed we've already seen some improvement in capital market sentiment, particularly around the soft-landing narrative in the United States. But I think we'll need another quarter of good inflation results for that positive sentiment to turn into action and for, with a lag, I think that means that transactions will begin to tick up in Q1 of 2024. I think we also probably a little bit of further price adjustment in the United States and, and other markets for that to happen. Now, leasing usually lags the economy by six months, but I think the economy is not quite behaving as it used to do. And we have certain sectors, for instance, retail, for instance, industrial, for instance, data centers, they've got long-term tailwinds that I think may accelerate the normal process. So, they might start to pick up at the same time as capital markets transactions do, Q4 of this year, Q1 of 2024.

Julie Whelan:
Okay. Well, something to watch out for. And before we end this section, what are you most closely watching that you think our listeners should keep an eye on also?

Richard Barkham:
Well, big picture, Julie, the economy is still transitioning from the pandemic. During the pandemic there was extensive spending on goods. We are now transitioning to much more spending on the services sector, and that explains why we've got a degree of service sector inflation still running in the economy. It also explains why consumer economies like the U.S. and the U.K. are doing well, and export economies like Germany and China have run a little bit into headwinds. So that's the big picture. I'm also watching good growth in Japan. It's an export economy, but it's doing well because of domestic consumption, and it's been a long time since I've been able to say that, so that's really an interesting story. But most of all, I think I'm keeping a close eye on wage and salary growth, both in the U.S. and Europe because that's what central banks themselves will be watching that feeds through into core inflation. And if that eases quicker than we expect, then I think this road to a soft landing might open up further. We're not there yet, but that's what I'm watching.

Julie Whelan:
Well, thank you Richard. I often say that although I'm not an economist, I have learned enough from you to be dangerous. So it's messages you deliver like this that help all of us navigate this sector with more confidence. So thank you for your comments. So let's continue by talking about the global capital and debt markets landscape. Richard mentioned that we need inflation data to move in the right direction before we can see a meaningful uptick in capital markets transactions. So let's see what our other experts have to say. I'm pleased to be joined by Henry Chin, Head of Investor Thought Leadership, and Darin Mellott, Capital Markets Research. Welcome Henry and Darin.

Henry Chin:
Hey, it's good to join you virtually from Hong Kong.

Julie Whelan:
So comments so far have made it clear that these persistent rate hikes are absolutely having an impact already. So give us an overview as to how deep that impact is across commercial real estate sectors in global geographies. Henry, why don't you start?

Henry Chin:
Sure. Actually, let's start with talking about the investors sentiment. I have to say, global investors continue to be very cautious when it comes to new acquisitions. Major concerns include the availability and the cost of a finance pricing gap between buyers and sellers and negative spread. When we look at different asset classes, fundamentals for logistics and multifamilies remain solid and cap rate expansions is largely due to the higher cost of finance. However, the positive rental growth will continue and somehow can offset the negative impact on the cap rate expansions. Now, when it comes to retail, the cap rate for retail enter the repricing cycle at a higher level this time. Therefore, cap rate expansion could be lower. Some investors are turning their attention to retail assets, particularly in Pacific and Japan. Now let's talk about offices. In terms of a price adjustment, office has been hit the most, particularly in the U.S., followed by Europe.

Henry Chin:
However, capital value in Asia-Pacific somehow remain resilient. The journey of a price discovery has not yet finished. So we all expect you to see further cap rate expansions in offices globally. During this cycle, it's fair to say that the cap rates for commercial real estate has moved out globally, but at various levels, the U.S. has seen the strongest repricing in Europe. There are great variations across countries and property types. I would like to highlight the U.K. has seen the most repricing for logistics in continental Europe; office and multifamily have seen the biggest expansions. Asia Pacific, somehow in general, has seen the smallest movement among three regions. And my colleague Darin will walk you through the cap rate movement in detail across three regions. Darin, over to you.

Darin Mellott:
Thanks, Henry. By the end of the year, we expect that cap rates will have moved out by around 125 bps, across various property types, closer to 200 in office. Importantly speaking, Julie, this is speaking very broadly. We're seeing wide variations across geographies, property types and specific assets. That said, we think the prices will stabilize across most asset classes this year into early next year, with the exception being office, where we may continue to see some movement in pricing into mid-2024. Now, in continental Europe, office and logistics yields have moved out about 120 bps from their lows in early 2022, and retail has moved out by about 70 bps during the same period. We expect that prime property yields in most countries and sectors will continue moving out until the end of the year. Now, like in America, this is speaking very broadly, with variations between geographies and specific assets and property types. In Asia-Pacific, many markets continue to register negative spreads, further cap rate expansion is expected outside of Japan and China, and we expect cap rates to expand in the range of 75 to 150 bps from peak to trough across that region.

