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Let’s Make a Deal

“Repricing” was the word of the day at the “Let’s Make a Deal” panel at the 2022 DLA Piper Global Real Estate Summit, as several accomplished dealmakers engaged in a lively and wide-ranging discussion about current events shaping the real estate marketplace today and in the future. 

Much of the discussion centered on the timely topics of interest rate changes and inflation.  This mirrored an overwhelming sentiment in DLA Piper’s 2022 State of the Market Survey that interest rate changes (76 percent of respondents) and inflation (84 percent) will impact the commercial real estate market over the next year, in line with their anticipated impact on the broader economy.

Panel chair Jonathan Pearce, Global Head of Leasing and Development at Ivanhoe Cambridge, kicked off the conversation by asking the panel how rising interest rates were impacting their thoughts on buying and selling real estate.  The panel acknowledged that rising interest rates were significantly impacting transactions in the pipeline, with repricing by buyers being the current norm for any transaction that had been awarded in the last 60 to 90 days.  Panelist Tal Peri, Head of US East Coast & Latam for Union Investment Real Estate, predicted off-market approaches for sellers seeking fast sales to a smaller pool of buyers.  Panelist Scott Goodman, Principal of Farpoint Development, was optimistic about opportunities, noting that “real estate is a good place to be in a recession.”

On the topic of inflation, all panelists agreed that inflation is inevitable, especially following an extended period of very low interest rates.  Panelist Doug Lyons, Managing Principal at Pearlmark, noted the stabilizing effect of sustained inflation.  He said he sees more discipline today than in prior cycles, but worries that the fast rate of inflation is not properly accounted for in expense growth projections.  Panelist Joe Gorin, head of US Real Estate Equity Acquisitions and Portfolio Management at Barings, reported cost increases ranging from 35 to 50 percent.  Pearce noted that appraisals are not keeping pace and are lagging behind real-time pricing.  The panelists all expect to see more aggressive cost overrun protections and adjusting expense growth protections to mitigate the inflationary impacts.

Development opportunities are being similarly and predictably impacted, but the panelists are finding opportunities to create value.  “There is still a ton of capital” willing to deploy in some of the hardest hit asset classes, like retail, hotel, and hospitality, noted Lyons.  Goodman predicted that people will be hungry for experiential retail, following more than two years of pandemic restrictions.  He drew comparisons to the Roaring Twenties that followed World War I and the 1918 flu pandemic.  Disciplined investors will be able to withstand the “re-pricing storm.” 

Looking at global issues, the panelists observed that Russia’s invasion of Ukraine has shifted investment policy worldwide.  Europe is in a recession, which is likely to deepen as gas shutoffs and disruptions to the global food supply chain continue.  Germany will particularly be affected, given its proximity to Ukraine and the impact of the war’s refugee crisis.  These conditions, they said, are leading to a shift in investment policies as investors seek the relative stability of the US. 

When asked how they are addressing environmental, social and governance (ESG) concerns, panelists described ways they are incorporating ESG principles in their projects. 

Goodman offered Farpoint’s development of Bronzeville Lakefront, in Chicago’s historic Bronzeville neighborhood, as a case study in how real estate development can strive to positively influence community health outcomes and address structural racism. The team working on the project, he said, is highly diverse, but even more importantly, Bronzeville Lakefront will be a center for health equity, anchored by healthcare and technology research and development workplaces.  Lyons noted the importance of embedding ESG principles in an organization’s decision-making and governance.  In addressing climate impacts, the panelists overall warned against so-called greenwashing and emphasized it is essential to ensure that reporting requirements are properly understood.  Peri and Gorin noted that the US lags behind Europe in implementing universally rigorous regulatory regimes addressing climate impacts.  The panelists also observed  that investors haven’t figured out weighted risk or uniform metrics, making it a challenge to evaluate and measure ESG impacts.   

Will there be a return to the office?

When asked what’s next for the workplace and collaboration, panelists agreed that in-person collaboration is important, but calibration and balance will be ongoing, at least for the time being.  Lyons noted the health and vitality of Chicago’s 24/7 live-work environment in Fulton Market.  Location and walkability, he said, are key.  Office environments in the STEM and life science fields must be in person, and some workers may migrate back to the office to avoid the fear of missing out.  This creates an exciting environment for value-add office investors that are creating truly differentiated products.  Conversely, Gorin cautioned that the suburban office marketplace is particularly at risk for properties which are not campus environments that drive inperson attendance. There is a risk of bifurcation between “haves” and “have nots” among office owners, he said.

What’s next?

Panelists expect a dynamic environment over the next 12 to 18 months.  Rising interest rates coupled with a pullback from senior lenders will provide opportunities for mezzanine debt or preferred equity investors.  On the equity side, there was consensus that many investors are still facing sustained pressure to deploy capital, notwithstanding interest rate and pricing volatility and the war in Ukraine. 

Gorin was optimistic that, following a short-term slowdown in transaction volume, sales pricing would stabilize, with the bid/ask spread eventually narrowing.  For investors, following markets and submarkets that attract highly educated skilled workers will be key. 

Goodman was equally sanguine that there were enough buyers in the marketplace to present opportunities to creative sellers.  Specialty asset classes like data centers may become more attractive over the next 12 months as interest rates and inflation present less of an issue.