M&A trends in real estate: 2023 mid-year update

The new monetary regime with the global increase in interest rates, led by institutions like the US Federal Reserve and the European Central Bank, has resulted in higher borrowing costs and global valuation pressures. At the same time, the way businesses operate and how people live, work, and play in a post-COVID-19 world has significantly changed. Although some of these trends were evident before the pandemic, others have accelerated, such as the growing demand for environmental and health benefits offered by green residential buildings, and the increasing expectations for environmental, social, and governance (ESG) standards in the corporate office sector. These shifts and new preferences are having a significant impact on commercial property, but are also creating M&A opportunities.

While funding markets remain constrained, investment resources for M&A continue to flow, with private capital and select public entities looking to accelerate their property investments to take advantage of the changing landscape. In the upcoming 6 to 12 months, we anticipate entities with significant capital like private equity firms, family offices, sovereign wealth funds, and other investors to be more present in the M&A market, drawn by lower valuations, distressed situations, and the new trends mentioned above. Casinos, wellness resorts, and sports entertainment facilities could be a focus of M&A attention.

Against a backdrop of significant global differences, certain regions are likely to witness more intense M&A activity, with increased capital investment in markets such as Australia, China, India, Japan, and the US. The Middle East, traditionally an outbound investor, faces stricter legislation for international investments, creating an avenue for more inbound investment. Overall, the real estate industry is addressing the ongoing challenges by taking a long-term approach and focusing on value creation to deliver sustainable results.

Key issues driving M&A activity in real estate

Office
Macroeconomic events and rising interest rates are causing double-digit vacancy rates in the global office subsector, making acquisitions, construction debt, and financing more challenging. However, this is creating M&A opportunities particularly in high-demand regions like certain Asian cities and prime locations with modern, high-quality buildings. Unlike the West, Asia has shown resilience in the office space sector, is leading in the return to office, and maintaining stable office valuations. In Europe, regulations necessitating energy-efficient buildings are increasing the demand for quality assets. Starting 2023 in the Netherlands and 2030 in the UK, office buildings must have an energy performance certificate (EPC) with a rating of C or above in line with the companies’ net zero goals, thereby increasing the demand for green technology-based, advanced office spaces.

Industrial
The industrial subsector is driven by the surge in online commercial activity and changes in supply chains. In the Americas, although demand in the US is decreasing, demand in Mexico is growing due to the shift of production operations closer to the end markets, driven by supply chain disruption concerns. Similarly, South America experiences a thriving M&A environment because of growing ecommerce and agribusiness. In Europe, the industrial sector’s deal market remains active because of healthy rental growth and interest in energy-neutral properties, rising construction costs, and stricter environmental regulations. The Middle East and Asia-Pacific regions continue to prosper due to the ecommerce boom, leading to high occupancy and rental growth.

Residential
The residential real estate sector continues to perform strongly with an active deals market. Globally, higher interest rates have driven the costs of homeownership, thereby increasing demand for rental properties. This, along with inflation and supply constraints, has pushed up rental prices and counteracts the rising cost of capital for investors. In the US, the residential sector provides investors with stability amidst economic uncertainty, despite shortages in affordable housing. Regulatory changes in Europe favour tenants, which might limit deal activity. Mexico and the Middle East, burgeoning as digital nomad hubs, see increased rental demand, with the Middle East benefiting from relaxed regulations for foreign investment. In Australia, investor interest in the manufactured housing and build-to-rent sectors is growing due to financial benefits and is emerging as an alternative investment asset class.

Retail
While retail in South America is slowly recovering from COVID-19 and global economic uncertainty, retail in North America, Asia-Pacific, and EMEA is expected to sustain its robust performance, though potentially at a slower pace due to higher interest rates and inflation. The trend of consumers returning to in-store shopping and spending more on services has maintained strong retail rent growth with minimal available retail space. High demand persists for prime locations as brands aim to expand their physical presence or innovate in line with shifting shopping behaviours. These behavioural shifts are also encouraging the transformation of shopping centres into mixed-use, experience-oriented properties, driving M&A activity through 2023. Consequently, margins are anticipated to improve as tenants and landlords collaborate on repositioning these properties for mutual benefit.

Hospitality
Despite macroeconomic uncertainty, M&A activity in the hospitality sector is projected to stay high, fuelled by increased leisure travel and recovering business travel. The pent-up travel demand is improving hotel occupancy rates, even though inflation-driven operational costs pose challenges. Regulatory actions like stringent fire safety rules in the UK might reduce the number of transactions. However, the hospitality sector is set for growth, with more M&A expected in 2023, supported by increased investment in the Middle East and Asia-Pacific, and a generally positive outlook for tourism.

And how about Switzerland?

The property market in Switzerland has shown resilience across the country despite rising interest rates, supported by high net immigration and increasing demand for residential property.

In principle, the cash in-flows of investment properties can be optimised through increases in rental income and reductions in vacancy rates. At the same time, the buyers’ willingness to pay is decreasing, which currently leads to slightly declining market values (this trend may be accelerating in the second half of 2023).

Fully leased investment properties in central locations are less price sensitive than investment properties with higher vacancy rates in peripheral areas. The rental income from commercial properties can be adjusted to the national consumer price index by means of indexation. With the increase in the reference interest rate for mortgages from 1.25% to 1.5% at the beginning of July 2023, current residential rents can be increased for the first time since the introduction of the reference interest rate in 2008.

Regulatory restrictions on pension institutions' real estate quotas, combined with lower share prices in 2022, have led to exits from real estate investments, falling share prices of real estate vehicles and real estate companies, and corresponding price declines.

The combination of reduced capital availability and higher borrowing costs is prompting institutional property investors to require higher portfolio yields. This is widening the gap between buyers' willingness to pay and sellers' expectations. Transaction activity is expected to slow further in the second half of 2023, and property prices could continue to decline. In particular, development properties and residential properties with renovation backlogs in the cantons of Geneva, Vaud and Basel-Stadt, where rent increases are regulated by the government, will become less attractive due to low initial yields.

2023 mid-year M&A outlook for real estate

Macroeconomic unpredictability and more regulatory hurdles will continue to impact the real estate sector in the near future. However, industry leaders who develop long-term strategies and focus on a well-thought-out value creation plan for consistent results will be able to manage these cyclical issues. Given the continued availability of capital for M&A, we expect that the demand for premium properties worldwide and emerging opportunities, especially in the Middle East and Asia-Pacific, will lead to a more dynamic deal activity in the coming months

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