Julie Whelan:
Okay, so gentlemen, theme number one seems to be repricing will continue around the globe. And I know when I see sales, I shop more. So hopefully that will be true in this case also. Now, these interest rate hikes have also brought the banking sector into the spotlight, especially small banks. The topic of debt defaults in commercial real estate (CRE) is under a lot of scrutiny. Darin, I know you just wrote a great paper on this. Is this a global topic? Is it isolated to the U.S.? Is it as big a problem as headlines would lead us to believe?

Darin Mellott:
Well, it, it is primarily a U.S. problem, and it stems from issues in the office sector, and that's where challenges in the office sector are most pronounced. So that's where I'll focus my comments, but there's no doubt that we're going to see a significant amount of distress, particularly in office, as I mentioned during the coming quarters. Now, let's put this into a bit of perspective. U.S. banks have about $1.7 trillion in exposure to CRE. However, office debt only accounts for about $340 billion of that. So again, perspective is everything. This is about a percent and a half of the banking systems’ total assets. Also, during the global financial crisis, as you mentioned, some people wonder about wider implications. This was, you know, the global financial crisis was driven by residential real estate, which in 2007 made up 20% of bank assets compared with commercial real estate accounting for closer to 10% of bank assets today, with much more conservatively underwritten loans. Still, we think losses could be substantial.

Darin Mellott:
U.S. banks could see up to $60 billion in losses over the next several years with office accounting for roughly $26 billion of that. Again, for context that's equivalent to roughly 3.5% to 7.5% of total exposure. In the context of total banking assets, losses are within a few tenths of a percentage point of the total. So we think that this is going to be particularly problematic for smaller community banks, but we don't think these losses on their own would destabilize the financial sector. That said, it will create headwinds for our sector, for commercial real estate and the economy as a whole, as the credit flow is restricted.

Julie Whelan:
Well, that is awesome context, Darin and $60 billion does seem like a big number to me, but everything is relative in understanding this in context of the GFC is very, very helpful. So Henry and Darin, let's end our capital markets discussion and leave our viewers with your summary of what they can expect the rest of this year into 2024.

Henry Chin:
Okay, Julie, I do wish I had a crystal ball to predict the future. I think early this year we did expect that the rate high cycle would have come to the end by now, so investors would have resumed their investment activities soon after. However, as Richard has mentioned, due to the stronger than expected service performers and much tighter labor conditions, global central banks have continued to keep the policy rate at the higher levels. But based on CBRE’s, and so many different studies and cap rate surveys, financial-related factors continue to be front and center of investors' mind. Therefore, we do expect global transaction volume to drop by around 34% this year before starting to recover in 2024. I would really want to highlight there are major differences between the three main regions when it comes to investment activities. In where I am, in Hong Kong, in Asia-Pacific, we do expect investment activity to drop by 15% this year, and Japan continues to outperform due to the lower cost of finance and the better and sound fundamentals. Activities in Australia, mainland China, Singapore and Hong Kong all remain muted, and it is worth noting that Korea was the first major economy to hike the policy rate in late 2021.

Henry Chin:
And since the Bank of Korea indicated that the policy rate-hike cycle is coming to the end, so the cost of financing started to trend down. It was 7% in January and it is now 5% as of last week for the stabilized asset. Therefore, we are starting to see signs of a green shoot in the investment activities, particularly in Korea. Darin, your prediction for the U.S. and Europe?

Darin Mellott:
Yeah, so we expect that investment activity will be down, and I'm speaking of volumes here by 37% year-over-year in the U.S., which is close to 2016 levels. We don't expect volumes to pick up meaningfully in the U.S. until 2024. That said, we are starting to see some green shoots, particularly in multifamily, where we expect volumes to pick up notably in the second half of the year. I would say that our expectations for recovery are driven by a few factors. Number one, appetite for real estate investment remains strong, and number two, investors should get clarity with regard to interest rates in early autumn, allowing for more confident underwriting and activity to begin picking up. Now, in Europe we expect investment volumes to decline by about 35%. So that for them, again, that takes us back to volumes last seen in the last decade, of 2013-2014. The major sectors, we expect the logistics to recover first, but residential yields are lowest as rental fundamentals remain strong there. Retail and office are still facing structural headwinds, although the prime segment is more resilient and we expect the northern and western European markets to recover the soonest.

