Hidden Gems - 3 Undervalued Commercial Real Estate Opportunities in 2023

As we move into the middle of the end of the third quarter, several real estate opportunities have emerged that investors, developers, and property owners should have on their radar. 

Although they have a less obvious upside than office-to-apartment conversion projects in New York City, these underexplored aspects of the contemporary U.S. marketplace transcend any single region, property type, or asset class and offer significant returns for development companies, investors, and occupiers.

Qualified Opportunity Zones Have Considerable Upside 

Created as a provision of the Tax Cuts and Jobs Act of 2017, Qualified Opportunity Zones (QOZs) are primarily economically disadvantaged areas that offer significant financial incentives for real estate developers and investors. But many strings are attached to the benefits the program provides. 

Federal and state policymakers have designated more than 8,700 QOZs across the United States based on regional poverty levels and household income. Land improvements, construction, and renovations in certified areas must be paid for by Qualified Opportunity Funds (QOFs), entities dedicated to improving the quality of life in a QOZ via real estate development. In practical terms, that means businesses and apartments that bring residents new jobs and appealing living spaces.

The IRS and Treasury Department have stipulated that QOF projects must double their basis, excluding land value, within 30 months. 

If the government standards are met, QOZ projects provide two remarkable benefits. One, stakeholders can defer federal taxes on capital gains from qualified projects until the property’s sale or 2028, whichever comes first. Stakeholders are also entitled to a 10% tax exemption on assets held for a minimum of five years, which increases to 15% in year seven and 100% in year ten. Chicago’s Cresset Partners has utilized the program to secure $3 billion in capital for active and completed projects in Seattle, Houston, Portland, Austin, and Nashville.   

Although the program isn’t new, investments in Qualified Opportunity Zones exceeded $10 billion in 2022. As a result, the program blew past its fundraising goal of $100 billion, four years ahead of schedule. 

Because of the dynamics involved, QOZ projects require significant risk tolerance, especially in a down cycle, but developers shouldn’t ignore federal development stimulus incentives like this. Diligent and well-informed teams can use the QOZ program to turn real estate opportunities into reputation-defining successes. 

Multifamily is The Most Durable Real Estate Asset Class

Although the market has experienced significant volatility in recent years, multifamily is one of the most consistently valuable asset classes. While certain property types are susceptible to major changes in demand due to shifts in consumer preferences, people will always need good places to live. For that reason, developers should prioritize its robust fundamentals over overvalued flash-in-the-pan opportunities that could leave them financially underwater. 

The Federal Reserve increased the key rate seven times in 2022 to clamp down on soaring inflation. The monetary policy changes destabilized cap rates across the board, generating negative leverage that affected 30% of all commercial mortgage-backed security loans (CMBS). Shopping mall and warehouse owners and stakeholders felt the pain most acutely as analysts predict demand for online retail and interest in remote work will make them less valuable over time. 

Multifamily also took significant damage last year, with property prices sliding 14%, but it has a much better long-term outlook than other asset classes. Hungry young professionals moving to metros like Detroit, San Antonio, and Chicago for good jobs and cultural experiences keep rents high and occupancies low. 

Another indicator that apartments will not only rebound but grow is the financial challenge of becoming a homeowner in 2023. 

Ed Chazen, a real estate professional for more than 40 years and senior lecturer at Boston College, Carroll School of Management, believes affordability will be a secular driver for multifamily. 

“In 2012, the median price to buy a house in the U.S. was $251,700. By 2022, it was $467,700. So housing prices [have grown] at 6.4% per year for ten years,” said Chazen. “I also looked at the necessary household income to support the purchase of a house. Because a customary ratio is a median price divided by a median income, that's a measure of affordability. In 2012, the median household income was $51,371, and 10 years later, it was $70,784.” That's a compound growth of 3.2%. House prices grew at 6.4% a year, twice the rate of the growth in household incomes. 

“We have a problem where purchasing a home is more and more out of reach for households, particularly for young families forming a household and looking to move to the suburbs and get their kids into good quality school districts. That's one factor supporting continuing demand for apartments, particularly larger units with two and three bedrooms.”

The bottom line is that apartments aren’t going the way of the classic ‘90s food courts or sprawling cubicle-filled workplaces. The career ambitions of young workers and the yearning to settle down among young families will revive multifamily pricing sooner rather than later and support its growth for generations to come. 

Data Centers Are the Secret Foundation of Modern Life

Data centers are also an undervalued investment and development option in 2023 because they quietly support nearly every aspect of modern life.  

The facilities housing large and complex computer systems that serve as the foundation of the internet by securely processing, storing, and transmitting vast quantities of data have evolved into huge, cutting-edge properties over time. As they serve as infrastructure for everything digital, they play an essential role in the function of businesses, governments, and institutions. They come equipped with strict temperature controls, fire suppression systems, and multiple backup power generators. 

The role of data centers in modern life is only growing as organizations shift their operations online. Advancements in artificial intelligence and the expansion of high-speed digital communications networks enable people to turn to time-intensive manual tasks like financial modeling, genetic research, stock trading, and retail security to sophisticated automated platforms.   

In addition, the rise of streaming video, music, and gaming services like Netflix, Steam, and Spotify has upended how the public enjoys entertainment. Just as Amazon revolutionized shopping, these services allow consumers to pursue their hobbies and interests on demand from the comfort of their homes. 

As the world further embraces digitalization, the need for data centers with the capacity and throughput to support professional and personal online activity will only increase. According to a report by Allied Market Research, the global data center market will be worth $517.17 billion by 2030, with an estimated compound annual growth rate of 10.5% until the end of the decade. By contrast, the organization pegged the sector’s value at $187.35 billion in 2020, meaning pandemic-driven demand for online services massively increased the need for hyperscale data centers.  

With that said, there are two big obstacles to the property type’s growth; power and land. 

Hyperscale data centers - the kind IBM, Google, and Apple use - have massive footprints and electricity demands. Due to space and resource constraints in many major markets, smaller metros like Salt Lake City, Columbus, and Reno are catching the attention of investors and operators. 

Until recently, data center demand has been a niche driver for commercial real estate as it only makes up only 1.3% of the market. But that classification is becoming increasingly obsolete in the always-on, always-connected landscape of 2023. Developers that can tackle the unique infrastructural, legal, and municipal challenges associated with their expansion have an opportunity to help usher in the future. 

Want to know more about the trends that will define the industry this year? Watch our webinar, How Technology and Real Estate Intersect in 2023, for insights you won’t find anywhere else.