New CRE Asset Classes Steal the Spotlight in 2023

Commercial real estate investors have been making the safe bet for the last two years. With widespread uncertainty, capital has favored stable investments in high-profile asset classes with strong fundamentals. Industrial and multifamily properties have overwhelmingly ranked the highest for transaction volume in Q3 202. By contrast, more unstable property types like office, retail, and hotels - all of which saw a deterioration in demand during the pandemic - have experienced waning investor interest. 

The new year is on track to upend this trend. 

Investors are increasingly looking to take advantage of surfacing distressed market opportunities and pursuing assets with a more attractive risk-return profile. The strategy is particularly appealing in an environment with rising interest rates because investors are seeking property types with high cap rates. Experts have crowned offices, data centers, senior housing, and mid-and-upscale hotels as the best investment opportunities in 2023. 

Office

The office market has arguably had the toughest recovery following the pandemic. Less than half of employees have returned to the office since work-from-home policies were enacted in 2020. U.S. office occupancy has contracted by nearly 25 million square feet this year, and office owners have lost some $500 billion in value. Moreover, the pandemic catalyzed a permanent change in office usage, with hybrid work becoming a new standard across industries. 

It’s been a stormy season for the sector - but opportunity is on the horizon. 

In Deloitte’s 2023 Commercial Real Estate Outlook survey, investors expect downtown office buildings to deliver the most attractive risk-adjusted return profile next year. The combination of widespread vaccinations and the return-to-work trend gaining momentum has created a favorable dynamic for the segment. Analysts expect investors to put money into suburban and downtown office properties over the next 12 to 18 months.

The best opportunity is redeveloping dated and obsolete office assets into properties that meet hybrid worker preferences. The most sought-after changes include buildings with spaces for collaboration and socialization, health and wellbeing amenities, and future-ready technologies that provide fluid movement from home to office. Smart development software can help to augment returns on these projects. Modern platforms use predictive analytics and machine learning to improve budget and schedule management and reduce cost overruns.   

Data Centers

Data centers have been a surprise darling in commercial real estate. Increased data consumption and demand for cloud storage have boosted demand for data center space globally. In the real world, physical properties containing massive server clusters are the actual “cloud” that houses your data. 

Next year, investors should retain a healthy appetite for the asset class. 

In Deloitte’s survey, investors ranked digital economy properties, including data centers and cell towers, as the second choice for attractive returns next year. The acceleration of information technology adoption is driving market interest in the space. In 2023, worldwide IT spending is expected to increase by 5.1%; software spending with cloud options is predicted to grow by 11.3%. Gartner reported in a recent survey that CIOs had been instructed to accelerate digital technology adoption next year.

Senior Housing

Like office space, senior housing was a casualty of the pandemic. COVID-19 superspreader events originated in senior care centers in the early days of the global health crisis, derailing occupancy growth and reducing rental rates in the sector. Senior housing has rebounded after the widespread distribution of vaccines and booster shots. Occupancy levels for the property type exceeded 80%, and price-per-bed rose 22% annually in the second quarter of 2022. Investors have shown renewed interest in the asset class this year, driving a 61% increase in investment volumes. 

Senior housing has a long runway of growth ahead. Experts predict elders will represent 21.6% of the U.S. population by 2040, up from 16% in 2019. PwC and the Urban Land Institute forecast senior housing will become more attractive than other property types due to the demographic shift. Investors surveyed by Deloitte rank senior care in the top five asset classes to deliver superior risk-adjusted returns next year. 

Mid and Upscale Hotels

Travel is officially back. U.S. hotel occupancy levels this year reached 72%, and average daily room rates grew to $157, the third highest on record. Although the industry has yet to see demand match pre-pandemic numbers, 66% of Americans feel safe flying and staying in a hotel, which will drive the segment’s recovery. As demand returns to the travel and lodging market, hotels are positioned as one of the best investment options in 2023. 

While the overall hotel market has improved, mid and upscale hotels offer the best opportunity for investors looking to realize above-average returns. 

PwC believes investor interest in upscale hotels will lead the pack in terms of temporary lodgings next year. Luxury and midscale hotels also have improving investment prospects, driven by the resurgence in travel. However, investment enthusiasm for economy hotels is expected to deteriorate somewhat in 2023. 

Expectations for Multifamily and Industrial  

For the last two years, multifamily and industrial properties have dominated the commercial real estate investment market. Over the last 12 months, multifamily investment totaled an incredible $381 billion, an annual increase of 54.2%. Industrial property transactions reached $180 billion in deal activity in the same period, growing 31% year-over-year. But in surprising change, investors have cooled on the formerly red-hot asset classes. 

However, investment activity in both multifamily and industrial waned in the third quarter, with transaction volumes falling 18.9% and 23.6%, respectively. The downturn in interest is mainly due to weakening return profiles. Rising interest rates have suppressed cap rates, making those property types less appealing to investors. 

Reduced investor enthusiasm for multifamily and industrial will likely carry into 2023. Financiers will seek alternative asset classes with attractive return potential. Of course, increasing interest in niche assets will not derail these two powerhouse property types. The strong fundamentals of both segments will make them top investment opportunities again in 2023.  

Investors are in the middle of strategically repositioning acquisition plans to pursue emerging market opportunities. In 2023, it is back to basics. Leading market analysts agree these four properties are poised to offer the greatest potential for the highest returns. 

Want more insights into the 2023 real estate marketplace? Download our 4 Recession-Proof Asset Classes whitepaper to find out which segments perform the best amid economic uncertainty.