R E A L E S TAT E
O U T LO O K
J U LY 20 24

Facingthe Music:
Challenges andOpportunities inToday’s Commercial
Real Estate Market

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RE AL ESTATE OUTLOOK • JULY 2024

3

W R I T T E N B Y:
John MurrayManaging Director
Global Private Real Estate

SUMMARY•

The headwinds buffeting the commercial real estate market will
likely result in a materially slower recovery than that seen after the
global financial crisis.

•

Nonetheless, the market is entering a phase with numerous
opportunities for those with capital, patience, agility, and expertiseto provide financing solutions to both lenders and borrowers.

•

From a sector perspective, we believe investors should focus onhigh conviction themes, including digitalization, decarbonization,and demographic shifts, targeting sectors such as data centersand logistics.

François TrauschCEO and CIO
PIMCO Prime Real Estate

For commercial real estate (CRE) borrowers and lenders, central banks have been a persistentsource of frustration in recent years. Aiming to rein in stubborn inflation, the Federal Reserveand most of its peers have maintained elevated interest rates longer than anticipated. That’s
their mandate, of course. But the consequences have been immediate pain for CRE borrowers
facing higher debt costs, along with a duller discomfort from falling valuations due to reduced
liquidity and higher capitalization rates.
Today, short-term interest rates appear to have peaked, and long-term interest rates are
slowly trending lower. One might – but should not – see these trends as leading to a dramatic
recovery of the sort induced by quantitative easing in the aftermath of the global financial
crisis. Prevailing market assumptions, with a forward curve indicating real rates 200–300
basis points (bps) above 2021 levels, suggest that cap rates will remain elevated, keeping
property values 20%–40% below their 2021 highs.
As a $1.5 trillion wall of loan maturities hits over the next two years,1 the implications areprofound. In an elevated interest rate environment, borrowing costs and cap rates will remainchallenging. Lenders and borrowers will be forced to “face the music”: In the near term, we
expect further declines in appraised valuations and price indices, making loan extensions evenmore difficult to rationalize.
There’s also geopolitical risk. Conflicts in Ukraine and the Middle East, tensions between
the U.S. and China, and major elections this year give rise to additional uncertainty. Thisis compounded by growing concerns over climate change that directly affect real estate
investment and development.
While these uncertainties will prolong liquidity pressures, they also create opportunities acrossthe financing spectrum. For those with capital and proficiency in customized solutions, private
opportunities range from senior debt to mezzanine debt and preferred equity. Continued
volatility may also create relative value opportunities across the four quadrants of real estate
investment: public and private equity, and public and private debt. Additionally, some sectors
and geographies remain attractive based on long-term fundamentals, implying an attractive
entry point today given the liquidity pressures facing CRE broadly (see Figure 1).

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RE AL ESTATE OUTLOOK • JULY 2024

Figure 1: Global real estate heat map – 2024 vs. 2023 outlook by sector and region

Outlook

May
2024

May
2024

May
2023

May
2023

 Trends in leisure and corporategroup travel improving

May
2024

May
2023
May
2024
May
2023
May
2024

 Strong fundamentals

 Niche sector

 Stable rental growth Price discovery

 Uncertain demand Challenged capital markets

 Price discovery ongoingModerate

May
2024

May
2023

 Bifurcation continues

May
2023

May
2023

Good

 Limited investor appetite

May
2024

 Deeply discounted

 Leasing stabilizing

May
2023

 History of tenant restructurings

May
2024

 Resilient leasing demand

May
2023

 Business travel sluggish

May
2024

 Limited supply

Excellent Rental growth normalizing

 Tourism rebound, undersupply

May
2023

May
2024

May
2023

May
2024

May
2023

 Sun Belt oversupply Yields stabilizing

May
2023

 Niche sector

 Limited power supply

May
2024

 Modest rental growth

May
2024

 Moderate oversupply

 AI and cloud demand

May
2023

May
2023

 Strong lease mark-to-market
supports cash flow

May
2023

overbuilding concerns

May
2024

 Power, ESG, and

May
2024

 AI and cloud demand

May
2024

OutlookMay
2024

Outlook

May
2023

May
2024
May
2023
May
2024
May
2023
May
2024

Asia-Pacific (ex China)

May
2024

May
2023

Europe Affordability advantage vs.
home ownership

May
2023

OfficeRetailLodging

Living(multifamily)

Living(student housing)

Logistics

Data centers

SectorU.S.