Julie Whelan:
Well, thank you Henry and Darin. The capital markets environment remains tough clearly, but you have reminded us that there are plenty of strong fundamentals that are ready to lead the way as our economic environment becomes more clear. Now, interestingly, we did an online poll before this webinar and it aligned with your thoughts. So 44% of respondents suggested that U.S. multifamily would garner the most investment capital in the back half of the year. So those green shoots that you're talking about, Darin, are coming true and 33% suggested it would be industrial & logistics. So we'll talk again at year end to find out. Now I'd like to move on to our specific sector discussion and we're going to start with the global office market landscape. We just spoke about how fundamentals are so important for a capital markets rebound, but office is the asset that has the most challenged fundamentals in today's environment. Reduced demand, rising vacancy and rents that are declining are all bellwethers of this market right now. For this discussion, I'm joined by Ada Choi, Asia-Pacific Office Research, and Jessica Morin in U.S. Office research. Welcome, Ada and Jessica.

Ada Choi:
Hello Julie.

Jessica Morin:
Good to see you, Julie.

Julie Whelan:
Great to see you both. So as you both know so well, the way we work has permanently changed. As a result, many occupiers are solving for new portfolio strategies and those strategies are often resulting in contraction. That reality is at the core of what is challenging office market fundamentals today. Now we just released our suite of occupier survey studies around the globe. I want to hear what you learned from that survey about how occupiers and employees have changed their office usage patterns. Ada, let's start with you from an Asia-Pacific perspective.

Ada Choi:
Sure, I would like to deliver some good news. I think Asia Pacific is leading the way in terms of return to the office. The average office utilization rate in the region was about 65% as at the end of Q1 2023 led by the greater China and North Asia markets, which have already been largely back to the pre-COVID levels. I think cultural factors, smaller home size and extensive public transportation system enables people to prefer to work at the office. However, we notice that even Asian companies have realized the importance of flexibility, and therefore they lowered expectation for their staff to work fully in the office. It only means that their staff can work from home if they need to, not meaning that they can work outside the office regularly.

Jessica Morin:
And in the U.S. and Europe office utilization's lower than what it is in Asia. In our spring 2023 occupier sentiment survey, more than 75% of respondents in Europe and the U.S. reported average utilization that's below 60%. And so while those averages look similar in the U.S. and in Europe, there are very key differences. So in the U.S. there's a greater variability in how organizations are utilizing the office, with many leaning into the office, but still some leaning into remote. Whereas in Europe, most organizations are really bought into this balanced hybrid approach with few leaning one direction or the other. So regardless of their approach to hybrid work, occupiers in both regions do expect office usage to increase through the remainder of this year and into 2024.

Julie Whelan:
Well, I find those regional differences interesting and we could have a whole conversation about what's behind them, but for now it's good news that usage is anticipated across most of the world to grow as we move into 2024. Now globally net absorption has fallen negative in 2023 and vacancy is on the rise, as I mentioned before. One thing I want to pick apart for our listeners is how much office fundamentals are struggling from the secular impacts of hybrid work that we just talked about versus that layered effect of the economic cycle that Richard spoke about. So Jessica, I know you've done some work on this lately. Let's start with you.

Jessica Morin:
Sure. So in the U.S. demand measured by tenants in the market has remained pretty stable so far this year, but office leasing activity has not yet stabilized. So what that tells me is that tenants are really deferring these leasing decisions until there's a greater degree of economic clarity. And so this mix of the economic uncertainty plus the hybrid work makes it difficult to discern which is the primary cause of reduced demand. But because we saw leasing activity exceed pre-pandemic levels for several months in 2021 before that economic uncertainty set in late last year, it’s likely that the cyclical events here are the bigger factors. So once we have economic stabilization, we can really expect to see a rebound in TIM and leasing activity. And then on top of that, construction completions also peaked in 2021 and they're likely to stay low for the foreseeable future. So that's also going to support market fundamentals once we see demand pick up in late 2024. And then talking to my colleagues in Europe, it's a similar story. Both factors are impacting the market, but economic challenges especially are impacting weak leasing activity in Europe so far this year. And so volume is down there by about 20% compared to where it was in the first half of 2022. And it's going to be the second half before we see any material signs of improvement there.

Ada Choi:
Well I think in Asia-Pacific I would say that the office performance is largely affected by the economic cycle and the supply peak that pushes vacancy to a 20-year high. Recovery in mainland China is weaker than expected while supply is really high resulting in further decline in rents.

