As we look ahead to 2023 with COVID-19 hopefully in the rear view mirror for the most part, we are seeing a number of predictions about what is in store for 2023 and beyond. Rising interest rates, changing tenant demands, and the cooling industrial market are just a few of the factors that will influence how 2023 shakes out for commercial real estate. In summary, while there are considerable pressures affecting the commercial real estate market as this article is being written, the outlook for 2023 from most experts is generally positive with an easing of pressures expected in mid to late 2023.
Rising interest rates and high inflation
There has been some unease in the market in recent months in terms of interest rate hikes in rapid succession in the second half of 2022. Underwriting criteria have become more stringent and lenders and investors have become more cautious. It’s unclear how long the interest rate hike will affect the market, which has led to increased caution among all real estate players and some homeowners taking their businesses off the market and some buyers pulling out of deals and not being around. willing to take the risk. in moving on.
Related to the growing hybrid nature of the office workforce, digital economies and virtual connectivity are top of mind for all players in the commercial real estate industry.
A slowdown is expected for at least the first half of 2023 given the uncertainty in the market. Whether rates will stabilize, rise or fall is unclear, and economists and the Bank of Canada potentially have different views on what that looks like. Investors and owners are cautious in terms of how high inflation will impact their bottom lines, and many companies expect spending cuts and lower revenues due to slowing consumer demand and pressures from the administration. the workforce. That being said, experts generally predict that the current volatility in commercial real estate should level off by mid-2023. There is plenty of dry powder left waiting to be laid, which bodes well for more activity in mid-to-late January. 2023.
Changing tenant demands
One of the longer-term impacts of the COVID-19 pandemic has been a tenant push for more flexible office space, including common areas, the ability to “hotel” employees, and electronic and virtual connectivity. robust and versatile. The growing acceptance (and worker demand) of a “hybrid” arrangement presents unique challenges for homeowners, landlords, and retailers alike. The way buildings and office space are used is undergoing a major change. Tenants and owners, especially public company tenants and owners, are also increasingly focused on ESG considerations and related reporting to their shareholders.
These environmental and social governance issues are top of mind for owner/investors and tenant/occupiers alike (and increasingly lenders). Many landlords are requiring tenants to adhere to increasing and onerous sustainability requirements and associated reporting obligations. Industry players focus not only on sustainability and governance issues, but also on climate-related regulatory actions, especially foreign investors who are interested in investing in new jurisdictions. While most offices in major urban centers have remained largely empty for the past two years or more, we are beginning to see a return of the workforce to the office, at least part-time, with a greater presence at partner retailers when those workers are returning to the office.
Given rising interest rates and stricter underwriting by lenders, it is not surprising that there has been a slowdown in activity in the commercial real estate market in the second half of 2023. Difficult underwriting criteria have made it difficult for buyers to qualify for financing which is greatly hampering business volume. This has led to less competition for properties and, as noted above, some owners are taking their properties off the market until conditions are more favorable. Despite a more difficult financial environment, certain asset classes within the industry continue to be sought after. For example, while the industrial market has cooled off a bit in recent months, it is still a very viable and stable asset class, as are data centers, warehousing, warehousing and fulfillment centers, multi-family residences, as well as life science buildings or development opportunities.
Virtual connectivity, cybersecurity and PropTech
Related to the growing hybrid nature of the office workforce, digital economies and virtual connectivity are top of mind for all players in the commercial real estate industry. There is a huge demand for cloud computing and storage, which has increased interest and demand in data centers and related infrastructure. This also introduces important considerations related to data protection and confidentiality and cyber security. “PropTech” (also known as “property technology”) continues to be a key focus within the industry in terms of how to best leverage new and improved technology with the “bricks and mortar” of commercial real estate. Interest is expected to in proptech continue to be a strong trend in 2023.
- The long shadow of the pandemic in the agreements. In real estate contracts, we expect to continue to see force majeure exceptions for COVID-19 as it is now a known event, but with the expectation and focus on the fact that future pandemics or epidemics and associated government-mandated closures will constitute force majeure events (but will not lessen a tenant’s obligation to continue paying rent, for example). Expect the language of force majeure clauses and associated exclusions to be of particular note.
- Greater scrutiny in obtaining financing. Lenders will be rigorous in signing agreements, as well as associated legal documentation, given the tighter loan market.
- Budget priorities increase in development and construction. Inflationary pressures will drive both developers and owners to focus on costs (and cost reduction measures) with a greater degree of detail and specificity in development and construction contracts.
- Lease negotiations may continue to drag on. Tenants and landlords are likely to continue to dig deeper into issues of particular importance to them, as highlighted in this article, and tenants are likely to demand much greater flexibility in terms of flexible office space, floor plate accommodation, and shorter lease terms.
- ESG focus continues. Expect to see more and more detailed and onerous “ESG” and types of reporting clauses in contracts, particularly from public market players.
- Changing rules for foreign buyers. A legislative change that takes effect on January 1, 2023 may also have the effect of chilling certain parts of the commercial real estate market, such as multi-family residential, whose law and associated regulations were passed on December 2, 2022 related to the Residential Property Purchase Prohibition Act by Non-Canadians. Certain exemptions under the Act are available and the impact of this new legislation remains to be seen, but it is an important legal consideration when advising foreign buyers who are interested in acquiring a residential interest in Canadian real estate.
2023 is bound to be interesting and dynamic in the real estate industry. The rapid pace of change in this market requires great attunement with many important and sometimes subtle legal considerations. Particularly in the midst of today’s broad economic volatility, knowledgeable and experienced legal counsel and other advisors who have a pulse on ever-changing market dynamics that enable them to negotiate “market” terms will be more important than ever.