 AI and cloud demand Policy and operational risks
 Persistent demand Yield expansion, oversupply

 Strong leasing, undersupply Competition, scalability

 Strong leasing, yield spread Potential yield expansion
 Tourism rebounding Capacity constraints
 Pent-up leasing demand

 E-commerce,

weak sentiment Improving office reentry

 Yield expansion, oversupply,
weak sentiment

Moderately Poor

Poor

Note: Nuances of cyclical opportunities and key risks vary by region.
Source: PIMCO Global Real Estate Forums 2023 and 2024

These takeaways were gathered from PIMCO’s second annual Global Real Estate Investment Forum, held in May. Similar to
PIMCO’s Cyclical and Secular Forums, this event convened global investment professionals to discuss the near- and longterm outlook for commercial real estate. PIMCO has one of the world’s largest CRE platforms, with over 300 investment
professionals managing close to $190 billion in assets across a broad spectrum of risk profiles in public and private global realestate debt and equity markets.2

RE AL ESTATE OUTLOOK • JULY 2024

5

Key sectors
DATA CENTERS: A RACE FOR POWER IN THE AGE OF AI

Data centers will play a pivotal role in investor portfolios in the
coming years. They are critical infrastructure, offering investors

The AI boom has set off a global dash for data centers andgreen energy to power them, and it also has introduced broadrisks to CRE. Over the long term, AI could reduce the need fora way to capitalize on AI growth as suppliers to AI platforms
without having to bet on the ultimate winners in AI technology.

office space, decrease demand for student housing, lower
urban population density, and make long-term leases andData centers offer investors a way
to capitalize on AI growth without
having to bet on the ultimate
winners in AI technology.

secondary locations less attractive. However, the pace andscale of repercussions remain unclear. (See our June 2024
article, “Powering the Future: The Strategic Role of Data
Centres in the AI Evolution in Europe”.)
What is clear is that demand for AI and cloud services has
ignited a global scramble for data center capacity. In the firstquarter of 2024, global leasing volumes surpassed 1,800
megawatts, a sevenfold increase from just three years ago.

3

Growth shows no signs of slowing, with tenants contracting
for entire campuses rather than individual buildings. This is
amplified by governments’ quest for digital sovereignty –LOGISTICS AND WAREHOUSES: SECULAR DEMANDSUSTAINS LONG-TERM GROWTH
We anticipate that deglobalization and e-commerce willcontinue to drive sustained long-term growth in warehouses
and logistics. Though geopolitics will influence demand,

the ability to control critical data, software, and hardware.
Conversely, limited supplies of power are becoming a growing
constraint on data center development across the globe.

logistics facilities linked to digitalization trends, such as
e-commerce, appear to have a more reliable demand trajectory(see Figure 2).

Figure 2: Online commerce continues to grow
Online sales as a percentage of total retail sales 2021  2026 (forecast)

50%

40%

30%

20%

Source: Green Street and CBRE as of April 2024

U.S.

World

U.K.