Julie Whelan:
Okay, so it seems that this economic weakness is really a big part of the story right now and that once that passes or at least we get more clarity around it, that we can expect a rebound. Now you also both bring up a few good points that I would like to highlight. Jessica, I find that one stat is sometimes forgotten and that's in 2021 leasing activity for a few months exceeded pre-pandemic levels. So clearly we were seeing a rebound and we can expect that that is going to happen again once we have more certainty. And Ada, you specifically mentioned the supply peak. That is the story in many parts of the world where we continue to deliver a lot of supply to markets, but that's likely to slow going forward and there isn't a whole lot coming behind it. So this should automatically help fundamentals.

Julie Whelan:
Also, I would like to end with a bright spot for office: Rents have been buoyed by the prime office market, and that prime office market has been very resilient throughout the pandemic and into this year. Now flight to quality has always been a trend during recessionary periods, but the reason why was usually because occupiers were able to take better space for a lower cost. But this time the story is a little bit different because price sensitivity doesn't seem to be the driver behind success of the market. So what are your views on that? Ada, let's start with you.

Ada Choi:
Julie, I think nowadays people are comparing the workplace environment with their home as they can work from home. So for companies and occupiers, they realize that they need to provide a good working environment so as to boost office utilization. This drives the flight-to-quality relocation with strong preference to offices with good transportation and amenities. Jessica, how about your markets?

Jessica Morin:
Yeah, in Europe and the U.S., the trend is very similar to what you described in Asia-Pacific. The flight to quality actually may even be more pronounced because as we discussed earlier, employees in these regions have more choice. And so employers are using the office to draw them back through better location, aesthetics and amenities. And so in Europe, access to transportation and sustainability features are really becoming much more prominent factors when tenants are selecting locations and their buildings. And so as evidenced, supply conditions in the core and CBD markets are much tighter and occupier choice is much more constrained. For example, in Paris, their overall vacancy rate is around 7.5%, but in the CBD, it's just over 2%. And so we are seeing prime rents across Europe that are generally at least stable and in some cases it's rising. In the U.S. we're also witnessing this flight to quality and it's especially apparent in younger buildings. So consistently we've seen positive net absorption in buildings that were built since 2010 throughout the pandemic. And the vacancy rate in these buildings are about 400 basis points below the overall average. In Manhattan, the availability rate for mid- and lower-quality buildings is near 21%. But for better buildings in the Midtown core where there's this easy access to transportation and renovated and well-amenitized buildings, that rate is closer to 13%.

Julie Whelan:
Wow. So you have just both described that bifurcation in the market that we're seeing. So thank you, Ada and Jessica. The office market is the most challenged as we proceed through this year and into next, but there are many resilient areas and plenty of reasons why this sector is poised to rebuild fundamentals over the longer term. So now we’re going to move onto our discussion and we’re going to focus on hotels and multifamily, two assets where consumer demand is less of a question, even if economic uncertainty is a short-term challenge. So to discuss multifamily and hotels outlook, I am joined by Rachael Rothman, Global Hotels Research, and Matt Vance, U.S. Multifamily Research. Welcome, Rachael and Matt.

Rachael Rothman:
Thank you Julie. Pleasure to be here.

Matt Vance:
Thank you Julie. Great to be here.

Julie Whelan:
Good to see you both. So Rachael, let's start with you. Last time we talked in 2023 Outlook, you indicated that easing international travel restrictions and uptick in business travel and even the trend towards “workcations” were providing optimism for the hotel industry. Does the slowdown in global growth that we've discussed change your outlook for the rest of this year and into next?

Rachael Rothman:
Well, if we could just set the table for a minute and take a quick walk around the globe and talk about what's happened in the first half of the year. In the U.S. we’ve seen room revenues up about 5%. In Europe, they’re up 20. And in Asia-Pacific, over 50. As you mentioned, this growth has been fueled by work flexibility, improvement in group business in the U.S., Americans’ strong desire to travel abroad, particularly to Europe, and the reopening of China and Japan. We do expect growth to slow as we move into the back half of 2023 and 2024. Of course, given the strong trends year-to-date, in addition, it can take time to add back long-haul flights and there has been some friction in the visa process, but as that eases, we do expect trends to resume. A few markets that we expect to be standouts going forward: In Europe. We'd like to highlight Italy, France, and Spain again, that strong U.S. consumer appeal. In the United States, markets with strong long-weekend demand, that would be Savannah, Anaheim and New York. And in Asia-Pacific, we do expect Singapore, to remain a standout market and we do expect to see strong growth in Japan, Thailand and Indonesia. Overall, as Ada mentioned, this moderating supply growth across the globe does give us a strong runway for growth and we are optimistic on hotels going forward.

