The changing face of real estate 

Despite recent challenges, there is cause for optimism in the real estate market, which presents potentially significant opportunities for investors. Moreover, secular trends, including technological advancements, demographic changes and housing needs, are driving compelling investment prospects in the real estate sector. 

Over time, real estate has demonstrated its ability to adapt to changes in consumer behavior driven by long-term secular trends such as technology and demographics. The shifting demand for different property types is one significant adaptation. While the pandemic caused occupants to re-evaluate what they want and need from office space, many other property types are experiencing secular tailwinds and benefiting from significant demand and strong rental value growth. The evolution of asset types within institutional real estate portfolios is another adaptation, with portfolios now including a much broader range of property types. Building design has also transformed, influenced by technological advancements.

The office sector is currently undergoing a transformation to meet the needs of the modern workforce. High-quality office spaces that provide a more comfortable working environment compared to working from home are becoming increasingly important. North America, particularly the US and Canada, has the highest concentration of AI companies and generates more AI-related jobs than any other region. This trend will lead to increasing demand for a new type of office space that is more efficient and caters to the needs of an evolving workforce in the digital age.

The real estate sector has faced challenges recently, including declining valuations and a decrease in demand for office properties. The decline in valuations is primarily attributed to aggressive monetary tightening and higher interest rates, which have increased borrowing costs and dampened transaction volumes. Limited transaction data has made it challenging to determine accurate market values for properties.

Mercer believes that the global economy is on track for a “soft landing”, supporting continued strong occupational fundamentals in most real estate sectors. Core funds are reaching a multi-year low in their net asset values, substantiating the potential for double-digit returns in 2025. However, macroeconomic indicators, such as interest rates and the lagged effect of private market valuations, are still expected to pose challenges, which is likely to subdue sentiment among real estate investors in the short term. 

Despite the challenges faced by the broader real estate sector, private core real estate stands out for its resilience, income potential, and attractive entry points. We believe that the current market conditions have the potential to present appealing opportunities for investors to enter the real estate market. Prospective investors should consider whether to wait for all data points to turn positive since the lag in reporting may mean that real-time recovery could easily be missed. Regardless of short-term noise and opportunity, it is important to focus on the medium-term and long-term benefits of a real estate allocation.

The real estate sector has recently experienced fluctuations in returns due to asset repricing. However, despite this volatility, the underlying fundamentals of the sector remain robust. There has been a notable resurgence in necessity-based retailing. High-conviction managers are showing a preference for the industrial and multifamily sectors, as they offer strong demand and a stable income stream. The industry is also being shaped by technological advancements and demographic shifts, leading to a growing focus on niche sector opportunities. 

While many funds currently see net redemptions, these can quickly turn to net inflows once data shows that appraisals accurately reflect the true market value. As most valuation data gets reported with one to two quarters’ delay, this means that investors should consider investing in real estate in the present time.