Asia-PacificJapan

Australia

China

0%

South Korea

10%

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RE AL ESTATE OUTLOOK • JULY 2024

In the U.S., the near-term outlook is slightly less positive. The

Deglobalization and e-commerce
will continue to drive sustained
long-term growth in warehouses
and logistics.

multifamily sector overall is experiencing record new supply,with apartment completions reaching a 40-year high of
583,000 units last year.6 This surge has led to rising vacancies
and, coupled with widening cap rates, has resulted in market
values dropping by more than 25%–30%. While long-term
tenant demand fundamentals remain strong for multifamily

In Europe, demand is slowing but rents continue to increase.
Logistics, once again, tops many investors’ shopping lists, andmay provide a floor to today’s widened capitalization rates.
In the Asia-Pacific region, online sales are projected to growfrom about 20% of total sales in 2021 to nearly 40% by 2026.4
Further, deglobalization continues to drive nearshoringand “friendshoring” trends. Vietnam and India will gain ascompanies shift production from China, while reshoring could
benefit Japan and South Korea.
In the U.S., industrial demand remains positive, although net– particularly as higher rates exacerbate already challengedaffordability metrics – these short-term pressures suggest
more distress in the near term for the U.S. multifamily sector.
Overall, the U.S. market is likely to stabilize by 2026.
Construction starts have fallen due to higher costs and tighter
financing. The Sun Belt, spanning the southern tier of U.S.
states, shines as a key area of growth. The region is home tohalf of the country’s population, and its incoming domestic andinternational migration is projected to drive the vast majorityof the increase in the U.S. population from 335 million today to
373 million by 2054.7

absorption has slowed over the last six months, with the firstquarter of 2024 being the weakest first quarter since 2012.5
New deliveries have peaked, although some lower-barrier Sun
Belt markets are digesting a supply wave that could lead toa prolonged period of higher availability, particularly amonglarger industrial properties; in recent years, developers have

The global outlook for apartmentbuildings is generally positive amid
strong structural demand.

focused on projects over 100,000 square feet.

MULTIFAMILY HOUSING: STRONG DEMAND, BUT
RECOVERY DELAYED IN THE U.S.

OFFICES: FACING HEADWINDS, BUT NOT EVERYWHERE

The global outlook for apartment buildings is generally positive

The global outlook for offices remains challenging. Demandamid strong structural demand.

and price discovery are limited worldwide, with valuations

In Europe, rents are rising steadily with no signs of abating.
Limited supply, exacerbated by high development costs andstricter environmental regulations, is meeting firming demandas household formation accelerates and migration to major
metropolitan regions continues.
In the Asia-Pacific region, prices and rents are firming amid
moderate undersupply. Soaring home prices and urban migration
by younger individuals are driving demand. Demographic shifts,
such as delayed family formation and the rise of single-personhouseholds, are reinforcing the trend of renting for longer
periods. In addition, the evolving emphasis on community living
and access to amenities has boosted the growth of thematic
residential and co-living spaces across the region.

still under pressure as global CRE owners and lenders look
to reduce office allocations. The share of offices in global
institutional CRE portfolios has fallen from 35% in 2022 to 29%
today,8 with further declines likely.
However, regional outlooks vary. In Europe, there is relatively
healthy demand for green, high quality buildings in prime
central business districts. The work-from-home trend is lessentrenched in many parts of Europe, partly because workers
tend to live in smaller homes in city centers and have better
public transportation. Tenants tend to be stickier because of
the Continent’s linguistic, currency, and regulatory diversity,
which complicates corporate relocations. Importantly, energy
regulations will likely dramatically reduce existing supply,as many office buildings will struggle to meet increasingly
stringent rating requirements in Europe.

RE AL ESTATE OUTLOOK • JULY 2024

7

In the Asia-Pacific region, demand for offices in central

Figure 3). In the U.S., corporate cost-cutting and a stronger

business districts remains broadly near 2021 levels. This iswork-from-home trend have led to office demand lagging

due to generally smaller apartments, shorter commutes, andbehind job creation. Here, we expect prices and rents outside ofa more persistent ”work-at-the-office” culture than in the West.

class A+ buildings to continue falling as private capital remains

As in Europe, demand is strongest in central business districts,

cautious and headline cap rates continue to expand.

especially for buildings with “live, work, play” amenities (seeFigure 3: The U.S. leads in working from home
Number of days working from home per week
3.5
3.0
2.5
2.0
1.5
1.0
0.5

U.S.