Julie Whelan:
Hey, well that's great news and personally I feel like so many of my own family and friends are visiting Europe this year and all those countries that you mentioned. So those trends are certainly ringing true to me. I want to hop in their suitcase. So Matt, let's talk about multifamily for a minute. Over the last year, the conversation around multifamily has been focused on softer demand and a lot of development, which can usually create an imbalance in the market. But with interest rates that have risen and therefore the cost of mortgages being more expensive, do you expect this to actually drive an uptick in multifamily demand?

Matt Vance:
Well, Julie, the multifamily sector nearly rebalanced itself this year already. U.S. renter demand came back very strong in the second quarter, just as we've been projecting. It almost even kept pace with near-record supply. This is really important, because vacancy only moved up another 10 basis points. It returned to its long-run trend of 5%. Now the single-family market, on the other hand, is not balanced at all. We estimate there's a shortage of around 3.1 million homes nationally, and because of this market tightness, prices are up all right. And when you combine that with higher mortgage rates, buying a home has become extremely difficult for many. So I don't know, to answer your question, Julie, that this will cause enough of an uptick in demand to overcome some of the things that are or will be weighing negatively on new apartment leasing, things like a slowing economy, slowing job growth and other economic turbulence that we heard about from Richard. But it is absolutely helping to preserve existing demand and existing occupancies. And this is something property owners are very focused on right now is that preservation of existing occupancy.

Julie Whelan:
Yeah, it's easier to keep an existing customer than to get a new one, right? So what are your expectations for the rest of the year moving into next year? And you have any anecdotes that you can share with us about the story globally?

Matt Vance:
Absolutely. The same story that I just described applies throughout much of the world as central banks have grappled with inflation raised interest rates and the cost of buying homes. It's keeping renters renting for longer, virtually everywhere. So for the balance of this year, we expect healthy demand in the U.S, to come up just short of the pace of new supply. Vacancy will likely climb another 25 or even 50 basis points by the end of the year, which will weigh slightly on rent growth, which we expect to decelerate a bit further into the 1%-2% range later this year. Now beyond 2023, we expect fundamentals to settle into their long-term trends in the U.S., around 2.5% annual rent growth and more stable supply and demand dynamics. But other areas of the world all seem to be experiencing multifamily fundamentals that look a lot more like the U.S. did 18 or 24 months ago. Supply and demand imbalances are driving record-low vacancy rates and often double-digit rent growth across continental Europe. We're seeing it in Australia, the U.K. and elsewhere.

Julie Whelan:
Interesting dynamic. So Matt, another question for you. I just spoke with Ada and Jessica about the office market and we know that vacancy in the U.S. is elevated. It's likely to stay elevated for longer structurally because a lot of buildings are just going to become obsolete in this current environment. And this has led to a lot of discussion about what to do with those functionally obsolete buildings and maybe converting them from office to multi. So what's your view on promoting this kind of conversion? Is it going to help promote better communities in our cities?

Matt Vance:
Well, it is certainly complicated to make these conversions work financially, and some buildings are just simply difficult to convert because of the way they were built. But we have found that across the U.S. we see about 30 of these conversions each year. It represents hundreds of multifamily units, but with a housing shortage in the millions, as I said, it's not really moving the needle for supply. But it is more supply, which is a good thing for the long-term health of the residential market. That being said, these conversions can have a big impact at a local level. They preserve buildings which are often historically significant. They add hundreds of new residents to otherwise quiet blocks of the city and enhance the local livability and the live-work-play vibe of these neighborhoods.

Matt Vance:
We're talking with local and national policymakers about this topic, and there is a lot of strong interest among these groups to support this. We've seen public-private partnerships work in places like Kansas City, Chicago, and elsewhere. And we're seeing it this year in California, with $400 million earmarked in the budget just for these office-to-multifamily conversions, and when we break that down, that $400 million is really enough to bridge that financial gap between today's office property owners and multifamily redevelopers, and is enough to fund as many as 16 of the average office-to-multifamily conversions and really reshape as many as 16 historically significant city blocks.

Julie Whelan:
Really interesting. I think that with all of this change, it is really going to benefit our cities and I am very pro for having more people have more affordable living in our cities. 'cause I think it'll make all the difference. So Rachael, commercial real estate often has to adjust to disruptive forces. And Matt in a way just talked about using the disruption in office to the advantage of multifamily and ultimately the health of our cities. So one of the disruptive forces for hotels has been this growth in short-term rentals. Can you speak about how that trend is changing demand for hotels?