CanadaU.K.

The Netherlands

Germany

Switzerland

FranceBelgium

Australia

ThailandSingapore

Japan

South Korea

India

China

0.0

Source: Green Street and JLL as of 3Q 2023

TAKEAWAYS: SEIZING OPPORTUNITIES AMID CHALLENGES
The commercial real estate market stands at a crossroads, beset by formidable challenges yet brimming with
opportunities. Elevated interest rates, geopolitical tensions, and climate change concerns have created a complex andoften dismaying landscape for CRE borrowers and lenders.
Yet these very pressures also set the stage for innovative financing solutions and strategic investments. For thoseequipped with capital and expertise, today’s environment offers fertile ground for opportunities across the financing
spectrum, from senior debt to mezzanine debt and preferred equity. Sectors such as data centers and logistics, buoyed byenduring trends in digitalization and e-commerce, present particularly enticing prospects.
Navigating this turbulent terrain will require resilience and adaptability. The ability to discern and exploit hidden opportunities
amid market volatility will be essential. By homing in on high conviction themes such as digitalization, decarbonization, anddemographic shifts, and leveraging PIMCO’s extensive expertise and global platform, investors have the potential to not only
weather the current storm but also thrive in the evolving commercial real estate landscape. The road ahead is fraught withuncertainties, but it is also rich with potential for those ready to face the music and seize the moment.
1 Source: CBRE as of May 2024
2 Source: PIMCO as of 31 March 2024. Includes assets managed by Prime Real
Estate (formerly Allianz Real Estate), an affiliate and wholly owned subsidiary of
PIMCO and PIMCO Europe GmbH, that includes PIMCO Prime Real Estate GmbH,PIMCO Prime Real Estate LLC and their subsidiaries and affiliates. PIMCO Prime
Real Estate LLC investment professionals provide investment management
and other services as dual personnel through Pacific Investment Management
Company LLC. PIMCO Prime Real Estate GmbH operates separately from PIMCO.

3
4
5
6
7
8

Source: datacenterHawk as of 31 March 2024
Source: Green Street and CBRE as of April 2024
Source: Green Street as of April 2024
Source: CoStar as of 17 March 2024
Source: U.S. Congressional Budget Office
Source: Pension Real Estate Association Investment Intentions Survey,
2022 and 2024

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PC616_4649795

CMR2024-0711-3709057

All investments contain risk and may lose value. Investments in residential/commercial mortgage loans and commercial real estate debt are subject to risks that include
prepayment, delinquency, foreclosure, risks of loss, servicing risks and adverse regulatory developments, which risks may be heightened in the case of nonperforming loans. The
value of real estate and portfolios that invest in real estate may fluctuate due to: losses from casualty or condemnation, changes in local and general economic conditions, supply
and demand, interest rates, property tax rates, regulatory limitations on rents, zoning laws, and operating expenses. Investments in mortgage and asset-backed securities arehighly complex instruments that may be sensitive to changes in interest rates and subject to early repayment risk. Structured products such as collateralized debt obligations
are also highly complex instruments, typically involving a high degree of risk; use of these instruments may involve derivative instruments that could lose more than the principal
amount invested. Private credit involves an investment in non-publicly traded securities which may be subject to illiquidity risk. Portfolios that invest in private credit may beleveraged and may engage in speculative investment practices that increase the risk of investment loss.
There can be no assurance that the trends mentioned will continue. Statements concerning financial market trends are based on current market conditions, which will fluctuate.
There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability toinvest long-term, especially during periods of downturn in the market.
This material contains the current opinions and views of the manager and such opinions are subject to change without notice. No representation is made or assurance given thatsuch views are correct. This material is distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular
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