Rachael Rothman:
Absolutely, Julie. That is of course a hot topic in our industry. Short-term rentals have been around for a very long time, but the advent of web services like a VRBO or an Airbnb that dramatically increased access to short-term rentals and then COVID and social distancing spurred trial that many people may not have used in the past. Since COVID, just in these three short years, we've seen short-term rentals grow to close to 18% of what we might call hospitality room-night demand. That's up a full five percentage points. And of course, short-term rentals and hotels often fill different use cases or need states, but it's still important to remember that this shadow supply is competition that can impact any hotel in a given market in terms of both occupancy and pricing power. So something to be aware of for developers and owners as they move forward.

Julie Whelan:
Yeah, very interesting to keep on top of those local trends, I know that just this summer I've stayed both in short-term rentals with my family and hotels, and you're right, they definitely serve very different use cases. So thank you Rachael and Matt. Consumer trends in the way we work, the way we live, even the way we vacation are pushing both of your assets in the right direction. And these assets will thankfully continue to shape the future of our cities and there are exciting things to come. So industrial and retail is what we're going to move on to next. These are two assets that are fundamentally sound, although the reasons behind those fundamentals are quite different. To discuss these market sectors, I'm joined by Amanda Ortiz, U.S. Industrial Research; Pol Marfa, Europe Industrial Research; and Brandon Isner, U.S. Retail Research. Welcome, Amanda, Pol and Brandon.

Amanda Ortiz:
Hi, it's great to see you, Julie.

Pol Marfa Miro:
Great to be here, Julie.

Brandon Isner:
Thank you very much, Julie. Great to be here.

Julie Whelan:
Good to see you all. So Amanda and Pol, let's start with industrial. Coming into this year we discussed how industrial could be resistant to a global slowdown in growth, yet we have seen demand slip a little bit in 2023 and rent growth recede. But important to note that both are still in positive territory for your sector. Has this slippage been more than you anticipated? Do you expect industrial demand and rent growth to further moderate? Amanda, let's talk about the U.S. first.

Amanda Ortiz:
Yeah, well for the U.S. this slowdown was definitely expected, and so far it has been more or less what we anticipated. But industrial demand is still fairly strong. Year-to-date absorption totaled almost 126 million square feet, which is about half of what it was last year, but it's also just about right where we were in 2018 and in 2019.

Amanda Ortiz:
So although demand has slowed, the data is showing us that the market is simply normalizing. At the same time, from an anecdotal perspective, there are still plenty of tenants in the market that have space needs, but many occupiers are just exercising a wait-and-see approach to anticipated transaction, mainly due to the lingering economic uncertainty. For occupiers, though, the space needs are there, but various financial factors, like rising interest rates and less available capital, for both new projects and property trades, are just causing some occupiers to pause. And Julie, you also mentioned about rental rates, and as far as rates go, financial uncertainty has also impacted rent growth. Taking rent growth, which is growth based on completed transactions, was almost 17% at midyear. And it seems to weaken just a little bit every quarter. But 17% is still very strong as far as historical year-over-year growth goes.

Amanda Ortiz:
But another reason for moderated rent growth is that influx of new supply to the market. This increased supply has contributed to a more balanced market, just reducing that upward pressure on rents. The market is still on pace though to record double-digit rent growth in 2023. And we project that rents will continue to grow anywhere between 12%-15% at year end. So all this to say, yes, the current state of the market has softened from the record and unsustainable fundamentals of 2021 and 2022, but the outlook moving forward remains very positive as the U.S. industrial sector remains healthier now than it was prior to the pandemic. Pol, have you noticed similar trends in Europe?

Pol Marfa Miro:
Well, I was just agreeing with you because the picture for industrials in Europe is very similar to the one that for the U.S. so leasing activity is down around 30% and our forecast is for it to remain relatively subdued for the rest of the year. We're seeing occupiers struggling to predict their own current demand levels and having very slow decision-making processes and well that's driving the market in the end. Having said that, our recently published European logistics survey showed how the largest occupiers remain very bullish, with over two thirds of respondents planning to expand their logistics footprint over the next three years. Expansion plans are challenged by the still very low supply. In fact, logistics vacancy was exhausted even more in Europe than it was in the U.S. during the pandemic-boosted demand period. And despite a mild increase in the last few quarters, same as in the U.S., we are still below 3% and we don't see it significantly improving anytime soon.

Pol Marfa Miro:
Certainly not getting anywhere near 7% levels that we had just 10 years ago. We also expect that rental growth will moderate from the annual double-digits seen in 2021 and 2022, but will remain positive due to the mentioned supply-demand imbalance. And these robust fundamentals justify the over $14 billion in the investment market that are still targeting European industrial and logistics assets as their main objective, more than any other sector alone in Europe. As Henry and Darin said earlier, there has been strong repricing for logistics in Europe, particularly in the U.K. So even if the market is not very active right now, investors are certainly monitoring it very closely.

Julie Whelan:
Thank you both for the dense data that you have given us. That’s been great. And what you’ve reminded us is that when sectors are normalizing off of record highs, it can lead to a narrative where the normalizing period can be seen as a negative, but in fact it’s actually a positive because we’re getting back to sustainable territory. Now I can tell you as of last week, I have a teenager in my family, and I watch his shopping preferences very closely and I have no doubt that the industrial sector is going to stay alive as younger generations exert so much of their buying power online. So we’re going to move to retail right now. Brandon, as I mentioned, retail also has decent fundamentals, but for very different reasons than industrial. And it’s a little bit of a mixed story. So limited development and strong post-COVID consumer rebound has created resiliency behind retail. But do we expect that this is going to change given the state of the economy and what’s happening globally with this?

Brandon Isner:
Well, Julie, that’s a good question. I would say yes, but you’re right that retail is a bit of a mixed bag globally, as it's so dependent upon the consumer. In Europe, retail sales volumes have been on a mild downward trend as real incomes have been squeezed due to inflation, but they remain about 2% above pre-pandemic levels. So that's fairly solid. The U.K. is essentially in line with their pre-pandemic levels. Consumer confidence remains challenged, but footfall at CBRE-managed retail properties across Europe continues to improve. In the Asia-Pacific region, core inflation has decelerated in China. Richard talked a little bit about this earlier, but it's accelerated in Japan. Spending has continued particularly with urban households, but it looks as if any further spending will be, could be tapping into savings as savings rates have been declining.

Brandon Isner:
We're already seeing a leveling off of spending in June. But tours for available real retail spaces are at a high level, which is leading to generally strong leasing activity. And then we come to the U.S. which is a little bit more confusing. Core inflation is decelerating. Consumer confidence has begun to rebound slightly, but remains well below long-term averages. And some segments of retail are starting to see some cracks, with year-over-year decline in sales for retailers such as home and garden retailers, department stores, electronics and apparel. Additionally, student loans coming back into play in September could mute retail spending this holiday season. Yet the restaurant industry remains very strong, which is a sign of continued discretionary spending. On the real estate side, U.S. retail remains at a very low availability rate of just 4.8%. That all said, despite retail having good fundamentals, it's difficult for retail developers to justify breaking ground on large projects because construction costs remain so high, especially in the U.S. and with little new construction, current tenants have become stickier. Renewal activity among retail REITs has been strong with many reporting near all-time highs in occupancy.

Brandon Isner:
So, again, we're seeing record low levels of activity or availability and we're in a place where news such as the Bed, Bath and Beyond liquidation is actually a positive for the market, as it is opening up space in places where there's very low levels of availability. Tenants need that space and landlords are able to ask for higher rents than the previous tenant was paying, which that's how it's supposed to work, correct? Globally, retail rents are up about 3.9% in the Americas, about 3.8% in Europe and down just about half a percent in the Asia-Pacific region, so fairly strong. Global retail yields are around 5.2%, which is quite attractive to investors that are giving retail a new look. It's a very good balance of supply and demand right now, which should continue throughout the year.

Julie Whelan:
You say that rising rents are how it's supposed to work, and I think that really depends on what side of the equation that you're on, but I understand what you're saying, so that's great. So Brandon, I also love what you said about the big box liquidations because many I have heard may lend themselves to more pickleball courts, which is going to take the place of those retailers. And given I just picked up that sport, I'm all about that development. Excellent. So Brandon, another question for you. We've heard a lot of news about downtowns being challenged in this post-COVID world and some of our legacy High Street districts are experiencing a high level of vacancy for the first time. Is this going to be a long-term problem, or do you see immediate solutions to this?

Brandon Isner:
I don't believe it's a long-term problem. When all this dust settles, these world cities are going to remain hubs of business and tourism and honestly, there's been a noticeable amount of luxury retailers that are investing heavily in their flagship stores along some of these most famous streets in the US and in Europe and the Asia-Pacific region. We recently did a focus report on Toronto where strong tourist activity from China is driving retail and restaurant sales within the Bloor-Yorkville district, which is their high street district. Additionally, a study of seated diners in restaurants within the U.S. found that some of our legacy primary markets, you know, New York, D.C., Philadelphia and Chicago, they're experiencing double-digit growth in seated diners, while some of the hot Sunbelt markets have cooled a bit. And another trend we've noticed is the idea of some of these legacy high street retail districts losing a bit of momentum to the emerging high street retail districts. And this can be due to several factors: more favorable rents in the emerging districts or perhaps the perception of crime in some of the legacy districts can make it a challenge to attract retailers. So many high-end retailers are seeking space in some of these emerging high street areas, which often have the advantage of other areas of new development, such as new multifamily hotel and office development.

Julie Whelan:
Very interesting. These emerging markets are certainly a topic of discussion. I can say I was just in downtown Boston over the weekend and one of the things that they've done in their legacy High Street district is close the street to traffic on Sundays in summer in order to drive more pedestrian foot traffic as a means to attract people, which I think was very interesting and creative. So thanks Amanda, Pol and Brandon for this discussion on retail and industrial. To draw back to Richard's comments in the beginning, he felt that longer-term tailwinds in industrial and retail could counterbalance any economic softness. And you have painted that picture for us nicely. So we have one final sector to cover and I would like to end by talking about this alternative asset that is a quiet but strong performer: data centers, with more dependence on digital infrastructure due to the acceleration of remote work, which we've talked about, mobile devices and apps, and even artificial intelligence that has been dominating the headlines. This is an asset where demand seems to have no limits. To discuss this, I will be joined by Gordon Dolven, [Data Center Research]. Welcome Gordon.

Gordon Dolven:
Thanks for having me, Julie.

Julie Whelan:
So Gordon, you just wrote an awesome global paper on data center performance globally. Talk to us a little bit about your findings.

Gordon Dolven:
Yeah, data centers have performed incredibly well thus far through the year, and they look to carry that momentum throughout the rest of 2023. There are a couple of different dynamics on both the supply and demand side that are impacting the strength in digital infrastructure and data centers. On the supply side, vacancy remains incredibly low across the globe. So we looked at North America, Europe, Latin America, and Asia-Pacific, and the reason that vacancy is low is because right now there are some power issues in terms of availability that are delaying the timeline for projects to be put onto the market, which would help out inventory and supply levels. Additionally there's a lack of leasing availability alluding to that vacancy rate being low. But the byproduct of that is that asking average pricing rates across the globe have increased on average 5%-15%, and in some markets it's up 30% year over year.

Gordon Dolven:
There is one bright spot on the supply side. Sydney, Australia, grew their inventory number 30% year over year. And this is because, um, large legacy players and markets in Asia Pacific and Singapore and Tokyo and Hong Kong have had some issues with land availability, land pricing and power constraints. On the demand side, Julie, there is still a robust amount of appetite from cloud service providers and technology companies that continue to absorb space wherever they can get it. And artificial intelligence, which has been around in the industry for five to 10 years has continued to gain momentum with new startups entering the foray this year, and we're looking to see how much space they do want to take down throughout the rest of the year.

Julie Whelan:
Wow, interesting. Data centers may rival industrial in terms of the asset that's in favor. So there have to be some challenges. What do you see as the biggest headwinds that data centers actually have to battle against right now?

Gordon Dolven:
Yeah, the biggest issue right now Julie, is availability. So large corporations, if they're going from on-premises to co-location, they're struggling to find a turnkey solution with one operator in one market. So we're seeing across the globe a lot of occupiers having to segment out their requirement to different operators, to different regions, to different markets in order to fulfill the demand that they're seeking. On the power side, we still have some transmission and distribution delays and issues, but there are some bright spots that I do want to highlight as well, given that these headwinds are something that we can do something about. So recent federal legislation provided $2.5 billion to modernize our electricity grid here in North America. And I'm really proud of the fact that in digital infrastructure we're leading the way in terms of low-carbon and renewable-energy initiatives. So whether this is nuclear, wind, solar or hydropower, we are at the forefront of trying to bring on new renewable and low-carbon energy solutions for the industry. And we look forward to monitoring that the rest of 2023.

Julie Whelan:
Absolutely. Well, thank you Gordon. You mentioned two topics that we haven't talked a lot about this session, but which remain top of mind for our industry, and that’s sustainable green power and artificial intelligence. We could have another hour-long conversation just about those two things. So thank you for your comments. So that concludes our trip around the world to discuss commercial real estate sectors as we embark on the last half of 2023. Thanks to my colleagues for their education and insight today. And thank you all for joining our call. While the end of 2023 will likely see a softening in the economy, it will also bring us closer to a period in 2024 where more clarity should emerge. 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. We also welcome you to visit our cbre.com Research and Insights page to learn more about the topics we discussed today. And be sure to listen in on next week's episode of The Weekly Take podcast. Richard will be doing a deeper dive on some of the topics that we discuss today. Wishing you all health and wellness. Have a wonderful day.